| Jul. 16, 2018
FAQs on the Markets and Economy
Is City National Rochdale’s investment outlook still positive?
Based on our outlook for solid economic growth and improving corporate earnings, we remain bullish on equities in general and continue to see attractive prospects in the opportunistic fixed income class. Bear markets outside recessions are rare.
Still, we believe investors should prepare for more moderate returns in the months ahead and perhaps greater volatility. Patience and discipline will be more important than ever.
The investment landscape is growing more challenging as investors adjust to more typical late-stage expansion conditions of higher inflation, rising interest rates and less accommodative monetary policy. Meanwhile, rising trade tensions and other geopolitical risks mean markets will likely continue to be subject to periodic swings in sentiment and potential pullbacks.
This does not mean there are not more worthwhile gains ahead for investors, but it does highlight the value of active management and the need for investors to become more selective.
We actively manage portfolios to be aware of where we are in the cycle, to take advantage of opportunities as they arise and to be on alert if conditions deteriorate.
Are Dividend and Income equities still attractive?
Yes, we believe the strategy remains attractive as it moves past the earlier weakness resulting from outsized expectations and reactions to higher rates. While we continue to monitor the path and prospects for rates, over the long term, there is significant data demonstrating that there is not a strong correlation between high dividend stock returns and the direction of interest rates.
Rather, interest rates are just one of many factors impacting long-term performance, and dividend stocks can do well over the course of a rising rate environment, provided that the economy improves and earnings are growing. Meanwhile, our focus remains on identifying undervalued, high-quality companies with solid prospects for dividend growth under most conceivable economic environments. We are pleased to have seen the average dividend in the portfolio increase +9% in the last 12 months and +7.7% halfway through 2018.
Going forward, we continue to feel that our modest return expectation of 6-8% over the next 12 months, driven by dividend yield and yield growth, is realistic.
How concerned should investors be about rising trade tensions?
Going only by what has actually been implemented, rather than merely threatened, we believe that the fallout for economic growth and corporate profits will be relatively manageable. Should tensions continue to escalate and further actions be put into place, the impact will become increasingly significant.
Unfortunately, the current situation is both complex and fluid, making it difficult to confidently predict an eventual resolution. Moreover, the history of trade actions like we are now experiencing is rife with unintended consequences.
Our asset allocation and investment strategies are positioned to take this uncertainty into account. We are overweight U.S. equity markets and underweight international equity markets, which we believe will be more affected by rising trade disruptions. Likewise, our domestic equity strategy has little exposure to the sectors most likely to be impacted, such as autos and semiconductors.
It’s from this relatively strong position that we’re watching the markets, looking for signs that conditions may deteriorate but also keeping an eye out for opportunities. For example, we recently added some short-term EM credit as spreads widened out to levels we felt incorporated a worst-case outcome.
With unemployment at its lowest point in decades, why are we not seeing better wage growth?
There appear to be several factors behind the disconnect between job gains and wage growth this expansion. One reason, there’s likely more labor market “slack” than the unemployment rate is telling. Under a broader definition of unemployment — including anyone in their prime working years not actively looking for work — recent wage growth has been much more in line with historical norms.
Another issue is that the most closely watched measure of wage growth — average hourly earnings — excludes benefits. Many employers have been reluctant to commit to higher wages, which are notoriously difficult to cut, and instead have used higher benefits to attract workers.
Perhaps the biggest reason though is that productivity, the main long-term driver of wages, has been subdued this expansion, while technology, outsourcing and globalization have made it easier for businesses to find cheaper alternatives to increasing employee pay.
Despite all this, measures of wage growth are slowing improving, and surveys show an elevated share of firms are now planning to raise compensation in the months ahead.
It’s unlikely we will soon see a return to more historical wage growth, but we believe the dwindling availability of workers will continue to gradually put more upward pressure on wages.
What information came out from the recently released FOMC minutes?
The Fed has reaffirmed its commitment to gradually raise the federal funds rate. The Fed’s median projection is for two more hikes this year, ending the year at 2.375%. Other forecasters have just a small variance from that level in their projections for the year-end federal funds rate (chart).
This outlook is being supported by the strength of the economy and the fiscal stimulus.
The Fed did mention rising concerns, particularly around trade tensions and emerging market weakness. However, these concerns are currently outweighed by the strong domestic economy and inflation being near its target of 2.0%.
