Investment Roundtable and Outlook for 2018 - Capital Group
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WINTER 2018
Investment
Roundtable
and Outlook
for 2018
GLOBAL OUTLOOK KEY TRENDS FOR 2018 ENDANGERED JEWELS AUTHOR INTERVIEW
Members of our investment Themes likely to have a Destinations around the Advice for taking a
team discuss their thoughts significant impact on world to visit before they tech break and turning
on the year ahead companies of all types completely disappear boredom into brilliance
O PE NING TH O UG H TS
I’VE FOUND THAT THE MOST
EFFECTIVE INVESTORS TEND TO
EMPLOY UNCONVENTIONAL
WISDOM WHEN EVALUATING
POTENTIAL OPPORTUNITIES.
The Wisdom of Thinking Differently
I’ve always been a big fan of unconventional wisdom. From Thomas Edison and Benjamin Franklin
to modern names like Steve Jobs, Elon Musk and James Dyson, some of our nation’s biggest
innovators have built their legacies — and changed the world — through unconventional thinking.
By the same token, I’ve found that the most effective investors tend to employ unconventional
wisdom when evaluating potential opportunities. After all, if you look at things the same way
as everyone else, you’re bound to deliver mediocre results. That’s why Capital Group’s team of
analysts spends so much time traveling the world, meeting not only with company executives but
also with customers, suppliers, policymakers and many others to uncover insights that may have
been overlooked.
The events of 2017 clearly demonstrated why unconventional wisdom is such a critical investment
mindset, and why sticking to your plan despite all the outside noise is so important. Going into the
year, the so-called conventional wisdom was that the Federal Reserve’s plan to raise interest rates
would harm bonds, U.S. equities would continue to do better than their international counterparts,
and emerging market stocks had seen their best days. What happened? Bonds continued to do
well, despite a cumulative 0.75% Fed hike; international markets charged significantly higher than
the U.S.; and emerging markets were the strongest asset class of all.
So what’s the outlook for the year ahead, particularly with most broad stock indexes at or near record
highs? You’ll get insights on that, along with more enlightened and unconventional wisdom, in our
fixed-income and equity Investment Roundtables, which begin on page 6. Our team members
share their views on what moved the markets last year, explain what they’re focused on now and
reveal how they are positioning their portions of client portfolios.
When it comes to making your vacation plans for the coming months, conventional wisdom might
lead you to visit one of any number of popular destinations. But on page 16 we suggest a number
of places to consider that are off the beaten path and in jeopardy of disappearing in the future, for
reasons we detail.
Finally, conventional wisdom tells us that being bored is bad. Our featured author begs to differ.
Manoush Zomorodi says we are so connected to our smartphones and other mobile devices that
we never take the time to properly unwind. In her new book, Bored and Brilliant, she suggests
small ways to spend less time connected to technology and more time spacing out to unlock our
creativity. She shares some of her best advice on page 18.
On behalf of everyone at the firm, I hope you enjoy this issue, and I wish you and your family a
wonderful year ahead.
John Armour
President
Capital Group Private Client Services
FEATURED ARTICLE
Editor-in-Chief
Kirk Kazanjian
Writer
Walter Hamilton
Copy Editor
Ruth Hamel
Designer
Brendan Heisler
Marketing Associate
Brendan Heisler
Publication Coordinator
Kathleen Park
16 | Travel Jewels to Visit
Contact Before They Disappear
333 South Hope Street Here are a dozen endangered
46th floor
destinations to add to your
Los Angeles, CA 90071
vacation list
Website
capitalgroup.com/pcs
IN THIS ISSUE
2 | Investment Commentary 6 | Equity Roundtable 10 | Bond Roundtable
Stocks and bonds post a A look at the prospects for Our fixed-income investment
banner year, fueled by tax continued gains in stock team shares its thinking on
reform and a measured Fed markets around the world the year ahead
13 | Tax Policy Impact 14 | Key Investment Trends 18 | From Bored to Brilliant
Analyzing the pros and cons Two themes driving profound A strategy for taking a break
of the new tax bill for high net change for companies across from your smartphone to
worth investors many industries think more clearly
20 | Tax Planning Guide Find Us Online
Here’s a handy sheet with
the new tax rates and other
important provisions
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is
intended to highlight issues and not to be comprehensive or to provide advice. The thoughts expressed herein are based upon sources believed to be reliable and are subject to change at any time.
