On the Radar

City National Rochdale, | Mar. 18, 2019

FAQs on the Markets and Economy

Is February’s disappointing jobs gain a sign that the labor market is weakening?

The increase of only 20k jobs last month was a big miss on expectations, but there is good reason to look past the dour headline number. Weakness in hiring was, in part at least, influenced by temporary factors such as the government shutdown and poor weather. Notably, the slowdown also came on the heels of two months of strong consensus-beating gains.

Meanwhile, the report was filled with plenty of other positives that indicate overall labor conditions continue to be strong. The unemployment rate edged lower, the labor force participation rate maintained January’s gain and hourly earnings accelerated, rising to 3.4% year-on-year — the fastest pace in almost 10 years.

Monthly payrolls can be volatile, making it important to look at the recent trend. The three-month rolling average of job gains is a healthy 186k, which is more realistic of current conditions than either the 311k rise in January or the 20k rise in February.

We expect job growth to slow in the year ahead, but it will be on the back of a labor market that has essentially achieved full employment rather than any pronounced deterioration in domestic demand.

Modern Monetary Theory (MMT) has been in the news lately. Simply put, MMT says a government that borrows in its own fiat currency isn’t constrained by deficits because the bonds it uses for financing its debt can always be paid off by printing more currency. If an excess of spending strains resources and causes inflation, monetary policy can be adjusted to rein it in.

The MMT has been around for more than a century, and it became popular again thanks to Bernie Sanders’ 2016 presidential run. Rising political star Alexandria Ocasio-Cortez believes it is a way of financing the Green New Deal, legislation she is co-sponsoring.

Jay Powell is not a fan. He recently told the House Banking Committee, “The idea that deficits don’t matter for countries that can borrow in their own currency, I think, is just wrong.” Furthermore, he added that the Fed’s role is not to provide support for particular policies. Clearly, he was stating that the central bank’s balance sheet should not be utilized to finance something like the Green New Deal.

One of the reasons for the MMT’s increasing popularity is that it appears to be a justification for the enormous and growing federal debt.

The ECB made a big pivot toward being more accommodative. Back in December, it thought the 19-nation eurozone didn’t need any extra help, and it was setting up plans to reduce its stimulus of the economy — even talking about raising interest rates sometime down the road.

But, storm clouds are now darkening on the ECB’s outlook of the global economy — there is the economic slowdown in China, fears that the U.K. will make a chaotic exit from the EU and the aftershocks of the U.S. trade wars. Economic weakness has caught the ECB by surprise. Italy is in a recession, and Germany has narrowly avoided one.

This change in outlook has forced the ECB to downgrade its outlook on the economy. It cut the 2019 GDP outlook to 1.1% from 1.7%, and it cut the inflation forecast to 1.2% from 1.6%. The ECB will be deploying new longer-term loans known as TLTROs (targeted longer-term refinancing operations), which are offered to banks and offer them an incentive to increase their lending to businesses and consumers.

We continue to be cautiously optimistic in our view of the U.S. equity market for the balance of this year, though we expect more muted returns and continued volatility. While the damage from the recent correction has not been fully repaired — the market is still about 4% below last year’s high — investors seem to be now pricing in a more reasonable balance between present risks and opportunities.

The Fed’s dovish turn and a resumption of trade negotiations with China have improved sentiment, while recent earnings results are consistent with our view that corporate profits are likely to rise again this year, albeit at a more modest pace, on the foundation of continued economic expansion. We remain hesitant, however, to signal the “all clear.” The pace of recent market gains is not likely to continue, and while we do not expect markets to retest December’s lows, some type of consolidation or pullback would be normal in the months ahead.

Valuations are less compelling now than they were late last year, and to warrant higher multiples, we’ll need to see resolution on a number of policy fronts, particularly trade. Still, we expect the bull market to continue, and that over time, equity prices will grind higher in line with modest corporate profit growth.

Given our positive assessment of the fundamental backdrop, we remain bullish on equities in general for 2019 and continue to see attractive prospects in the opportunistic fixed income class. Still, we believe investors should prepare for more moderate returns in the year ahead and continued volatility.

The investment landscape has grown 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, trade tensions 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. Our equity and fixed income research teams have made deliberate risk mitigating changes to help fortify client portfolios against the type of turbulence we have recently experienced while leaving them well-positioned to take advantage of opportunities should they present themselves.

Municipal bond mutual fund flows of nearly $14 billion (through the first week of March) established record receipts for the period. The robust net capital additions into the high yield and investment grade segments have bolstered investor demand for municipal bonds.

The YTD gross supply of new municipal bond issues is relatively in line with the five-year average and moderately higher (roughly 7%) over the previous year. However, after accounting for redemptions, maturities and coupon payments, the resultant net negative supply has led to deal oversubscription and compressed spreads.

In states affected by the limitations imposed on SALT deductions — for example, California — in-state preference for tax-exempt income has particularly driven investors to optimize their tax efficiency. Despite expensive valuations (the 10-year Municipal-Treasury Ratio at a 52-week low), such dynamics could dampen seasonal weakness that typically surfaces during March and April.

Shorter-term tenors offer real returns (taxable equivalent yield) providing an attractive opportunity for cash and liquidity management mandates, and the shape of the municipal yield curve remains relatively steep versus Treasuries, thus providing incremental value further along the term structure. Since the beginning of the year, nominal municipal yields have declined, helping the performance of the asset class. The Bloomberg Barclays Municipal Bond Index has returned more than 1.7% YTD (compared to roughly 90 bps for the broad Treasury Index).

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Important Disclosures

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 include, but are not limited to, stock market, manager, or investment style risks. 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 may include, but are not limited to, interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond risks. 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.

Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

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.

Index Definitions

The Standard & Poor’s 500 Index (S&P 500) is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.

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