FAQs On the Markets and Economy

1. What is City National Rochdale's outlook for 2018?

The solid economic outlook and rising corporate profits we project for 2018 support our view that investors will continue to benefit more from our higher allocation to equities over bonds. Rising rates will be less beneficial to existing bonds, hence our underweight during this year.

Importantly, the investment landscape is growing more challenging, by which we mean after a long period of highly accommodative Fed policy and well below average stock market volatility, the next few years will likely see higher volatility, rising inflation and moderate tightening from the Fed.

All this means that active management of equity and fixed income investments will become increasingly valuable to mitigate beta across client portfolios. The next few years may not be friendly to most passive based strategies.

Beginning in 2017, both our equity and fixed income research teams made deliberate risk mitigating portfolio decisions. These decisions have already resulted in better performance for our client portfolios during the increased volatility in early 2018.

Within equities, we have methodically lowered our ownership of companies that were not rock solid with respect to earnings growth, steadiness of earnings and resilient business models. Today, our emphasis is primarily on steady growth companies rather than on cyclical earnings growth.

In our equity income strategy, we've reduced exposure to interest rate-sensitive sectors like utilities and are focusing on companies that have consistent, predictable dividend growth, which we feel can offset some of the effects of rising rates and help drive longer-term total returns.

For fixed income portfolios, we have made a number of changes in response to prospects of higher interest rates, such as shortening duration, while also increasing credit quality in recognition of late-cycle indicators.

Most notably, we have placed greater focus on floating-rate securities, which have a coupon that adjusts higher when short-term interest rates move upward. With the Fed expected to hike rates another four times this year, these bonds provide extra income with lower price sensitivity.


Chart 1

2. What did the Fed decide at their recent meeting?

As expected, interest rates were kept unchanged, but the Fed appears firmly on track to raise rates another quarter point in March. That will be the first of the three quarter point hikes the Fed has planned for 2018.

Although near-term risks were seen as “roughly balanced," some Fed officials have raised their growth outlook since their last meeting in December.

This is a result of the strength of recent economic data, accommodative financial conditions (chart) and the expected impact of the $1.5 trillion tax cut and two-year budget compromise.

All minds are focused on the incoming price and wage data which, if consistent with forecasts for the year, means the Fed will see continued rate increases as required to moderate concerns over future inflation expectations rising too much.

Given this, we believe the Fed will ultimately raise the funds rate four times this year to 2.375% – a view that is now also rapidly gaining traction in the markets and among other economists.


Chart 2

3. Why is the dollar weakening?

Despite the strong US economy and gradually rising central bank rates, the trade-weighted value of the dollar has depreciated almost 10% in the past year (chart).

The value of the dollar reacts to many global issues. The most notable is the growing strength of other economies and the reduced political risk, especially in regards to a significantly diminished chance of a Eurozone break-up.

The dollar's decline can be a tailwind for the US economy this year. It makes U.S. exports cheaper abroad, and thus helps to drive production at home.

On the other hand, the weaker dollar does pose a risk to inflation through a pick-up in imported goods prices. This linkage is already showing up in higher producer prices for goods, which could ultimately lead to higher prices for consumers over the course of the next year.

We do not expect much of a change in the US dollar during 2018.


Chart 3


4. Are higher interest rates and inflation a concern for the US economy?

At this stage, we view prospects for moderately rising inflation and gradually rising interest rates, when driven by better GDP growth, as a development that reflects the health of the US economy.

Improving economic momentum appears well supported by increasing confidence, which in turn is helping drive better business investment and consumer spending.

In the near term, expansionary fiscal policy will provide further stimulus to growth, as lower tax rates and deficit spending filter through the economy.

Over time, higher interest rates can undermine consumer and business spending, which would subsequently lower profits and stock prices. However, those concerns are not for this year.

With the economy now having reached what is called “non-inflationary full potential resource capacity,” additional growth going forward moves the economy into the later stages of this expansion (chart).

Nevertheless, we see only beginning signs of the type of imbalances – debt growth (particularly in the corporate sector), over-investment, significant capacity constraints – that usually precede recessions.


Chart 4


5. Do current municipal bond market yields offer opportunities for investors?

Municipal bond yields have risen approximately 50 bps (0.5%) YTD on AAA-rated benchmark 10- and 30-year maturities, achieving levels not seen in over 12 months.

The slope of the municipal yield curve has steepened more than 50 bps since the beginning of the year (the difference between two- and 30-year maturities), which has caused current rates to increase, a positive for future investors.

Medium- to longer-term municipal bond valuations are currently fairly priced, suggesting a deliberate approach to investing capital, and cash flows could add incremental portfolio yield.

Shorter-term valuations (less than five years) are fully valued. However, near term variable-rate securities currently offer attractive yields on an absolute (above 1%) and tax-adjusted basis (near 2%), mitigating the risk of Fed rate hikes on shorter-dated bonds.

Relative attractiveness of municipal bonds versus global alternatives underscores the value of the asset class with taxable equivalent yields above those of Treasuries and sovereign debt (see chart).


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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.