There is no guarantee that any projection, forecast or opinion in this publication will be realized. Past results are no guarantee of future results. The information provided herein is for informational
purposes only and does not take into account your particular investment objectives, financial situation or needs. You should discuss your individual circumstances with an Investment Counselor. Any
reproduction, modification, distribution, transmission or republication of the content, in part or in full, is prohibited. © 2018 Capital Group Private Client Services.
The Capital Group companies manage equity assets through three investment groups. These groups make investment and proxy voting decisions independently. Fixed-income investment professionals
provide fixed-income research and investment management across the Capital organization; however, for securities with equity characteristics, they act solely on behalf of one of the three equity
investment groups. Not all of the analysts and portfolio managers featured in this publication are involved in the management of Capital Group Private Client Services portfolios.
INVESTM E NT C O M M E NTARY
At right: Industrial
welding robots at
work on an auto
manufacturing line.
It’s rare for a U.S. economic expansion to
enter its ninth year, and rarer still for the pace
of growth to be accelerating. Then again,
BROAD-BASED
it’s uncommon for earnings to be so sturdy,
consumer confidence to be so vibrant and
GROWTH AND BUSY
unemployment to be so low. And the good
news extends far beyond the U.S. Favorable
FACTORIES HAVE
conditions are taking hold around the world,
with major economies undergoing a burst
PROPELLED GLOBAL
of synchronized growth. Of course, financial
markets still face an assortment of challenges,
MARKETS
including Federal Reserve rate hikes,
geopolitical tensions and jitters over the sheer
length of the economic upturn. But many of the
catalysts that have powered the stirring global
rally appear to be firmly rooted, spurring hope
that further gains will come.
2 C A P I TA L G R O U P P R I V AT E C L I E N T S E R V I C E S
After years in which the U.S. was the
global economic torchbearer, gains in CORPORATE EARNINGS HAVE RISEN IMPRESSIVELY
the rest of the world have been striking. Profits have jumped throughout Europe, Japan and the emerging markets.
Previously lagging international equity
markets have reached multi-year highs, 2016 Actual 27.3%
2017 Estimated 23.3%
carried along by many of the forces
that fueled the U.S. in recent years. The
broad-based nature of the expansion 16.1%
Earnings Growth
suggests that we may be experiencing a
so-called virtuous cycle in which positive 10.2%
forces become self-sustaining and 7.0%
growth begets further growth.
0.5%
Manufacturing has stood out as perhaps
the brightest spot on the world -0.8%
-3.5%
economic stage. As shown at the bottom
Global United States International Emerging Markets
of page 4, factory activity is expanding
in virtually every country — its best Source: FactSet
performance in more than a decade.
Perhaps most notable: long-drowsy
Europe is registering many of the the U.S. may be picking up steam. Of course, the procession of record
strongest readings. Economic growth topped 3% in back- highs has pushed stock valuations
Other indicators rounding out the to-back quarters for the first time since to elevated levels. Lofty valuations
encouraging global picture include 2014, and many of the factors that have don’t necessarily precipitate market
corporate earnings, which are up been at the heart of the U.S. expansion corrections, and many of the negatives
strongly in the U.S. but even more so remain well-entrenched. Unemployment that historically presage lengthy market
in Europe, Japan and the emerging has dropped to a 17-year low, while downturns, such as unrestrained
markets (see the chart at right). Likewise, consumer confidence is just off a 17-year investor euphoria, are not prevalent.
