1. What expectations should investors have for portfolio returns?
Over the next year we anticipate equity and fixed income returns to be below historical averages, tempered by the effects of global monetary policy and the influence of global economic growth.
U.S. equities are now at record highs, supported by a modest but improving corporate profit outlook. However, valuations – though not excessive – do appear “full & fair.” This will likely limit upside potential in stocks to below historical average while volatility levels are expected to be at least normal if not higher.
While our current overweight for growth and dividend equities has been rewarding for all clients, from a risk/return perspective we are carefully considering whether a reduction in our equity exposure going forward is warranted.
Nearly two years ago, we reduced European equity exposure in client portfolios to just 5%, significantly less than the typical allocation of 10%-20% in a normal global asset allocation, and thereby limiting clients’ exposure to challenges now confronting Europe.
We continue to maintain our exposure in EM Asia which is focused on healthy growing domestic consumption and new-economy businesses in the region.
In fixed income, we are maintaining our current positioning across government, IG, and HY bonds. While IG bonds appear fully valued and yields are historically low, potential uncertainty ahead reinforces core fixed income’s role as a stabilizer in volatile markets.
2. Should we be worried about the lower-than-expected jobs gain in August?
Despite falling somewhat short of expectations, August’s 151,000 increase in jobs was still respectable, particularly after the strong monthly gains we saw in the prior two months.
Monthly payrolls are notoriously volatile, and other indicators continue to suggest that labor conditions remain healthy. For example, the level of initial jobless claims is at a 43-year low, and job openings are at a record high.
We do expect to see a slowdown in the pace of hiring as the expansion further matures and the economy moves toward full employment.
However, tightening slack in labor conditions should eventually generate stronger wage growth, which would provide households and the economy with important new support.
3. Does the recent low level of market volatility imply a market correction is imminent?
With stock markets near record highs and investor complacency at elevated levels, volatility is unlikely to stay low, and a near-term pullback is possible.
Keep in mind that September and October have historically been associated with higher volatility and declines in market returns.
Still, a low level of volatility does not imply that a major market correction is imminent. History shows that volatility can remain low for extended periods of time unless an event occurs to trigger a market correction.
Moreover, other conditions that often precede a significant correction are not present. In fact, they are moving in the right direction.
While valuations appear full, they are not overstretched. In addition, after reaching a trough earlier this summer, earnings now appear poised for a turnaround and are supported by a weaker dollar and more stable oil prices.
U.S. economic growth is also likely to improve, thanks to ongoing strength in the job market, signs of wage increases, continued upticks in housing and, lately, manufacturing.
Corrections are a normal part of market movements, which should encourage clients to stay the course when markets get choppy.
4. Is the Phillips curve no longer a good indicator of inflation?
The Phillips Curve, which demonstrates the inverse relationship between unemployment and inflation, has long been a core component of the Fed’s macroeconomic model.
As the unemployment rate falls, employers must pay higher wages to attract workers, which translates into higher prices in general (and vice versa).
The problem is that the link between unemployment and inflation (not just in the U.S., but globally) has weakened in recent decades.
Part of this reflects structural changes: technological progress and globalization have made it easier to substitute workers, while central banks have simultaneously been successful in taming inflation expectations.
Barring further large falls in unemployment, wage growth and thus broader price inflation look set to remain low.
This presents a new challenge for policymakers attempting to engineer the first rate hike cycle in 10 years and will likely keep rates lower for longer.
5. Why are yields in the High Yield sector falling?
It is as simple as demand outpacing supply, which is pushing up the price of the High Yield bonds.
Investors are looking for higher yielding investments and appear to be choosing the High Yield sector.
In an environment of stable credit risk and a simulative central bank, the reward seems to outpace the risk.
For comparison, the yields are relatively high (as of 8/31/2016):
- High Yield Corporates: 6.31%
- High Yield Municipals: 5.08%
- S&P 500: 2.01%
A combination of the higher income and price appreciation has pushed up the YTD total returns (as of 8/31/2016):
- High Yield Corporates: 14.35%
- High Yield Municipals: 9.08%
- S&P 500: 7.82%
6. What happened at the August 26th Kansas City Fed’s Economic Symposium in Jackson Hole?
The Fed is building the case for raising interest rates.
Janet Yellen stated: “…I believe the case for an increase in the federal funds rate has strengthened in recent months.”
This view is consistent with other recent statements by senior Fed policy makers.
City National Rochdale believes it will occur in December at the earliest, after more economic data becomes available and the November election.
With regard to John Williams’ (SF Fed President) research paper laying out the case for raising the Fed’s 2.0% inflation target, Chairwoman Yellen stated that the FOMC is not actively considering it, but it does need more research.
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.
An investment in money market funds is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in money market funds.
High yield bonds offer a higher yield and carry a greater risk of loss of principal and interest and an increased risk of default or downgrade than investment grade securities.
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.
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 Investment Products: ▪ are not FDIC insured ▪ are not Bank guaranteed ▪ may lose value
The CBOE Volatility Index® (VIX® Index®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.