FAQs on the Markets and Economy
Has City National Rochdale’s outlook changed for 2018?
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.
None of this means 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.
Recently, we have moved up in quality in both our fixed income and equity portfolios to prepare for the volatility we have been experiencing. At the same time, there are pockets of value in the market, and we seek to selectively take advantage of those opportunities.
Have the seven hikes in the federal funds rate increased investor interest in short-term investments?
There are many reasons for investors to put money into short-term investments. Sometimes it’s fear of price volatility of other asset classes and sometimes it might be the attractiveness of the yield.
In the past six months, the yield of 3-month LIBOR (a benchmark of short-term interest rates) has moved above the inflation rate (chart). Having a yield above the inflation rate makes short-term investments attractive for many investors. This follows about 8.5 years of interest rates below the inflation rate, which was primarily a result of the Fed’s ZIRP (zero interest rate policy).
This may be one of the reasons for the $200 billion increase in money market investments in the past year. They now total $2.8 trillion.
It is not just individuals; corporations have also been moving their money out of bank deposits and into managed short-term investments. Since the beginning of the year, City National Rochdale has had a $1.5 billion increase in assets in our Liquidity Management strategy.
How does City National Rochdale’s outlook for Fed action differ from the Fed’s?
Since January, City National Rochdale has been projecting a total of four rate increases of 25 basis points for 2018. Since the Fed already increased rates in March and June, it leaves two more rate increases this year (chart).
This projection was a little more hawkish than the Fed’s. For most of this year, the Fed was projecting a total of three rate increase. At their recent meeting in June, they boosted it to four increases. Some of the policy makers have attributed the increase to stronger 2018 economic growth as a result of the fiscal stimulus.
The federal funds futures market is not as optimistic. They fully price in one more hike, but have only about a 50% chance of a fourth hike this year.
For 2019, the Fed expects three rate increases, City National Rochdale expects two and the federal funds futures market expects just one hike. One reason why we are less hawkish is our belief that the Fed’s balance sheet reduction will put more upward pressure on intermediate rates than the market is currently pricing into their assumptions.
Are rising trade tensions a concern for the economic outlook?
Trade tensions have escalated faster and further than many anticipated, capped off last week by President Trump’s threat to apply a 10% tariff to $200bn of imports from China. With the China tariffs set to be introduced in a week’s time, and other potential actions by the Administration looming, we expect the trade rhetoric to remain intense. US trading partners have established a pattern of quickly imposing like-for-like retaliation in response.
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.
At this point, we continue to believe that the fallout for economic growth will be relatively contained. The reality is that most of the economic activity in the United States is for domestic consumption. Exports constitute about 12% of G.D.P.
However, there are signs that increasing tensions, along with the small tariffs already in place, are incrementally weakening growth, and we are watchful for further potential impact.
Are rising trade tensions a threat to the equity bull market?
While not insignificant, for now we estimate the impact to U.S. corporate profits to be relatively small, subtracting approximately just 1% from total EPS growth in both 2018 and 2019. Corporate profitability continues to be very strong and the outlook remains positive.
In fact, City National Rochdale has raised its 2018 estimated S&P 500 EPS growth to 16-18%, net of any trade impact. That’s up from our 13-15% estimate last quarter, and 12-14% entering the year, due to better-than-expected tax benefits and corporate buybacks, as well as stronger domestic & global demand, which has driven a recovery in top line growth.
We are projecting further solid organic earning growth of 5-7% (net of trade impact) in 2019 as the tax benefits roll off. However, if trade tensions escalate, the hit to earnings could grow more material, and we are paying careful watch.
Moreover, uncertainty surrounding trade is likely to weigh on sentiment in the months ahead and elevate volatility.