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 remain near 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%, which is significantly lower than the typical allocation of 10%-20% in a normal global asset allocation, 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. What did the Fed decide at its meeting that wrapped up on November 2?
The Fed decided to keep the federal funds rate at the current range of 0.25% – 0.50%. This came as no surprise, due to the close proximity of the meeting to the general election.
The Fed is expected to raise the funds rate at its next meeting in mid-December, unless the economy or financial markets come under pressure.
The trend for a rate hike has been brewing for some time (see chart).
At the previous meeting in September, three of the ten members of the FOMC wanted to raise interest rates, and an astounding nine of the 12 regional Federal Reserve banks requested a discount rate hike prior to that meeting.
3. What are the implications of this year’s presidential election for the stock market?
Despite a tightening in recent polls, a Clinton victory remains the most probable outcome of this year’s presidential election. This would largely represent a continuation of the current administration’s recent policy.
Markets would likely prefer a Clinton win over Trump, whose election could usher in major shifts in policy and considerable uncertainty.
In the past, “change” election years have seen volatility prior to the vote, only for the market to rally once the outcome became known and investors settled into the resolution of the uncertainty.
Over the long run, equities have generally performed well regardless of any particular combination of political party control of government (see chart).
Ultimately, companies’ abilities to grow their earnings and dividends and to keep valuations within a reasonable range are much more influential driving forces behind stock gains.
Once the election results are in, we will be able to provide more insights into the potential financial impact of the new president’s proposed policies. Keep an eye out for City National Rochdale’s forthcoming post-election special bulletin.
4. What did we learn from the recent GDP report?
Q3 GDP came in at 2.9%, slightly better than expected. This growth was a welcome relief following sub-1.5% growth in each of the previous three quarters.
The previous quarters were held down by inventories (found in the investment category) and trade; those reversed in Q3 (see chart). The economy appears to be headed back to its post-recession average of 2.1%.
Consumption, which is the largest portion of GDP and makes up about two-thirds of the total, was up 2.1% in Q3. It has been volatile on a quarterly basis, but is up a strong 2.6% in the past year.
Q4 growth is currently expected to increase 1.8%.
5. How do opportunistic asset classes perform during periods of rising U.S. interest rates?
Opportunistic asset classes tend to perform very well relative to U.S. Treasuries and Investment Grade bonds during periods of rising rates. These asset classes are more credit risk-centric than interest-rate centric, and their returns are fairly uncorrelated with U.S. interest rates.
Non-Investment Grade assets have larger credit spreads than like-maturity Investment Grade assets. As such, these opportunistic assets have a lower duration, or interest rate risk, than similar-maturity core assets. Moreover, Leveraged Loans are a floating rate product and directly benefit from an increase in interest rates.
We expect the relatively low level of corporate defaults to continue as corporate fundamentals remain strong outside of commodity-centric sectors.
6. Why is the Chinese yuan weakening?
While the rest of the world is focusing on elections and military conflicts, the yuan has been quietly falling in value. It recently hit a six-year low.
Part of this weakening is due to a stronger dollar, which can be attributed to the expectation that the Fed will hike interest rates in mid-December.
What’s more, capital outflows have hurt the Chinese economy. The government is also restraining government spending and credit growth.
It is believed that the Chinese central bank will allow a continued gradual weakening of the currency to help the export portion of their economy.
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.
The Barclays Aggregate Bond Index is comprised of U.S. government, mortgage-backed, asset-backed, and corporate fixed income securities with maturities of one year or more.
The Barclays U.S. Corporate High Yield Index covers the U.S.-dollar denominated, non-investment grade, fixed-rate, taxable corporate bond market and includes securities with ratings by Moody’s, Fitch and S&P of Ba1/BB+/BB+ or below.
The Barclays Emerging Markets High Yield Bond Index tracks the performance of the below-investment-grade U.S. dollar-denominated emerging market sovereign and corporate bond market.
The S&P/LSTA U.S. Leveraged Loan 100 Index is designed to reflect the performance of the largest facilities in the leveraged loan market.