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 that despite the recent financial volatility, the stage remains set for further worthwhile gains in equities and select opportunities in the credit segment of fixed income (see chart).

Moderately higher inflation and interest rates do not pose a significant danger for the U.S. economy which continues to exhibit strong momentum and low recession risk.

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 and higher volatility over the next few years.

otr chart

2. What happened at the January Fed meeting?

Janet Yellen presided over her last FOMC meeting. Jerome “Jay” Powell will be the chair at the next FOMC meeting on March 21.

This transition is expected to be smooth with no radical change in policy in the near-term.

In the annual change of some voting members of the FOMC, a few are viewed to be somewhat more hawkish than their predecessors. There are also some vacancies to be filled by the President.

We expect three rate hikes of 25 bps this year, the first will be in March. There is an outside chance of a fourth hike if GDP stays strong, inflation picks up, and financial conditions continue to ease.

Despite five rate hikes, financial conditions (a measurement of stock prices, interest rates, credit spreads and value of the dollar) remain favorable (see chart).

GS Index

3. Is the recent stock market correction signaling the end of the bull market?

No. We see the current pullback as a healthy and long overdue correction which can ultimately help extend the long running bull market, rather than the prelude to a more severe downturn.

The sell-off has been spurred by fears of higher real interest rates, as stronger than expected economic growth along with signs of wage pressures have lifted both market expectations for inflation and Fed rate hikes.

However, this represents a shift in sentiment rather than fundamentals. Recent data continue to indicate some of the best economic conditions for the eight-year U.S. expansion thus far, and double-digit earnings growth is forecast to continue through 2018, even with potentially higher interest rates.

While painful in the short-term, corrections in the vicinity of 10% are a normal part of market movements, and help prevent stock prices from rising too fast and out-of-line with the earning potential of the underlying companies (chart). 

Importantly, bear markets outside recessions are not common and none of the other factors that have been traditionally associated with bear markets – soaring commodity prices, aggressive Fed tightening, extreme valuations – are evident.

A correction like this can run further, but it also provides an opportunity as stocks become more attractively valued for clients to bring portfolios closer to their long-term strategic objectives.

S_P 500 Return

4. What caused the 10-year note to spike in yield?

The 10-year note jumped 30 basis points in January to end the month at 2.71%.

That monthly increase, while it seemed meaningful, was not that unusual.

What made it noticeable was the fact that it was the highest month-end yield we have seen in seven years.

Investors have begun to focus on a world of “easy money” moving away from us.

Fear of the possible rise in inflation was the catalyst for the recent increase in longer-term interest rates.

We continue to believe the 10-year note will end the year with a yield in the range of 2.5% - 3.0%, but the path there will be bumpy with the increased level of volatility in the markets.

Monthly Change in 10 yr yield

5. Is the upturn in global growth sustainable?

There is little evidence that the synchronized upturn in global growth is running out of steam. In fact, with most of the world now growing in lockstep, the global economy appears set for a period of its strongest and broadest growth in more than a decade (chart).

In the U.S., recently passed tax cuts are boosting growth expectations for an economy that already has considerable momentum going into 2018. At the same time, the latest business surveys suggest that activity in the Eurozone, Japan, and China remains strong.

The recent breakout in global growth reflects a number of positive developments. A rise in corporate profits has helped revive capital investment, while strong labor markets and relatively depressed inflation are fueling consumer spending.

Together this has lifted confidence and a positive feedback loop has fallen into place, where the pickup in global GDP and financial conditions is in turn further boosting spending and investment.

It is possible that heightened geopolitical risks (such as tensions with Korea, missteps in trade negotiations, or policy mistakes as major central banks begin to reverse years of ultra-accommodation), could at some point disrupt global activity and financial markets.

Still, the upswing in global growth is looking increasingly resilient and will likely continue well into 2018. 

Global Synchronized Upturn

6. Are higher interest rates and inflation a concern for the U.S. economy?

The U.S. economy remains on firm footing, even with the prospect of slightly higher inflation and interest rates ahead.

Improving economic momentum is well supported by healthy fundamentals and increasing confidence, which in turn is helping drive stronger business investment and consumer spending (chart).

Tax cuts and other fiscal stimuli are likely to modestly boost U.S. growth further for at least the next 12 months.

With the economy now finally operating at potential, we have moved into the later stages of this expansion, but we continue to see little evidence of excesses –massive debt growth, overinvestment, capacity constraints or extreme inflation – that normally precede recessions.

Inflation is showing early, but not pressing, signs of firming. While a tightening job market may increase wage and price pressures somewhat further in the coming year, the structural forces that have kept inflation subdued should enable the Fed to stay the course with its gradual normalization of policy.

Consumer ConfidencePNG

Index Definitions

The Standard & Poor’s 500 Index (S&P 500) is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.

Important Disclosures

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.

Indices are unmanaged and one cannot invest directly in an index.  Index returns do not reflect a deduction for fees or expenses.

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.