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.
How tight is the job market?
There are now more job openings than people looking for jobs (chart.)
Although this data only goes back to the early 2000s, it is the first time this has happened.
With the unemployment rate at just 3.8%, this makes it difficult for employers who are looking to quickly fill positions.
Employers will need to change their approach to hiring. They may need to pay more, accept a lower level of education, or even look to those that have criminal records or substance abuse problems.
Another alternative is to automate more jobs. This can been seen at fast food restaurants where order-taking kiosks have replaced some employees.
Is the surge in corporate leverage a concern?
The level of corporate leverage is sitting near its highest level in recent memory (see chart — darker line).
It has been brought on by low interest rates, high taxes for repatriating foreign earnings, heightened M&A activity and the rising popularity of share buybacks.
Although high, present financial conditions paint a much more sanguine picture for investment grade corporate credit. For example, operating earnings have kept companies’ abilities to service debt in line with longer-term averages (blue-line chart).
Much of the corporate debt proceeds have been used to remunerate shareholders via increased & special dividends and share repurchases. A suspension of these policies would immediately free up cash flow and allow existing debt to simply mature vs. having to be refinanced.
City National Rochdale core portfolios are skewed toward higher-quality names and do not have exposure to the riskier “junk” credits that this leverage phenomenon will likely hit the hardest.
What happened at the recent FOMC meeting?
The Fed increased the median federal funds rate to 1.875%, which was widely expected and marks the seventh increase in this cycle.
The median estimate for future rate increases moves up by one and now totals four hikes for this year (two have already been done). The previous projection was for a total of three hikes in 2018.
Since January, City National Rochdale has projected a total of four increases this year. The Fed has a more bullish view for the remainder of this year, compared to their past projections, which were released in March. GDP will be stronger; it was revised upward from 2.7% to 2.8%. Inflation (Core PCE) will also be stronger, moving up from 1.9% to 2.0%.
The unemployment rate will be a little lower; the projection has moved down from 3.8% to 3.6%. Overall, the statement was viewed as more hawkish than the markets anticipated.
Is productivity growth finally rebounding, and what could that mean for the economy?
While productivity growth remains near its lowest level since the early 1980s, the latest data indicate that the trend is showing some improvement.
Part of the reason behind the slowdown in productivity over this expansion has likely been due to fading impact of the turn of the century IT revolution, as output per worker has been trending lower since it peaked at more than 3% in the early 2000s.
Another reason has been a sustained shift down in business investment. From 2001-2013, the trend in capital stock formation fell from 4% to 1%.
It’s still early, but there are indications that the recent pickup in business investment, as well as the diffusion of new technologies, are now finally beginning to translate into stronger output per worker.
If so, there are several positive implications including: stronger potential GDP growth, reduced inflation pressures and higher corporate profit margins — all of which could help extend the economic expansion and the equity bull market.
Is the Eurozone’s recovery in trouble?
Fears that the ongoing Eurozone’s recovery is faltering seem overdone. Weakness in Q1 related partly to temporary factors, and the outlook for domestic spending still looks positive, with firms’ employment intentions and consumer confidence at high levels and bank lending growth rising.
While timelier survey measures of activity in the manufacturing sector have softened this year, they also continue to point to modest rates of growth ahead.
But the long-term outlook is still not very bright. Rebalancing is incomplete, labor market reform has a long way to go and existing backstops are not strong enough to prevent another crisis.
Though there is a sense of relief that some form of political stability has resumed for now, recent events in Italy are a stark reminder of how quickly things can unravel in Europe and the continuing risks regarding the future of the EU.
Our underweight to European equities reflects these relatively poorer long-term growth prospects, political risks, and secular headwinds.