FAQs on the Markets and Economy
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.
What was decided at the Fed meeting last week?
The meeting held few surprises, but contained important information that was well anticipated by the markets. The Fed raised the federal funds rate 25 bps to the median level of 2.125%, which makes it the third hike this year and the eighth in this cycle.
The Fed did not alter their guidance for future hikes: they expect one more increase this December, three increases in 2019, one increase in 2020, and no movement in interest rates in 2021 (chart). With inflation contained around the 2.0% level, despite the very low level of unemployment, the Fed has been able to fulfill its plan to gradually return interest rates to a more “normal” level.
The Fed is trying to strike a delicate balance as they raise interest rates enough to prevent inflation from taking off, but at the same time, they do not want to raise them too much to choke off the economic expansion.
What are City National Rochdale’s expectations regarding Q3 corporate earnings?
Strength in corporate earnings has been a key source of support for the stock market, helping to some extent offset worries over other issues such as trade tensions and Fed tightening.
The market will be looking for reconfirmation of earnings strength in the Q3 earnings reporting season, which has just gotten underway. Overall earnings growth reached its highest level in almost eight years in each of the last two quarters.
The pace of growth should subside from 25% in Q2 to 19% in Q3. Solid economic growth provides a supportive backdrop for revenues to grow an estimated 6.5% to 7%.
We will be looking at company comments and results to assess the effects of the dollar’s strength, rising interest rates, trade tensions, slower global demand, and whether companies are starting to feel the pinch of cyclical cost inflation.
Has the lower unemployment rate helped to provide a boost to incomes and consumption?
Yes, the strength in the labor market has created significant wealth for households allowing them to purchase more goods and services. The tax cut has helped too.
Since consumption accounts for more than 2/3 of GDP, this has given a boost to overall economic growth. The Fed has upped their projection of 2018 GDP to 3.1%; last quarter, it was just 2.8%.
Per capita disposable income (chart) has been on an upward trajectory for more than five years, following the tax hike in early 2013 that caused a downward shift in real disposable income and a drop in the saving rate too.
2.5 million people have been added to the payrolls in the past year ,and personal income is up 4.7% for the same period of time. This is all helping to pave the way for stronger consumer spending.
What does the new USMCA deal mean for the economy?
The new agreement is called the United States-Mexico-Canada Agreement (USMCA). The deal is subject to approval by the three parties, and in the case of the U.S., a Congressional vote. The most significant changes include new rules-of-origin provisions related to the percentage of imports permitted for goods produced within the region. Additionally, it includes better enforcement provisions and updated rules specifically pertaining to digital transactions and intellectual property intended to modernize the agreement.
Overall, though, the new trade deal represents relatively minor changes to the 20-year trade accord and won’t in itself have much impact on the U.S. economy. The most significant benefit is that it removes uncertainty about the Trump administration’s trade policies, helping business, and particularly automakers, move forward with factory investments, and ensures that potential significant economic fallout from supply chain disruptions is avoided.
It also offers encouragement that other trade disputes with the Trump administration can be resolved without significant economic consequences. Along with the deal recently made with South Korea, it provides another example of President Trump backing down from his hard-line protectionist threats in return for modest concessions that allow him to claim victory.
What are the potential implications of the upcoming midterm elections on the public finance sector?
Predicting political ramifications is an error-prone exercise, but with leadership in the House and/or Senate possibly up for grabs, 36 governor seats at stake, and the probable swing of leadership of some state legislatures, the composition of the future federal and state legislative bodies will unavoidably influence future policy and fiscal decisions. Here are three important issues:
Education: If recent teacher revolts are any indication, further pressure to enhance funding of education will likely occur and could impact the structure of state funding regimes for K-12 education (see chart).
Health care: This is a perennial policy risk that continues to garner significant attention. Health care cost are expected to grow at nearly 6.0% through 2026, which is a faster pace than growth of tax revenues. The federal and state governments will have to employ several options, like identifying new funding sources, restructuring, or cutting benefits.
Infrastructure: Almost everywhere, there is a need for an upgrade. The problem lies in finding a source of revenue. State and local governments bear the majority of that spending, often with debt issuance.