declining unemployment and increasing high. Barring an unexpected economic Equally important, earnings have risen
confidence among businesses and reversal, the jobless rate may dip below in lockstep with stock prices over the
consumers have become global 4% in 2018. The upbeat mood among past two years, keeping valuations at
phenomena. consumers has been evident in retail roughly the same level as two years
spending, with consumer outlays on ago. Nevertheless, extended valuations
To be sure, global gross domestic
durable goods rising strongly in the can indicate more muted equity gains
product has been modest compared
third quarter and year-end holiday sales moving forward.
with past upturns. But the improvement
registering their finest performance in
has raised hope that durable recoveries The overseas resurgence has been
some time.
are finally underway in nagging trouble impressive.
spots such as Europe and Japan, and Growth has been aided by modest
inflation and still-low interest rates. The firming of the international economy
that the global expansion has the
Despite a total 0.75% in rate hikes by the may be most evident in Europe, as the
potential to be “stronger for longer.” The
Federal Reserve, the yield on 10-year pickup that took hold last year gathers
International Monetary Fund expects
Treasury notes ended 2017 below 2.5%, momentum. Consumer sentiment,
growth to increase solidly in 2018, with
lower than its average over the past retail sales and corporate earnings
each of the world’s major economies
decade. Meanwhile, business sentiment have all moved higher. And though it’s
contributing. Despite the forceful
has soared amid the deregulatory push still elevated at 8.8%, the eurozone’s
rallies, equity valuations remain more
in Washington and anticipation of the stubbornly high unemployment has
attractive overseas. Within many sectors,
tax overhaul package that became law in dropped to its lowest level since
we are finding equivalent European or
December. Improved sentiment appears 2009. The improving conditions have
Japanese companies trading at notable
to be translating into business spending, prodded the European Central Bank to
discounts to their U.S. peers.
with capital expenditures improving begin gingerly stepping back from its
The U.S. economy keeps pushing into toward year-end. Overall, the tax cuts aggressive economic stimulus campaign.
higher gear. are expected to boost GDP by as much The central bank is keeping interest
In a recovery that has chugged along as a quarter point this year and next, rates anchored at historic lows, but it has
admirably but unremarkably for years, according to a Capital Group estimate. announced plans to scale back its
Q U A R T E R LY I N S I G H T S WINTER 2018 3
purchases of government and 2018 despite a market boom that middle class in the developing world
corporate bonds. has brought a flurry of deals and is expected to bring a rise in meat
Meanwhile, stock prices in Japan ballooning prices, according to consumption as consumers earn more
reached their highest level in a Capital Group’s China economist. disposable income. But share prices of
Among other positive factors, buying agriculture-related stocks — including
quarter century as solid exports
demand remains vibrant, trade-up farm-equipment and fertilizer makers —
helped to push up GDP for the
activity is robust, and mortgage debt is have lagged, creating attractive long-
seventh consecutive quarter. As in
manageable. term buying opportunities.
other countries, solid profit growth
in Japan is fueling corporate capital The rally in emerging markets equities Managers also have been attracted to
expenditures, employment gains and is more than 20 months old, with select stocks within the energy sector,
household spending. stocks up 70% since their trough which has been weighed down by
in early 2016. The outlook remains weak oil prices.
Emerging markets are on a roll.
promising, however, as these countries
The developing world is benefiting Bonds gained despite continued rate
shift their economic bases from heavy
from a confluence of factors, hikes.
dependence on smokestack industries
including robust global growth, to a greater reliance on the production Even as the Fed lifts short-term interest
solid commodities prices, ongoing of sophisticated technology. Overall rates, long-term rates have remained
economic reforms and rising domestic valuations are still attractive on a subdued. A variety of factors have
demand. In China, growth remained historical basis and compared with kept a lid on bond yields, including
strong as the government made developed markets. For instance, quiescent inflation and steady buying
economic stability a priority in the run- China, Taiwan and Brazil are all trading demand from overseas investors
up to party leaders naming President at about 13 times projected earnings because rates in Europe and Japan
Xi Jinping to his second term. over the next year, compared with 17 remain notably lower than those in the
Conditions should remain favorable times for the MSCI World index. U.S. The Fed is expected to continue
in 2018: exports are expected to rise pushing up short rates this year, but
As U.S. stock prices have climbed over
10% or more, while wages should the central bank has gone out of its
the past year, our portfolio managers
advance between 5% and 10%. way to move gradually and telegraph
have trimmed holdings in pricier areas,
Long-term challenges, such as high such as technology, and redeployed its intentions well in advance.
