Slow GDP Growth Likely to Lengthen Expansion, Potentially Aiding Stocks
U.S. Economy a Standout in Uncertain World
Strong Quarter for Dividend Stocks
U.S. Equities Remain Positive Despite Brexit
High Yield Income Continues to Pay Off
Fundamental Outlook Improves for Asian Emerging Markets
From the Desk of
GARRETT D’ALESSANDRO, CFA, CAIA, AIF®
The surprising news of the UK’s decision to leave the European Union was as much a rejection of the EU’s governance out of Brussels as it was of the cumulative effect of decisions that have altered the experience of life once known and cherished by the British. The global experience of free trade and open borders may bring benefits in the aggregate (according to economists), but as is often the case there are winners and losers from global trade. The losers have increased in numbers in Europe, the UK, and the U.S. They also have become more vocal in their distaste for, and perhaps distrust of, elected governments when it comes to managing their countries in a manner that provides a better living standard for all citizens, not just the winners.
For investors, focusing on risk management takes precedence over trying to predict the implications of Brexit well before any new agreements for economic cooperation between the UK and EU are finalized. Due to many factors, including the lack of clear leadership and competitiveness across Europe, City National Rochdale has not held more than 5% of our equity and fixed income allocations in the region for over one and a half years (despite those markets representing about 22% of the MSCI global stock value). That decision, while prescient, gives us confidence that whatever results from the coming UK-EU negotiations, our clients will remain observers since only a modest amount of our capital is allocated to that region.
It is important to note that while the impact of the Brexit vote was transitory on equities, it was rather dramatic on fixed income. Conservative investors in fixed income seek a reasonable return with a high degree of predictability. Political uncertainty leads to the pursuit of investments away from the areas of uncertainty. The UK’s vote to exit the EU altered both the returns available and their predictability. As a result, investors looked across the Atlantic for better yields and a more predictable government and social foundation. They are now investing in U.S. government bonds in preference to Eurozone bonds, driving U.S. yields to current record lows – and likely even lower in the near term. This interrelationship is bothersome because it means our interest rates are somewhat dependent on factors outside the U.S., which also means that our economy is somewhat captive to events occurring in the EU and the UK.
Lower yields are seriously unhealthy for capital lenders, insurance companies, pension funds, and all other investors that have material amounts allocated to U.S. fixed income securities. We believe these very low rates will not produce beneficial effects over the long term for our economy, and we note that yields this low could potentially create risks for investors were inflation to rise.
Equities remain near record highs while yields are near record lows. These low rates were caused largely by the uncertainty abroad and now bring financial uncertainty to U.S. fixed income investors. It has altered the Fed’s freedom to act solely on what is best based on U.S. economic activity and is, in our view, a situation that requires rigorous risk management.
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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.
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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, 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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