On the Radar

City National Rochdale, | Jun. 5, 2018

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.

However, the investment landscape is growing more challenging as investors adjust to a more typical late-stage expansion environment of higher inflation, rising interest rates and less accommodative monetary policy.

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.

The Fed has a much more upbeat view of the economy. It increased its assessment of the economy from “modest to moderate” to “moderately.” It may not sound like much, but for the Fed, it is a significant change in its outlook. It has indicated that manufacturing has “shifted into higher gear” and that business activity remains robust. That said, it is concerned about international trade policy, and consumer spending is a bit soft.

The Fed remains committed to a gradual path of interest increases. Despite the firming of inflation in Q1, it sees no need to raise rates at a faster pace than its current plan, which is a total of three increases this year.

Although economic fundamentals have not changed recently, despite the Fed’s recent comments, fed funds futures have fallen recently. This is mostly in response to the Italian political crisis, as some investors are afraid of “euro breakup” coming back into the news. That has put fear in the market (Italian yields have spiked, see question #3) and fear of slower global economic growth.

The yield on the 10-year Italian sovereign debt hit a peak of 3.15% on May 29 and ended the month at 2.77%. That is significantly higher than the April average yield of 1.77% (chart).

What is currently happening in Italy is a political crisis, not an economic crisis like the 2010-12 euro crisis that centered around Greece. Italy had an election in early March, and a majority was not elected. This led to months of jockeying to form a coalition government, which was recently formed by two rival populist parties from different ends of the political spectrum. What they had in common was being a euroskeptic.

They proposed a finance minister, Paolo Savona, who co-authored a guide to leaving the eurozone. This didn’t sit well with Italy’s president, Sergio Mattarella, who wants to form a new government with Carlo Cottarelli, a former IMF official and is pro-euro. Mattarella believes the coalition government would abandon the euro without sufficient public debate and posed a risk “for Italian families and their savings.”

Since then, there has been significant political fighting concerning the financial markets.

The Trump administration has now followed up on steel and aluminum tariffs against China by announcing it will also let exemptions for the EU, Canada, and Mexico expire. All four have threatened to retaliate.

Relative to the overall size of U.S. trade and underlying GDP, the near-term costs of recent U.S. trade actions look manageable. However, the longer-term costs of potential trade wars are greater. The Dallas Fed estimates that a trade war with the EU and China would reduce U.S. economic growth by nearly 3.5% in the long run.

Our sense is that the president’s actions are most likely being used as a negotiating approach. But if more severe and provocative protectionism is forthcoming, it would be a serious concern for global economic performance and financial markets.

Trade tensions are unlikely to be resolved soon, and uncertainty driven by headlines may weigh on investors and the economy. Still, for now we continue to believe fallout will be relatively contained and that the risk of escalation to a full-blown trade war remains low.

Emerging Asia equities have underperformed overall EM (and Developed Markets) this year, as oil and commodity prices have rallied and tariff‐war concerns have raised uncertainty levels.

Over the near term, we expect policy uncertainties to prevail; they may continue to hurt EM Asia market sentiment.

However, our long‐term outlook remains supported by positive fundamentals, including demography, income growth, urbanization trends, and saving/investment behavioral characteristics. We continue to focus on sectors and companies that should benefit from these long-term structural tailwinds.

Moreover, with the recent market pullback, Emerging Asia equity valuations look increasingly favorable, both on a long-term historical basis and relative to other geographies.

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Important Disclosures

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed. Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change. There are inherent risks with equity investing. These include, but are not limited to, stock market, manager, or investment style risks. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices.

Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability. Emerging markets involve heightened risks related to the same factors as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks, and less-developed legal and accounting systems, than developed markets.

There are inherent risks with fixed income investing. These may include, but are not limited to, interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond risks. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed income securities and during periods when prevailing interest rates are low or negative.

Investments in below-investment-grade debt securities, which are usually called “high-yield” or “junk” bonds, are typically in weaker financial health, and such securities can be harder to value and sell and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.

The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the federal Alternative Minimum Tax (AMT), and taxable gains are also possible.

Investments in the municipal securities of a particular state or territory may be subject to the risk that changes in the economic conditions of that state or territory will negatively impact performance. These events may include severe financial difficulties and continued budget deficits, economic or political policy changes, tax base erosion, state constitutional limits on tax increases, and changes in the credit ratings.

Investments in emerging markets bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more-developed foreign markets.

Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

Returns include the reinvestment of interest and dividends.

Investing involves risk, including the loss of principal.

As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money.

Past performance is no guarantee of future performance.

Index Definitions

The Standard & Poor’s 500 Index (S&P 500) is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.

MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.

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