debt levels, remain a concern, but the cash into less richly valued sectors. Worldwide, monetary conditions are
they are unlikely to weigh on China’s For example, positions have been expected to remain accommodative as
economy in the near term. Housing initiated in some agriculture- and food- global central banks continue to make
should contribute to growth in related businesses. The growth of the liquidity plentiful.
FACTORIES ARE BACK IN BUSINESS
Europe is leading a global manufacturing resurgence.
62 Europe
31 of 32 countries tracked are in expansion territory.
Manufacturing Purchasing Managers’ Index
Germany
60
58
The Americas France
56 United Kingdom
Asia-Pacific
54
United States Japan
52
India China
EXPANSION
50
CONTRACTION
Source: Capital Group, Haver as of 9/30/17. The Purchasing Managers’ Index is an indication of whether business conditions for a number of variables in the manufacturing sector have
improved, deteriorated or stayed the same compared to the previous month. An index reading above 50 indicates an expansion, whereas a reading below 50 indicates a contraction. The
PMI tracks 32 countries. Each dot in the chart represents one of the 31 tracked countries with a PMI over 50. The only tracked country not included is South Africa, which had a PMI of 44.9.
4 C A P I TA L G R O U P P R I V AT E C L I E N T S E R V I C E S
Though Fed rate hikes are commonly
thought to dent fixed-income returns,
history shows that bonds can fare well if
inflation and economic growth are both
moderate and predictable. Barring an
unforeseen pickup in consumer prices, the
Capital Group fixed-income team expects
long rates to edge up only modestly as
the year progresses.
Among other indicators, our managers
are monitoring what’s known as the yield
curve, which measures the relationship
between short and long rates. Longer-
term Treasuries normally carry higher
yields than shorter-term issues, but the
gap between the two has narrowed
recently, raising fear that short yields could What It Is, How It Affects You and
exceed longer-term ones. Historically, Why It Has Dramatically Changed
that dynamic has been a harbinger of the Global Investment Landscape
potential recession. But Capital Group’s
fixed-income team believes that an
economic downturn is very unlikely in the
foreseeable future.
The municipal sector has been a particular You’ve no doubt heard about the rise of artificial intelligence (AI) and
area of strength within fixed income, with how it does everything from predicting what you’ll buy online to flying
solid returns and an encouraging outlook. the world’s largest jetliners. But what exactly is AI? How is it already
Despite lower income tax brackets for impacting so many parts of your life, often in unexpected ways? And
both companies and individuals, muni what’s coming in the future? At our upcoming client luncheon, you’ll
demand has remained strong, particularly learn firsthand what’s happening in the area of AI from a leading
in high-tax states that are likely to be authority on the topic. We’ll also take you on the road with our analysts
disproportionately affected by the to see how AI is being used to shape our future, and discuss some of the
reduced deduction for state and local
many investment opportunities they’ve uncovered.
taxes. Heavy muni issuance in advance
of the tax bill last year gave managers
the opportunity to acquire a range of
attractive securities in areas such as water FEATURED SPEAKER DATES AND LOCATIONS
and sewer, utilities, hospitals and single-
family housing. SAN FRANCISCO Tuesday, March 20
JARED FRANZ is a Capital
Bonds remain an essential part of investor Group economist, specializing
in artificial intelligence. BEVERLY HILLS Thursday, March 22
portfolios for the income they generate
Before joining the firm in
and the downside protection they offer 2015, he was head of NEW YORK Tuesday, March 27
during bouts of weakness in the equity international macroeconomic
markets. Despite the upbeat economic research for the Hartford and
a global economist for T. Rowe Price. He has a ATLANTA Wednesday, March 28
conditions in the U.S. and abroad,
PhD in economics from the University of Illinois
corrections in the stock market often
at Chicago, where he focused on technological CHICAGO Thursday, April 5
strike unexpectedly, and fixed income can change and economic growth. He also holds
provide a cushion against volatility. a degree in mathematics from Northwestern
LOS ANGELES Tuesday, April 10
University. He is based in our Los Angeles office.
