1. Have City National Rochdale’s expectations for portfolio returns changed since the election?
Yes. Given the potential pro-growth policies of a Trump administration, we see corporate profit growth improving over the next two years, supported by a longer economic expansion. Inflation from faster wage increases may cause interest rates to rise further. Federal spending may increase, and lower tax revenues may lead to higher annual deficits in the next few years.
Equity investors will primarily benefit in 2017, while fixed income investors will likely experience downward bond value pressure as interest rates rise.
Surveys of consumer and business optimism have reached multi-year high levels. Historically, when business executives and consumers feel better, spending increases. However, with investors making so many assumptions, it would not be surprising to see some downward equity price volatility as the legislative process takes hold.
Since timing equity markets to avoid short-term volatility is not realistic, we will continue to overweight U.S. growth and dividend equities and watch carefully for the longer-term benefits of Trump’s potential policies to materialize.
Our confidence in a longer economic cycle and improving corporate profits supports our preference towards equities over bonds. We are no longer on reduction watch for equities.
2. What did the Fed decide at its last meeting of the year?
The Fed concluded its two-day meeting and decided to increase the overnight federal funds rate by 25 bps to a range of 0.50% to 0.750%, reflecting the Fed’s confidence in the strengthening of the U.S. economy and the budding signs of higher inflation.
This is the second rate hike in the cycle, following the move last December. Looking forward, Fed officials’ projections for 2017 interest rate hikes are steeper than their previous forecasts in September.
This rate decision was unanimous, widely expected by the markets, and unlikely to be a market mover.
3. Could Trump’s tax plan boost economic growth?
Yes, tax reform has the potential to at least modestly lift economic growth in the near term and could help extend the already historically old expansion.
Cuts to the individual tax rate would provide a significant increase in disposable personal income, which in turn should boost household spending. A decline in the corporate rate would make U.S. corporations more competitive, raise profits, and potentially increase investment and employment. On the negative side, a significant tax reduction would not be revenue neutral and would add to concerns about the long-term implications of the unsustainable growth in the national debt.
However, because of lags in the passage of legislation, we likely would not see any impact to the economy until later in 2017, with most of the benefits accruing in 2018.
Given how close the economy is to full employment, expansionary fiscal policy is likely to lead to higher inflation and thus a faster-than-expected pace of Fed rate hikes, offsetting gains somewhat.
4. Interest rates have moved up since the election. What is your outlook for investing in the bond market?
Yields have moved up substantially due to risk of more aggressive Fed policy and the increased probability of growth and inflation led by a higher fiscal stimulus. Mitigating some of that risk is the extension of quantitative easing by the European Central Bank.
Municipal bonds interest rates had initially increased more than those of taxable securities due to the threat of tax reform (reducing the value of the tax exemption) and possible increased supply, especially for infrastructure-related projects. Some of that movement has moderated during the first half of December.
We believe the recent back-up of interest rates creates an opportunity for investors. Investors should continue to allocate toward the higher yielding sectors.
5. Why have U.S. equity markets surprisingly rallied to record levels since the election?
A Trump presidency creates more political, economic and financial market uncertainty over the long haul than had Clinton won. However, the outcome is likely to be stronger near-term growth, though at the expense of longer-term sustainability.
Trump’s proposals are largely designed around bringing economic activity forward. This is more constructive for stocks than bonds. Cyclical areas in particular have rallied in anticipation of the incoming administration’s pledged tax cuts, increased infrastructure spending, and easing of regulatory burdens, which will drive growth higher. At the same time, investors have largely taken the attitude that a President Trump will pursue a much softer line on trade than some of his inflammatory campaign rhetoric would have suggested.
The likely reduction in the corporate tax rate should increase corporate earnings growth next year. Under these assumptions, City National Rochdale has raised our 2017 S&P EPS forecast to $134.
Finally, against a new reflationary outlook, equity prices may also benefit from modest multiple expansion.
6. Why have emerging market stocks fallen since the U.S. election?
The recent decline can largely be attributed to uncertainty over the future direction of U.S. foreign and trade policy, as well as the prospect of a stronger U.S. dollar. Over the next several weeks and months, we expect to get better clarity on the specific policies that a Trump administration will pursue, which should help settle markets.
For now, we believe Emerging Asia equity valuations are still relatively inexpensive (both on a historical basis and relative to other geographies), and corporate profit expectations are improving. Moreover, the region’s growth outlook remains resilient, supported by positive fundamentals including demography, income growth, urbanization trends, and saving/investment behavioral characteristics.
We continue to view the outlook favorably for stocks with a 7-10 year investment horizon. Our focus remains on sectors and companies that should benefit from these long-term structural tailwinds and that should not be directly impacted by negative implications of potential U.S. policy changes.
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.
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 & Poor’s (S&P) 500 Index represents 500 large U.S. companies. The comparative market index is not directly investable and is not adjusted to reflect expenses that the SEC requires to be reflected in the fund’s performance.