FAQs on the Markets and Economy
Has the volatility in the stock market affected the bond market?
There has been some movement in the high-yield sector, with credit spreads widening out 69 basis points from the lows of October, to 371 bps (chart).
The credit spread is the yield advantage that bonds have over like maturity treasury securities. The larger credit spread represents greater perceived risk of the bond.
The widening of the credit spreads is not a result of increased risk of immediate credit default, but instead reflects a greater feeling of uncertainty from the stock market. The high-yield market has about a 70% correlation with the equity markets.
Most of the poor performance in October has been at the lower end of the credit spectrum (bonds rated CCC), rather than the higher end of the spectrum (BB).
The Q3 GDP report came in strong; were there any surprises?
Q3 GDP came in stronger than expected, confirming the economy is maintaining solid momentum. Q3 GDP growth was 3.5%; this is on top of the 4.2% growth rate in Q2. It marks one of the best six-month stretches in the past decade.
A surprise came with unexpected weakness in business spending. This has been fading quickly since hitting a recent peak back in Q1 of 11.5%. But it fell in Q2 to 8.7% and in the recently released Q3 report it showed growth of just 0.8% (chart).
This was the area that the $1.5 trillion tax cut was supposed to boost with increased spending on capex, which would propel and sustain growth above the 3.0% rate.
It could be that corporations are focusing their tax savings on stock buyback.
Is the recent decline in stocks the beginning of the end for the bull market?
No. We see the current pullback as a healthy and probably overdue correction that can help ultimately extend the long-running bull market, rather than the prelude to a more severe downturn.
The sell-off has been spurred by concerns over a number of issues ,including: peaking corporate profits, slowing global growth, ongoing trade tensions, rising interest rates and a fading boost from fiscal stimulus.
The vast majority of corrections are relatively short-lived and don’t turn into bear markets. We have been expecting a return to more normal market volatility this year, as rates rise and central banks around the world are poised to provide less stimulus.
Our client portfolios are constructed with this volatility in mind and should withstand the correction relatively well due to our high-quality equity allocation and overweight to U.S. Large Cap stocks versus Midsmall Cap and International.
Has the sell-off in the equity market affected the Fed’s view?
At this stage, the Fed is probably not going to alter their tightening stance on monetary policy. They have five more hikes planned between now and the end of 2020.
The Fed takes a longer-term view on market conditions compared with how the press and traders look at the market. The Fed looks at the gains in wealth from the stock market over the past two, three, five and ten years, not the movement in the past month.
Not only has the stock market traded off, but financial conditions are getting tighter (chart). The Goldman Sachs Financial Conditions Index (FCI) measures financial conditions that influence economic activity. This index measures: federal funds, 10-year treasury yields, credit spreads, S&P 500, and trade-weighted dollar.
After years of getting easier, it has taken a turn, due mostly to the higher interest rates and value of the dollar.
What are the takeaways from the October employment report?
After a hurricane-dampened September, October’s better-than-expected 250,000 gain in nonfarm payrolls confirms that the labor market, a key pillar of support for the economy, remains strong.
The number of Americans with jobs relative to the population reached a new post-recession high and annual growth in average hourly earnings jumped to its highest rate in a decade.
While there is little doubt that the full-employment half of the Fed’s dual mandate is right on track, it has long been the inflation side of the scale that has caused head scratching among policymakers.
Inflation is on target now, and the question is how much pressure is bubbling beneath the surface. So far, there isn’t a great deal of evidence for a breakout in price pressures. The improvement in wages, while welcome, has yet to confirm a sustained trend, as similar one-off increases earlier in the year have proven temporary.
That underpins our expectation that the Fed can continue with its gradual pace of rate hikes without running the risk of derailing overall economic growth.
Is City National Rochdale’s investment outlook still positive?
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, concerns over global growth, rising trade tensions, midterm elections, 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.