| Jan. 10, 2019
FAQs on the Markets and Economy
What is City National Rochdale’s investment outlook for 2019?
Although it can be difficult to remain calm in the midst of market action like we’ve seen over the past couple of months, our advice is to stay disciplined and invested. Given our positive assessment of the fundamental backdrop, we remain bullish on equities in general for 2019 and continue to see attractive prospects in the opportunistic fixed income class.
Still, patience and discipline will be more important than ever. The investment landscape has grown more challenging as investors adjust to more typical late-stage conditions of higher inflation, rising interest rates and less accommodative monetary policy.
Meanwhile, concerns over slowing global growth, trade tensions, and other geopolitical risks mean that markets likely will continue to be subject to periodic swings in sentiment and potential pullbacks. Both our equity and fixed income research teams have made deliberate risk mitigating portfolio changes over the past year with the recent type of volatility in mind.
These decisions have helped fortify client portfolios to weather the turbulence we are experiencing, while leaving them well positioned to take advantage of opportunities ahead should they present themselves.
What is City National Rochdale’s outlook for the Fed’s monetary policy in 2019?
We expect the Fed to raise rates two times, for a total of 50 bps. This will bring the median federal funds level to 2.875%.
With the volatility of the stock market, the tightening of financial conditions, and inflation contained, the Fed may wait until June before hiking interest rates.
We believe the Fed will continue with its scheduled plan to reduce the size of its balance sheet, the reversing of quantitative easing. So far, it does not seem to have affected the yield curve.
We are looking forward to the increased transparency from the Fed. Starting with its upcoming January 30 meeting, the Fed will have a press conference following each FOMC meeting.
What is happening to the European economy?
In general, it is standing on weak footing and faces many uncertainties in 2019. Europe’s economic growth is anemic compared to the U.S. (chart). It is very sensitive to global growth and with the slowdown in global trade, economic growth is well below potential. This has helped to keep inflation at bay (CPI at just 1.6% and has averaged just 0.8% for the past five years), which is a problem for the ECB as it is reducing stimulus.
Although fiscal policy will likely stay slightly supportive this year or so, monetary stimulus is in its final innings (the Fed has already stopped QE). Brexit continues to be an important area of concern for Europe and the United Kingdom. The continued uncertainty of how it will be handled has kept investment down, helping to slow future economic growth.
There are some country-specific problems. Germany posted a negative Q3 GDP report. Although it is expected to bounce back in Q4, it just shows how low economic growth has been for the largest economy in Europe. Also, Italy continues to have a weak banking system and budget fights with the EC’s governing body.
A recession is not expected in Europe, but economic growth is expected to stay well below potential.
Why have longer-term yields fallen so much?
The yield on the benchmark 10-year note hit a recent high of 3.24% back in early November and fell to 2.69% at year-end and has since fallen a little further to 2.66% as of this writing (chart).
There are a number of reasons for this move; here are some of the more important ones: oil prices have plummeted (down 37% from October high of $76/barrel) which has helped to bring down inflationary fears and is also viewed as a leading indicator of weaker global economic growth, uncertainty of the forward direction of the economy, slower economic growth in China (the world’s second-largest economy), and increased buying in an asset allocation move away from the volatile stock market.
Interestingly, the drop in bond yields has improved financial conditions. The Goldman Sachs Financial Conditions Index, probably the best known of the various financial conditions indexes, attributes a 45% weighting to longer-term yields, so this movement has helped reverse the direction of this index.
The labor report breathed some fresh air into the stock market, how strong was the report?
It was very strong. The December nonfarm payrolls jumped 312,000, which is about 100,000 more than the five-year average monthly gain. Furthermore, the two previous months were revised up by 58,000.
Despite more than nine years of economic expansion, the pace of hiring continues to improve. The 12-month average gain is 216,000, up from a recent low of 176,000 in October 2017 (chart).
Wages increased and now stand at 3.2% y-o-y, the highest level in nine years.
The unemployment rate did increase to 3.9%, from 3.7%, but for good reasons, as the participation rate increased by 0.2pp to 63.1%. This is calculated from a separate survey.
Will the bull market continue in 2019?
Based on positive economic growth, earnings, and valuation factors, we continue to believe the long-running bull market remains intact. While the recent declines in stock prices have been severe, it is important to remember that market corrections are also normal.
Equity markets appear to have found their footing in the first two weeks of the new year, with more dovish signals from the Fed and a resumption of trade negotiations with China.
However, we think it is too early to declare the correction over, and we suspect the repricing process may last several months until we get more clarity on these issues.
Another important development investors will closely be watching for is any change in the earnings outlook. With EPS season around the corner, though reported results should be fine, guidance for 2019 is likely to be conservative.
The silver lining in the recent market pullback is that valuations have become much more attractive. We believe the fundamental investment backdrop today is more favorable than short-term moves and headlines might suggest. It may take time, but we believe investors will eventually reconnect to the still positive outlook, and stock prices will begin climbing higher.
