1.What are City National Rochdale’s expectations for economic and investment outcomes over the next 12 months?
The U.S., Europe, and emerging market nations are experiencing a coordinated period of expanding economies, rising corporate profits, rising incomes, moderate inflation, and low interest rates.
Though we see some indications the U.S. economy is entering the later stages of the business cycle, the domestic expansion is expected to continue at a modest pace over the next several quarters, and likely longer, provided there are no policy mistakes by the Fed (which is proceeding cautiously) or major disruptions on the geopolitical front.
We see continued growth for U.S. and global economies ahead; however, investors have fully priced in this positive outlook, and currently we see few compellingly attractive asset classes, whether we look at equities or fixed income. Of course, our economic and financial market outlook can be materially and adversely impacted by political events, which we cannot predict.
Consequently, we have trimmed our expected returns for growth equities over the next 12 months. On the fixed income side, given our forecast of moderately rising rates, we are also trimming our projected returns for high yield fixed income asset classes.
Overall, we believe economic conditions, relative valuations, and earnings growth expectations continue to support our overweight to U.S. equities and opportunistic credit, as well as our underweight to investment-grade bonds. However, given the recent appreciation in financial markets, investors should lower expectations for portfolio returns over the next one to two years. Moreover, patience is warranted for new cash investment.
2. What is happening with the Fed’s balance sheet?
As widely expected, the Fed has announced that it will start to slowly reduce monetary stimulus this month, by decreasing the size of its balance sheet. During the financial crisis, the Fed bought bonds from banks and added them to its balance sheet. This helped the economy by pushing down intermediate and longer term interest rates.
We believe the Fed is correct in its assessment that the economic and financial conditions are now strong enough for it to begin removing some stimulus. Importantly, its plan has been well telegraphed and, at just $10bn per month initially, the pace of run-down will be so gradual and predictable that it is unlikely to have a major impact on the economy or financial markets.
However, given the complicated nature of the financial linkages across the monetary system, we believe there is still some scope in the months ahead for increased volatility as global financial markets adjust.
3. Is the housing market outlook still positive?
Fundamentals remain strong in the housing market and we expect residential investment to be a positive contributor to economic growth over the next year.
In the near term, the coming months are expected to reflect hurricane-related disruptions to construction. However, with an estimated minimum 20,000 residential houses destroyed by Harvey and Irma, momentum should advance at a steadier pace once the rebuilding process begins.
Demand nationally remains strong as reflected in current record-low selling times in the new home market and elevated builder sentiment.
With consumer confidence high, tightening job market, and rising wages, first-time buyers are increasingly being drawn into the market after years of saving for down payments. In fact, after more than a decade of decline, household formations by owners is now growing faster than those by renters.
Importantly, lending conditions also remain supportive. Mortgage rates have declined over 50 basis points from their recent peak reached at the end of last year.
4. Given the relative underperformance this year to large-cap growth stocks, are high dividend and income stocks still attractive?
While HDI stocks have not moved up at nearly the same pace as other sectors of the market this year, we remain optimistic about dividend paying companies, particularly in light of their operating performance and yield.
We also note that some sectors, notably Real Estate Investment Trusts (REITs) and Consumer Staples, have had high relative underperformance over the past six months despite a steadily rising rate of dividend growth.
In our view, this has allowed many of the stocks in our portfolio to accrue value and makes them more attractive over the long haul.
For the next 12 months, we feel that modest total return expectations in the 5%-7% range, as driven by the current yield and projected dividend growth are realistic.
Although valuation is a concern, the outlook for economic growth remains solid and HDI companies should continue generating good operating results in this environment to support modestly higher prices.
5. How has the value of the U.S. dollar changed over the course of the year?
The value of the trade-weighted dollar has fallen for seven consecutive months (see chart).
The dollar had a strong rally at the end of 2016 and early 2017 with expectations of significant changes to tax policy and regulations. When they failed to materialize, the dollar began to weaken.
Then, a stronger-than-expected pace of economic growth in Western Europe and the emerging markets forced upward pressure on their currencies, thus weakening the dollar.
In the past few weeks, the dollar has stabilized. We believe this is due to political dynamics in Europe, especially after the German elections gave more power to the far-right Alternative for Germany party. The seats they won have made it more difficult for Chancellor Merkel to form a coalition government. Also, the anti-European movement in Spain is more challenging than even the Spanish believed.
The Fed now appears to have increasing confidence they can hike rates a few times in the next year. If that happens, the near-term view of the dollar doesn’t look as pessimistic as it has in the past several months.
6. How will the widespread damage to Puerto Rico impact its economic and financial restructuring?
Puerto Rico sustained widespread and catastrophic damage from Hurricane Maria.
The full extent of the cost of economic and physical damage is uncertain, but early estimates range from $30 billion to much higher. The Puerto Rican government reported 2015 GDP of $102 billion, which underscores the difficult challenges that lie ahead in their rebuilding and recovery.
Before the recent hurricanes, Puerto Rico had limited financial resources and had been working through a debt restructuring. The court-supervised restructuring is likely to be interrupted with delays.
Federal aid should provide relief to the Commonwealth.
Much of the Commonwealth’s debt complex was in, or expected to enter, default. The rebuilding effort is likely to take precedence. The court overseeing the island’s restructuring may look to the reduced economic capacity of PR in influencing recovery prospects for bond creditors. As a result, PR securities have experienced significant price declines post-Hurricane Maria, with some reaching all-time lows (see chart).
This massive fall in value doesn’t affect City National Rochdale managed accounts. As a firm, we started selling out of Puerto Rico bonds about five years ago.
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.
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.
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