On the Radar

City National Rochdale, | Jun. 13, 2019

FAQs on the Markets and Economy

Is the outlook for stocks still positive?

We continue to have enough confidence in the economic outlook, and see sufficient scope for earnings growth, to remain positive on U.S. equities. However, downside risks have increased somewhat and we expect volatility to remain elevated. Economic growth is slowing as the effects of last year’s stimulus fade and further escalation of trade tensions remains a significant concern.

For now, we expect that the impact to corporate profits will be manageable, but if the U.S. administration broadens its trade disputes with Mexico and begins targeting other trade partners on key sectors like autos, the impact will grow more significant and troubling.

Fed officials are mindful of the burgeoning risk to the economy and appear set to reverse course on interest rates. This should help blunt some of the damages from trade and provide more support to the long-running bull market. Late cycle conditions of slowing growth, volatility and greater vulnerability to policy missteps require investors to be more selective in their portfolios.

City National Rochdale has responded by focusing on higher quality and dividend-paying domestic companies, while reducing exposure to cyclical and export-oriented sectors most affected by global headwinds.

The Fed announced that it may cut interest rates if economic conditions deteriorate.

It is “closely monitoring” the trade developments but is unsure when and how they may be resolved. Just two weeks ago the president lifted steel and aluminum tariffs on Canada and Mexico to help smooth the passage of recently completed trade deal, USMCA (the new NAFTA).

Market expectations for Fed easing have increased in the past few weeks (chart). The federal funds futures market is a speculative market and currently is pricing in at least 50 bps in cuts this year.

An interesting phenomenon is occurring. The yield on the High Yield (HY) sector has been increasing while the yield on the Investment Grade (IG) sector has been falling (chart).

The yield increase for HY has been significant but not surprising as these securities tend to have price weakness during periods of market uncertainty. The yield decrease in IG is somewhat surprising.

This is a sector that is far more reliant on global trade compared to the HY sector. But it is much safer than HY and investors appear to view that as a benefit. It is worth noting that the yield drop in IG is not as great at government securities, indicating some concern for the future.

An important factor driving the HY market is the precipitous drop in commodity prices (down 8.0% since April highs). A big part of that is driven by the $15 drop in oil prices since the energy sector makes up more the 1/8th of the HY sector.

While the yield curve may be telling us that we are moving late into the cycle, we don’t think it’s telling us it’s time to sell risk assets yet.The recent inversion is certainly something to be watched, but it has not been a good indicator to use for timing changes to one’s portfolio. In the past, when there has been a prolonged inversion, risk assets have tended to do quite well for a year or more.

We also think the recent curve inversion has partly been driven by pressure from negative rates and slowing growth abroad, as opposed to any significant deterioration in the U.S. economic outlook. For now, investor concerns have been partly calmed by signals from policymakers that any slowdown in U.S. growth will prompt the Fed to cut rates.

Low interest rates and accommodative monetary policy have been a key source of support for the long-running bull market and economic expansion. This may be a time to be cautious, but there should be gains ahead as we move into the second half of the year and corporate profit results improve from the current weak patch.

Manufacturing has been weakening since hitting a cycle peak back in August of last year (chart).

Although still in an expansive mode, it has slowed due to weakening global demand.

The series of trade disputes, mostly over the past year, have been largely responsible for the economic slowdown since 2017. The OECD estimates that business investment will grow at an average rate of just 1.75% this year and next year, which is half the rate of growth of the previous two years. The more the tariffs increase, the more damage this will cause.

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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.

The Michigan Consumer Sentiment Index (MCSI) is a monthly survey of U.S. consumer confidence levels conducted by the University of Michigan. It is based on telephone surveys that gather information on consumer expectations regarding the overall economy.

The Bloomberg Barclays High Yield Municipal Bond Index is an unmanaged index made up of bonds that are non-investment grade, unrated, or rated below Ba1 by Moody’s Investors Service with a remaining maturity of at least one year.

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