You’ll find more on our current thinking
and how we’re positioning client portfolios
in our equity and fixed-income Investment SPACE IS LIMITED. For more information, and to reserve a seat for you and a guest at
Roundtable discussions, which begin on one of these events, please contact your Investment Counselor.
the next page. g
Q U A R T E R LY I N S I G H T S WINTER 2018 5
EQ UITY RO UNDTABL E
A Growing Global Economy
Creates a Positive Backdrop
for Equities
Pictured above from left to right: The past year was a rewarding one for stock investors, as solid economic
portfolio managers Will Robbins,
expansion in nearly all corners of the world resulted in higher corporate profits
Cheryl Frank and Tomonori Tani.
and a string of record highs for equities. The U.S. economy gained steam, while
Europe and Japan showed surprising strength. At the same time, the developing
world maintained its vigorous growth, leading to impressive returns for the
emerging markets.
The prospects remain bright for 2018, according to our Equity Roundtable
panelists, though markets will have to contend with a variety of challenges,
including elevated valuations and rising interest rates.
For more on this year’s outlook, we spoke with Capital Group Private Client
Services principal investment officer Will Robbins and Capital Group portfolio
managers Cheryl Frank and Tomonori Tani. Below is their take on what to watch
in 2018 and a look at how they are investing right now.
6 C A P I TA L G R O U P P R I V AT E C L I E N T S E R V I C E S
remained accommodative, and the
U.S. tax bill should contribute to higher
corporate earnings. All of this led to a
solid environment for equities.
Cheryl Frank: The market’s rise has been
driven by record corporate profits, led
by information technology companies.
We’ve also seen an easing regulatory
environment, particularly here in the U.S.,
and that’s been very helpful for business
confidence.
Tomonori Tani: This is the first time
we’ve seen synchronized global growth
since 2010. Growth
estimates are actually
“I’M FOCUSED ON COMPANIES THAT GENERATE A LOT
still being raised, OF FREE CASH FLOW AND THAT CAN KEEP GROWING
especially in the WITHOUT DILUTING SHAREHOLDER INTERESTS.”
emerging markets.
TOMONORI TANI
Yet, long-term bond Equity Portfolio Manager
yields remain lower
than the beginning
of 2017, despite a few rounds of Federal
Reserve rate hikes.
Indeed, emerging markets posted
very strong returns in 2017, as did the
broad international market index. In
fact, international equities did better
than U.S. stocks across the board. Do
you expect this trend to continue? growing without diluting shareholder
Robbins: It’s true that although the broad interests. I’m finding such opportunities
U.S. market as measured by the S&P in varied countries, including Argentina,
500 index did very well, international India, Brazil and China.
stocks fared even better in dollar terms. Will, the U.S. economic expansion
However, when measured in local is now in its ninth year and, as you
currencies, most foreign indices actually pointed out, equity valuations have
lagged the U.S. Coming into 2017, we become elevated. Does that give you
were very excited about opportunities reason for pause?
in non-U.S. markets, in part because of
Robbins: Keep in mind that bear markets
Were you surprised by the impressive favorable valuations outside the U.S. If
and, ultimately, recessions aren’t caused
anything, U.S. valuations have become
run-up in global equity markets in by old age. They’re a result of excesses
even more stretched by comparison.
2017? built up in the economy. From my
That’s not to say we’re bearish about the
Will Robbins: I was a bit surprised by the perspective, the U.S. economy doesn’t
U.S., but developed international and
considerable strength, but on reflection emerging markets are still very attractive appear to have a lot of excesses at
there are several reasons stocks did from a valuation perspective. the moment. Valuations are important
so well. A primary factor is that we’re and something we monitor closely.
