1. What expectations should investors have for portfolio returns?
Over the next year we anticipate returns 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, while not excessive, do appear “full & fair,” limiting upside potential to below historical returns.
From a risk/return perspective, we are therefore considering whether a reduction to our modest overweight in growth stocks is warranted. Our current allocation to U.S. high dividend stocks is expected to be maintained, but is subject to watch as well given rising valuation considerations.
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, 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. 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.
3. How is the change with money market funds affecting investment opportunities at the short-end of the yield curve?
In mid-October, institutional Prime & Tax-Exempt money market funds will no longer provide their shareholders a constant $1 net asset value and may restrict or charge fees for withdrawals.
This has caused many mutual fund companies to close their Prime & Tax-Exempt funds (note: government money market funds can continue to provide the constant $1 NAV).
These funds were enormous buyers of short-term corporate and tax-exempt debt. Now, top-rated issuing companies do not have a large natural buyer of their debt and prices have fallen, yields have shot up.
This has provided opportunities for liquidity management to be offered as a separate account to take advantage of these higher yields.
This is something the market has not seen since the Fed lowered interest rates to the near zero level back in late-2008.
If the Fed raises rates later this year, it may provide liquidity management accounts even more yield.
4. Is there reason to believe that the slump in industrial production from its late 2014 peak is bottoming?
Yes, the recent improvement in industrial output may be the first indication that stabilization in the dollar and energy prices are reducing headwinds to the sector.
Manufacturing output has increased now three months in a row, with the latest gain in July the largest in over a year.
The mining sector is also seeing improvement. Mining output fell 16.9% between December 2014 and the recent low in April 2016, mostly in reaction to the decline in oil and natural gas prices.
With the partial rebound in crude oil prices this year, drilling activity has already begun to recover.
While it’s unlikely that industrial production will swing back to a position of strength anytime soon, a bottoming in the sector’s slump would reduce a significant drag on overall economic growth going forward.
5. Should equity investors continue to remain underweight Europe?
We have been significantly underweight Europe for several years now, and for us to change that position we need to have more confidence in Europe’s outlook.
Euro economic data post-Brexit has held up better than expected so far, but it’s still much too early to fully assess its impact and there remains an extraordinary amount of uncertainty as to what will happen next.
This uncertainty comes on top of an already weak economic outlook that’s hamstrung by structural barriers to growth including an aging population, declining productivity, high unemployment, and diminished global competitiveness.
Additionally, we remain skeptical of the ECB’s ability to boost demand and fiscal reforms remain elusive in the face of political impediments.
For investors, corporate health is key and on that front the picture remains gloomy. European earnings have continued to deteriorate so far this year, falling 22% y-o-y in Q2 vs. –3.2% in the U.S.
Despite optimism among some investors for an earnings rebound in coming quarters, we remain skeptical. Not only is expected sales growth lower, but European corporate margins are declining vs. the U.S.
6. What is happening in Japan?
The Japanese economy remains stuck in a rut.
Just released GDP data show Q2 GDP rose just 0.2%, and y-o-y GDP rose 0.6% y-o-y.
Since Abenomics was introduced three years ago, Japan’s economy has increased just 0.9%, annualized.
Since hitting a pre-recession peak in 2008, their economy has only increased 0.2%, annualized.
With inflation at just 0.4%, it continues to be well below their target rate of 2.0%.
Unfortunately, the yen has been rallying since November due to a flight to safety, making their exports expensive.
Ultimately Japan will need to be more aggressive with their monetary and fiscal stimulus.
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