FAQs on the Markets and Economy
What is the outlook for U.S. earnings?
The outlook for corporate profitability has slowed after last year’s tax cut boosted double digit gains, but with continued economic expansion, subdued inflation, and low interest rates, we see enough earnings growth ahead to push stocks higher by year-end.
Q1 earnings season is nearly complete, and S&P 500 EPS growth is now tracking roughly flat year over year.
Encouragingly, that is a much better performance than the consensus estimate of a –5% decline when the reporting season began, and highlights the overall resiliency of US corporate profitability.
Weakness continues to center around companies with higher international revenue exposure where headwinds from the stronger dollar, slower global economic growth, and trade tensions are weighing on corporate bottom lines.
Our equity portfolios are focused on domestic growers and have stayed away from export-sensitive sectors of the economy, as well as global regions like Europe that are more exposed to trade disruptions.
Our base case expectation for modest 4% profit growth in 2019 has also incorporated worst-case assumptions of further escalation in trade tariffs with China.
With consumer confidence so high, what does that mean for the future?
The May release of the University of Michigan Consumer Confidence report shows more than a 10-point jump in the survey since the beginning of the year (chart) and places it at a 15-year high.
An important caveat to this report is knowing that it was taken before the collapse in the U.S.-China trade talks.
That said, although this trade debate has garnered a lot of headlines, so far it has had very little impact on consumers.
All the gain came from the expectations component of the index. This is very unusual at this stage of the business cycle because consumers generally believe that economic growth is not going to continue indefinitely.
Being in the tenth year of this economic expansion, this is impressive. The details of the report show 62% of consumers expect the economic expansion will continue for the next year, a 15-year high. At the same time, only 36% a downturn in the next five years, a 15-year low.
This report bodes well for consumer confidence to rebound in Q2 following a weak Q1, which was due heavily to the polar vortex.
What insight was gleaned from the release of the Fed minutes?
The Fed is in no rush to change the level of interest rates. Even if the economy strengthens, which it believes, the Fed plans on keeping interest rates unchanged for the year.
Although inflation, which stands at 1.6%, is below the target level of 2.0%, the Fed believes it is low due to transient reasons and will rebound. It has no plans to lower interest rates to spur inflation.
The federal funds futures market has a different view. It believes the Fed will lower interest rates this year (see chart).
City National Rochdale continues to believe the Fed will hold interest rates steady this year.
What is driving performance in the High Yield Municipal sector this year?
High yield (HY) municipal bonds have returned 5.3% YTD, according to the Bloomberg Barclays family of indices.
The yield earned on HY municipal bonds has dropped more quickly than the yield in investment grade municipal bonds, thus lowering the differential, a key valuation measure (see chart).
The demand for HY municipal bonds is outstripping the available supply in the market as investors have become more comfortable with the sector as the economic expansion continues to improve. Robust net inflows also support prices for HY municipal bonds, which could persist for some time despite stretched valuations.
The current yield-to-worst (YTW) on the HY municipal bond index stands at approximately 4.7%, an attractive yield for some investors, especially after the adjustment for taxes is considered.
At City National Rochdale, the rally is an opportunity to improve overall credit positioning, and to add bonds that retain adequate protections for bondholders.
What is City National Rochdale’s investment outlook?
Given our positive assessment of the fundamental backdrop, we remain bullish on equities in general for 2019 and continue to see attractive prospects in the opportunistic fixed income class.
Still, we believe investors should prepare for more moderate returns in the year ahead and continued volatility.
The investment landscape has grown more challenging as investors adjust to more typical late-stage expansion conditions of higher inflation, rising interest rates, and less accommodative monetary policy.
Meanwhile, concerns over global growth, 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.
Our equity and fixed income research teams have made deliberate risk mitigating changes to help fortify client portfolios against the type of turbulence we have recently experienced while leaving them well positioned to take advantage of opportunities should they present themselves.