Tani: For the portfolios I manage, I
witnessing synchronized growth in But valuations in and of themselves do
actually began boosting exposure to
economies around the world. This was not cause stock prices to decline or
emerging markets about 18 months
a bit uncertain at the beginning of the corrections to occur.
ago, and remain quite positive due to
year. Europe, for instance, was expected the still-large output gap after several Frank: The market has come a long way,
to grow only mildly, but it expanded years of macroeconomic adjustments. and stock prices do, on average, look
well above expectations. In addition, I’m focused on companies that generate somewhat expensive, particularly in the
monetary policy around the world has a lot of free cash flow and can keep U.S. It does make me wonder what could
Q U A R T E R LY I N S I G H T S WINTER 2018 7
fundamentals of individual companies automated solutions. Beyond that, I’m
and their management teams, income also excited about how our lives will
statements and balance sheets. I think be changed by electronic vehicles,
about their futures and the outlooks autonomous driving and more
for their industries. I try to filter out all digitally connected cars. Among other
the noise and short-term dynamics things, this could create additional
that may seem important in the demand for semiconductors.
moment but don’t matter much over Frank: Over the past six months or so,
the long run. I take a very long view. I have added to some of my energy
I’m not looking out over the next one holdings, which were hurt by the
or two years, but more like 20 years. In decline in oil prices. There are some
general, I believe equity investing will very compelling opportunities in this
offer attractive returns over the next sector, particularly among services
two decades, companies. Oil prices appear to have
though we’re bottomed, and if we have a continued
“I BELIEVE EQUITY INVESTING WILL OFFER ATTRACTIVE likely to strong global economy, there will be
RETURNS OVER THE NEXT TWO DECADES, THOUGH WE’RE
see plenty solid demand for energy. On the other
LIKELY TO SEE PLENTY OF VOLATILITY ALONG THE WAY.”
of volatility hand, I’ve been trimming my overall
CHERYL FRANK
Equity Portfolio Manager along technology exposure. The industry’s
the way. long-term outlook is bright, but some
Therefore, companies have had incredibly big
I want to build a portfolio of the very runs, leaving them with high valuations
best companies our research has and at peak margins. These are
uncovered.
Which industries or areas of
possibly get better and whether the the market do you believe are
favorable economic outlook is already particularly attractive?
priced into stocks. We are, after all,
Tani: I find the outlook for automation-
at all-time highs in corporate profits
related companies to be quite
and profit margins. But underneath
compelling, especially as the global
the surface, you see a different story.
population gets older. The global
Though the aggregate market may
population is still growing, but
be at peak margins, that’s not the
the working-age cohort — people
case with every sector. For example,
between the ages of 15 and 64 — has
industrial, financial and energy stocks
already peaked in OECD countries.
are well below past peak margins, and
The decline in the working-age
there is still room for certain parts of
population is especially noteworthy in
the economy to do better. The key
China. As workers retire, there will not
is to be selective in choosing stocks,
be enough
which is exactly what we’re focused on
younger
when building client portfolios.
people to “WHILE WE HAVEN’T HAD A BROAD CORRECTION IN THE
Please tell us more about your OVERALL MARKET, VARIOUS SECTORS HAVE BEEN CORRECTING
replace
ALL ALONG, WHICH IS ACTUALLY HEALTHY IN MY VIEW.”
approach to finding investments in them all.
the current environment. WILL ROBBINS
As a result, Principal Investment Officer and Porfolio Manager
Frank: While we do think about the there will
broader macroeconomic context, be an
we do fundamental research on increasing need for machines that can
companies from the bottom up. perform various tasks. This creates
I spend 90% of my time on the opportunities for companies offering
8 C A P I TA L G R O U P P R I V AT E C L I E N T S E R V I C E Sreally good stocks that got to be big
positions in my portfolio, and I felt it
was prudent to trim them back a bit.
Will, what areas are you drawn to?
Robbins: I think financials continue
to be a reasonably attractive place
to invest. Part of that assessment
is based on my belief that returns
are still not where the competitive
dynamics suggest they can go.
