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. The Fed recently released its September meeting minutes. Did they provide insight into future action on interest rates?
Almost all FOMC members agreed that the case for a rate hike had strengthened. However, there remains an ongoing debate between the Fed hawks and the doves.
Hawks believe we are near full employment. Any delay in raising interest rates increases the risk of the economy overheating and would require a rapid rate increase down the road.
Doves believe there is still slack in the labor force. They can wait for an interest rate increase because there are few signs of increased pressure on wages and prices.
There is also a sub-group of both hawks and doves that believe the Fed will lose credibility if it waits too long to hike rates.
We believe the Fed will raise the federal funds rate at the December meeting, scheduled for December 13-14. The market appears to agree with this prediction (see chart).
3. What are the implications of this year’s presidential election for the stock market?
According to the latest polling data, a Clinton victory is the most probable outcome of this year’s 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.
Keep an eye out for additional, in-depth election coverage from City National Rochdale, including a forthcoming special bulletin.
4. How is Q3 economic growth shaping up?
After struggling since last year, the U.S. economy appears to have regained some momentum.
Q3 GDP is expected to come in around 2.0% – 2.5%, a relatively significant improvement over of the past three quarters, which have all come in under 1.5%.
While challenges from global weakness remain, the downturn in U.S. industrial activity appears to be bottoming. At the same time, domestic demand remains resilient.
The consumer sector continues to be the clear driver of growth, supported by job and income gains.
Job growth, while slowing, remains strong as improving labor market conditions are increasingly pulling people off the sidelines and into the labor force. As these individuals become gainfully employed, household spending should find further support in coming quarters.
5. The trade deficit is often discussed in political speeches. How bad is it?
The trade deficit is not a scorecard for our economic strength. In fact, the general belief among economists is that trade deficits are neither inherently good nor bad.
The global acceptance of free trade has been the catalyst for the larger trade deficits we have seen in recent times.
Free trade has generally proven to be a net positive, generating vast improvements in the global living standard. Consumers have been able to purchase goods and services at lower prices, thus providing more funds for discretionary spending.
However, there is an important downside to receiving cheaper imports, most notably the loss of employment of the domestic producer of the goods/services that is competing with the new import. This tends to affect entire industries, so finding replacement work is very difficult. Training for a new profession takes time and is a drag on economic growth.
The trade deficit started to increase in the early 1990s as tariffs fell to the wayside. The North American Free Trade Agreement (NAFTA) was signed in 1993, and China joined the World Trade Organization (WTO) in 2001.
The U.S. runs an annual trade deficit of about $750 billion for goods and a trade surplus of about $250 billion for services. The net deficit is about $500 billion (see chart).
6. Are you concerned about the recent relative underperformance of Asia in the emerging market (EM) universe?
No, emerging Asia equities have performed very well this year, with the MSCI EM Asia Index up 12.77% YTD (returns in USD). We continue to view the outlook favorably for those with a 7-10 year investment horizon.
While resource-heavy countries — Brazil and Russia specifically — have had significant outperformance within EM this year, we attribute this largely to bottom hunting and momentum chasing by investors.
Emerging Asia equity valuations are still relatively inexpensive 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.
Our focus remains on sectors and companies that may benefit from these long-term structural tailwinds.
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 MSCI Emerging Markets (EM) Asia Index captures large and mid cap representation across 8 Emerging Markets countries (China, India, Indonesia, Korea, Malaysia, the Philippines, Taiwan and Thailand). With 550 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.