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 underweight bonds.

Given the potential pro-growth policies, including tax cuts and stimulus spending, we see corporate profit growth likely improving over the next two years, supported by a longer economic expansion.

Inflation from faster wage increases may cause interest rates to rise moderately. Depending on the specifics of tax cuts and spending increases, they may cause higher deficits.

Surveys of consumer and business optimism have reached multi-year high levels, which real economic growth in the U.S. and globally validate. 

Equity investors should benefit, while fixed income investors could experience downward bond value pressure as interest rates rise.

However, as the legislative process elongates and new expected U.S. fiscal proposals are delayed, downward equity price volatility is possible.


2. How does this Fed tightening campaign compare to others?

At just 15 months, the current tightening campaign is below the average of 21 months, and it is tied for the fourth shortest of all the campaigns since the late 1970s, when the Fed became aggressive at adjusting the federal funds rate.

It is unique that the Fed would wait a whole year for a second rate hike. Of the tightening campaigns during this period, the average period of time for the Fed to have their second rate hike has been just three months.

This tightening campaign is coming off the longest period of time (84 months) with no Fed action. This “tortoise” approach to reducing monetary stimulus has fostered improving valuations of many risk assets.

Based on current Fed communications, it is likely rates will gradually rise over the next 12- 24 months. Eventually the Fed thinks that the Fed funds rate would reach 3%. If this course of rate hikes occurs as the Fed thinks, ultimately we believe those rate increases will cause economic activity to weaken at a later date.


3. What does Fed tightening mean for investors?

The current Fed tightening cycle is not intended to slow an overheating economy. Instead, rates are simply being lifted from emergency lows, and monetary policy remains extremely accommodative.

Moreover, the Fed is painfully aware of the market impact from 2013’s taper tantrum and continues to favor a gradual, well-advertised approach toward policy normalization.

This combination is friendly to risk assets and supports our overweight to domestic and high dividend equities, as well as opportunistic credit.

Economic conditions are what matter. Low but rising interest rates are not a concern as long as economic and earnings growth is good, and inflation is anchored at low levels. 

Not until rates rise to a level that causes slowing economic activity in interest-sensitive sectors of the economy, like housing, autos, and business capital spending, will broader economic activity trends and earnings growth be at risk.

The U.S. equity market in particular has done well during past Fed tightening cycles against a backdrop of solid growth and low inflation. In contrast, fixed income investors will likely experience downward bond value pressure as interest rates rise. Our underweight reflects the limited return upside beyond the yield.


4. Is the Trump rally over?

The equity rally so far has been driven by expectations of coming tax cuts, deregulation, and more infrastructure and defense spending.

However, the failure of Republicans’ health care bill last week is the clearest indication yet that implementing President Trump’s legislative agenda won’t be as easy as investors had hoped.

Although there is no procedural reason why cutting taxes depends on health care reform, the fact that the latter proved so difficult doesn’t bode well for Republicans’ ability to work together on future legislation.

While we still expect a package of tax cuts to be passed by early next year, the risk of a further delay to Trump’s fiscal stimulus has increased somewhat as result.

Until we get greater detail on the composition and timing of new fiscal proposals, a pullback in the stock market is to be expected and we believe a better buying opportunity is ahead.


5. Is the weakness in recent “hard” economic data a cause for concern?

No, weakness in first quarter GDP has not been unusual in recent years, with average growth well below that of other quarters.

While some recent “hard” activity data has disappointed, this stands in stark contrast with a wide range of survey measures, or “soft” data which have moved up markedly over the past few months and are a better gauge of future growth.

Moreover, not all activity data has looked weak; the jobs market continues to show strength, equipment orders are picking up, and manufacturing output has climbed to its highest level since July 2008.

Consumer spending has been the most disappointing recently, but underlying fundamentals remain extraordinarily favorable and consumption has rebounded vigorously in the spring every time that first quarter growth has sagged in past years.


6. With the Fed raising rates, are high dividend & income stocks still attractive?

With rates at historic lows, many investors have used high dividend stocks, rather than low-yielding bonds, to pursue 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), should be realistic.


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 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.

There are inherent risks with fixed income investing.  These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond.  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.

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.

Non-deposit investments: are not FDIC insured, are not Bank guaranteed and may lose value.

Index Definitions

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.