1. What are City National Rochdale's expectations for economic and investment outcomes in 2017?
We continue to overweight U.S. growth and dividend equities and to underweight investment-grade bonds.
With the potential pro-growth policies forthcoming in 2018, including tax cuts and stimulus spending, we project corporate profit growth improving over the next two years at about 5% per year, supported by a globally synchronized economic expansion.
We expect moderate inflation from wage increases and stimulus spending, which should cause interest rates to rise moderately over the next 18 months. We do not expect a recession now through the middle of 2018 at the earliest.
Surveys show consumer and business optimism has reached multiyear-high levels while real economic growth in the U.S. and globally validates these surveys.
Equity investors should benefit, while fixed income investors could experience modest downward bond value pressure as interest rates rise.
With an uncertain legislative process and delayed fiscal stimulus, investors should expect bouts of downward equity price volatility until we know the outcome for tax changes, healthcare rules, and regulatory changes.
2. Does City National Rochdale think the Fed will still raise interest rates at its upcoming meeting despite the recent slowdown in inflation?
Yes, we fully believe the Fed will hike the federal funds rate by 25 bps to a median level of 1.125% at its June 14 meeting. The federal funds futures market places an 88% probability on this rate hike.
The yearly change in inflation, CPI, hit a recent high of 2.7% back in February and has recently drifted down to 2.2% due to no upward price movement in the index in the past three months (see chart).
Fed policy makers have been very vocal in declaring the economic and inflationary weakness in the early part of the year as being transitory. They fully expect a return to trend growth (2.0%-2.5% GDP growth) and inflation (above 2.0% CPI).
3. Corporate credit spreads are approaching their narrowest levels in about five years. Are investors still being compensated for the additional risks?
We feel corporate securities are relatively attractive in the current environment despite relatively “full” valuations.
While yield advantages are relatively narrow, we believe there is further room for continued contraction.
Healthy corporate profits, low default rates, legislative gridlock, and benign inflation mean corporate bonds still offer attractive risk-adjusted yields.
U.S. intermediate Investment Grade corporate yields are roughly 110 bps greater than a maturity equivalent treasury security. High Yield securities are 275 bps higher.
Increased political uncertainty is translating into market volatility. As a result, we have an increasing preference for stable, higher-quality credits and industries in portfolios.
4. With the Fed raising rates, are high dividend and income stocks still attractive?
With rates at historic lows, many investors have used high-dividend stocks, rather than low-yielding bonds, in pursuit of income. Conventional wisdom says that those investors should return to bonds when interest rates go up.
While that might be true if interest rates were at or above historical norms, our research has found that dividend stocks can do well in an environment where rates are rising gradually from low levels.
Although valuation is a concern, economic growth remains solid and the companies we are invested in should continue generating solid operating results, which is what drives the dividend and ultimately the long-term total return.
Over the next 12 months, we feel that modest return expectations in the 5%-7% range, as driven by yield (actual) and growth in yield (projected) are realistic.
5. Is rising household debt a concern?
Although household debt surpassed its 2008 peak in dollar terms during the first quarter, nominal incomes have risen by around one-third since then.
Relative to disposable income, household debt is still well below its pre-crisis peak and has actually been remarkably stable for the past three years or so.
Importantly, interest rates also remain significantly lower, meaning that the cost to service household debt continues to be much more manageable.
Pockets of concern have developed in the student loan and auto credit sectors, but neither pose anywhere near the level of systemic risk as the mortgage bubble did.
For auto loans, it is unlikely the increase in the delinquency rate to a four-year high foreshadows a more serious downturn, not least because lenders have already moved to tighten standards.
The continuing rise in student loan debt is more troubling, but there is little sign that we are approaching a tipping point after which we will likely see a sudden increase in defaults.
Overall, the bigger picture is that Americans' balance sheets continue to be in good shape, supported by rising incomes, higher savings, and increasing asset prices.
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 risks include, but are not limited to, stock market, manager, or investment style. 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.
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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.
Floating rate loan securities generally trade in the secondary market and may have irregular trading activity, wide bid/ask spreads and extended trade settlement periods. The value of collateral, if any, securing a floating rate loan can decline, may be insufficient to meet the issuer's obligations in the event of non-payment of scheduled interest or principal or may be difficult to readily liquidate.
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.
The Standard and 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.
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