1. What is City National Rochdale’s outlook for 2018?
The global economy continues to experience a synchronized period of growth, rising corporate profits, moderate inflation, and low interest rates that is expected to last into 2019.
As a result, we believe the stage remains set for further worthwhile gains in equities and select opportunities in the credit segment of fixed income (see chart).
In the U.S., the expansion is set to soon become the second longest in post-war history, and despite its advanced age, at this point only a limited number of our proprietary recession indicators are flashing yellow.
In fact, we expect recently passed tax cuts to provide a modest boost to GDP growth over the next several quarters and a meaningful increase in corporate earnings, which should help extend the long-run bull market for at least another year.
However, we do appear to be in the later stages of the market cycle and investors should recalibrate expectations for lower returns over the next few years.
The final stages of a market cycle can be rewarding, but last year’s impressive market gains are unlikely to be repeated and investors should lower expectations for overall portfolio returns in 2018.
2. What policy actions do you expect from the Fed this year?
We expect the Fed to raise the federal funds rate three times to the median level of 2.125%.
The Fed expects “gradual increases” in the funds rate and they project three rate hikes in 2018, two in 2019, and two more in 2020. They see the terminal rate at 2.875%.
These projections, along with the roll-off of some of their assets from quantitative easing, are the continued steps the Fed is taking toward interest rate normalization.
The appointment of Jerome “Jay” Powell as Fed chair should result in a smooth transition for monetary policy. That said, there are some personnel changes on the FOMC that may lead to greater policy uncertainty.
3. What is the 2018 outlook for U.S. equities?
We believe conditions remain in place for the U.S. secular bull market to continue through 2018, though with more modest returns in the 5-7% range.
Record highs in the stock market reflect improving global and domestic economic prospects, as well as the recent reduction in the U.S. corporate tax rate.
Corporate earnings will likely see a significant boost in 2018 due to the tax cuts, and we estimate that average earnings per share for the S&P 500 could rise 10-14% overall.
This should help support moderately higher stock prices and could encourage higher dividends, though some of the benefits to earnings growth are already priced into equity markets.
While valuations look full, they do not appear too expensive to prohibit further price gains. In fact, research shows that factors such as the state of the business cycle, business sentiment, and corporate earnings are more important in regard to near-term return expectations.
At 14 months and counting, we are in the longest period in S&P 500 history without a 3%+ correction. We expect a pullback in the quarters ahead, but we feel this would be a healthy development in the context of the ongoing bull market.
4. What is the 2018 outlook for dividend and income equities?
We continue to maintain our modest overweight to dividend and income equities, given solid dividend growth expectations. However, while valuations are full, overall expected returns should be lower than average.
Our strategy has been to blend high dividend growing firms with higher dividend paying companies. We are invested in companies that we feel can continue their solid operating results into 2018 and that can benefit from the new tax bill, thus driving dividend growth.
While prospects for upward movement in interest rates continues to be a concern for income-related investors, past research has found that dividend stocks can do well in a higher rate environment provided that the economy is growing and that companies can grow their earnings along with the improved economy.
Going forward, we feel that modest return expectations in the 6-8% range, as driven by yield (actual) and growth in yield (projected), are realistic.
5. Is City National Rochdale’s outlook for Emerging Asia equities still positive?
We believe 2018 will be another strong year for the region, though our expectations are for modest returns and greater volatility.
The rally has been driven by the upturn in international trade, underpinned by a synchronized recovery in global growth and U.S. dollar depreciation, which is supporting improvement in corporate profits, positive earnings, and greater regional inflows.
Even with the past year’s very strong overperformance, Emerging Asia equity valuations are still reasonable, both on a long-term historical basis and relative to other geographies.
Moreover, for those with a seven-to-10-year investment horizon, the region’s growth outlook remains resilient, supported by positive fundamentals including demography, income growth, urbanization trends, and saving/investment behavioral characteristics.
Our focus remains on sectors and companies that should benefit from these long-term structural tailwinds.
6. What is City National Rochdale’s 2018 view on the bond market?
There are three key areas that we focus on with interest rates.
First, short-term interest rates, which are controlled by monetary policy of the Fed, are expected to increase 75 bps. which will bring the Fed Funds rate to 2.125%.
Second, longer-term interest rates (10-year) are currently at 2.65% and are expected to move up gradually over the course of the year, due to a slowly increasing rate of inflation. We expect them to end the year in the range of 2.5% to 3.0%.
Third, credit spreads, which measure the yield difference between no-risk treasury securities and credit-riskier investments like a corporate bond, are relatively narrow and reflect the late stage of the credit cycle (strong corporate balance sheets and the economic expansion in its ninth year). It is also a statement of investor demand for a higher yield. City National Rochdale continues to believe that investors are modestly compensated for this risk in the near-term.
Overall, we expect credit spreads to remain somewhat range-bound and Investment Grade Taxables and Municipals to provide modest single-digit total returns in 2018.
Assuming credit spreads are relatively unchanged in 2018, CNR’s tactical overweight to credit should continue to perform well in a rising rate environment.
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