FAQs on the Markets and Economy
Will this year’s holiday season be a sales tax boon for state and local budget coffers?
The recent Wayfair Supreme Court decision allows states to enact expanded tax laws to include online sales from sellers without an in-state physical presence. More than thirty states currently operate some form of an economic provision vis-à-vis laws or regulations, etc., allowing them to capture online sales activity from merchants.
According to the Federal Reserve Bank of St. Louis, e-commerce as a share of U.S. retail sales is over 9% today, up appreciably from nearly twenty years ago when it was less than 1%. Adobe Analytics reported the 2018 Cyber Monday online sales reached a record $7.9 billion, a 19.3% increase YoY. Moreover, Black Friday pulled in a record $6.2 billion in online sales.
The Government Accountability Office reported states could net between $8 and $13 billion in incremental sales tax collections. However, states with the greatest potential absolute revenue upticks, such as California ($1B to $1.7B), are not likely to experience a material improvement in their credit trajectory as these amounts represent relatively small percentage gains versus their total budgets. Nevertheless, with time, the shifts in economic bases and consumer preferences, coupled with state (and local, if applicable) sales tax collection could positively impact the quality of select issuers.
What did Fed Chairman Powell say at his speech to the Economic Club of New York?
He says the federal funds rate is “just below” the broad estimates of the neutral rate. The neutral rate is the interest rate that neither stimulates nor constricts economic activity. When interest rates are neutral, the economy is on a sustainable path. It has been below the neutral rate since 2008.
The Fed calculates the neutral rate with a complicated model (chart). This is somewhat of a reversal from a statement he made back in early October when, in an unscripted moment, he stated that the funds rate was a “long way” from the neutral rate. This was viewed as a very hawkish statement and gave the impression that the Fed was preset on a hiking path to a level higher than neutral. This new statement, which is more market friendly, is consistent with one made recently by Vice Chair Clarida.
The Fed is still expected to raise the federal funds rate by 25 bps to the median level of 2.375 at their upcoming December 19th meeting.
Is the recent decline in stocks the beginning of the end for the bull market?
We continue to view the current pullback as a correction which can help ultimately extend the long-running bull market. While the U.S. and global economic activity is expected to moderate in 2019, growth is still projected to be above potential and recession risk remains low. Likewise, recent negative earnings sentiment is not about the direction of growth, but on the magnitude. We agree that earnings growth will slow next year, particularly as corporate tax cuts roll off, to a more normal rate of about 5-7%.
A further escalation of trade tensions with China appears likely, but on their own, their effects on the U.S. economy and corporate profits should be manageable. Far more concerning is the interest rate backdrop. However, rates continue to be low by historical standards and Fed Chair Powell’s recent speech has provided markets with some reassurance that central bankers are focused on the risk of overtightening policy and ending the cycle prematurely.
Over time, we expect investors will eventually reconnect to the broader positive fundamentals. In the meantime, our client portfolios are constructed with this volatility in mind and should withstand the correction relatively well due to our high-quality equity allocation and overweight to U.S. Large Cap stocks versus Midsmall Cap and International.
What’s the latest on Brexit?
After months of negotiations, UK and EU officials have finally agreed on the draft text of a Brexit agreement. The draft agreement means that there will be no hard border between N. Ireland and Ireland (the most contentious issue) and there won’t be a splitting of the UK customs area even if the UK and EU have not agreed to a ‘future relationship’ by the end of the transition period in 2021.
However, the plan still needs to survive vetting in Parliament. Opposition has already been fierce, and even the survival of Prime Minister May’s government is now in doubt. Looking forward, key dates to keep an eye on are the November 25 EU summit to formally agree to the deal and the December 10 UK Parliament vote should the EU approve the Withdrawal Agreement as expected.
Overall, this is an important, but fragile first step, and it remains very difficult to predict how the withdrawal process will eventually unfold.
This political uncertainty, along with relatively muted earnings growth and weak economic momentum, supports our continuing underweight to European equities.
Is City National Rochdale’s investment outlook still positive?
Based on our outlook for solid economic growth and improving corporate earnings, we remain bullish on equities in general and continue to see attractive prospects in the opportunistic fixed income class. Bear markets outside recessions are rare.
Still, we believe investors should prepare for more moderate returns in the months ahead and perhaps greater volatility. Patience and discipline will be more important than ever. The investment landscape is growing more challenging as investors adjust to more typical late-stage expansion conditions of higher inflation, rising interest rates, and less accommodative monetary policy.
Meanwhile, concerns over global growth, rising trade tensions, midterm elections, and other geopolitical risks mean markets will likely continue to be subject to periodic swings in sentiment and potential pullbacks.
None of this means there are not more worthwhile gains ahead for investors, but it does highlight the value of active management and the need for investors to become more selective. We actively manage portfolios to be aware of where we are in the cycle, to take advantage of opportunities as they arise, and to be on alert if conditions deteriorate.