Financials also offer some degree
of protection as a hedge if interest
rates rise. Health care is another area
I like. We’re in an age of innovation
in which important breakthroughs
are being made. It’s somewhat
analogous to what took place in the
tech world. Advances in technology
help to increase productivity and add
convenience to society as a whole.
In health care, we have this moment
in time where we’re witnessing
enormous innovation in terms of hikes. That definitely could increase a correction, they would naturally say
curing what were previously considered volatility in long-term bond yields and no. But their success has caused pain
to be incurable diseases. I want our prove more challenging for stocks. in some other sectors. That’s part of
clients to have exposure to companies It’s been more than a year since the creative destruction inherent in
that can benefit from this. I have we’ve seen a market correction of at the capitalist marketplace. So while we
positions in some large pharmaceutical least 5%. Are you expecting one in haven’t had a broad correction in the
businesses, as well as in smaller 2018? overall market, various sectors have
players focused on immuno-oncology, Frank: No market goes up indefinitely, been correcting all along, which is
where I believe there are enormous and we’ll surely have a pullback at actually healthy in my view.
opportunities. some point. Of course, it is difficult
Given the market’s strong advance,
As you look to the rest of the year, to predict the timing of a correction.
what are the biggest risks on the There are still a lot of positive things should investors consider reducing
horizon that could interrupt what has happening in the economy, and the their exposure to equities?
been a nearly continuous upward markets are reflecting this optimism. Frank: The biggest message I could
move for both the economy and the Ironically, in some ways, all the good possibly send to our clients is that the
stock market? news does concern me. We just passed best way to grow wealth is to work
Robbins: We are starting to see signs a big tax bill and everybody feels with your Investment Counselor to
of wage inflation, which could push good. We’ve seen in the past that high set an appropriate asset allocation
bond yields higher. I personally think levels of euphoria or complacency can
and stick with it for the long term.
there’s a chance we’ll see the yield foreshadow a pullback. That doesn’t
Timing the market, by shifting money
on 10-year Treasury notes approach mean a downturn is imminent, but it’s
in or out, or by moving it from one
4%. That could be disruptive and is something I think about.
strategy to another, is not advisable.
probably the highest risk on my list at Robbins: It may not be obvious given
this moment. Beyond that, it’s obviously This doesn’t mean you shouldn’t
the upward trajectory of the market
very difficult to predict exogenous rebalance your exposure between
overall, but corrections have already
events, such as further political tensions stocks and bonds if your allocation has
occurred in some industries and
with North Korea. sectors. Energy stocks, for example, shifted due to market movements, or
Tani: I’m also watching bond yields underwent a bruising pullback. The make adjustments as your personal
closely. We are late in the U.S. same is true in retail. If you ask the circumstances change. But the best
economic cycle, and rising wage CEOs of Facebook or Amazon or thing you can do is allocate your money
pressures may prompt more Fed rate Netflix whether they’re in the midst of wisely and stay invested. g
Q U A R T E R LY I N S I G H T S WINTER 2018 9M AC RO RO UNDTBAL E
Despite Higher Rates,
Bonds Remain Attractive
Pictured above from left to right: It might seem counterintuitive that a year marked by higher economic growth,
portfolio manager Mark Marinella,
analyst Courtney Wolf and portfolio
rate hikes by the Federal Reserve and a revamping of the U.S. tax code would
manager John Queen. be favorable for bonds. But that was the story in 2017 as mild inflation and
restrained central bankers helped to underpin the market.
The members of our Bond Roundtable expect that positive momentum to
carry into 2018, although they remain vigilant for signs of turbulence. Below,
portfolio managers John Queen and Mark Marinella, and analyst Courtney
Wolf, share their insights into the factors that have kept the fixed-income
market on firm ground and discuss what may lie ahead in the months to come.
10 C A P I TA L G R O U P P R I V AT E C L I E N T S E R V I C E SBonds had a good year, despite a year, there was concern that the pro-growth
cumulative 0.75% increase in the fed policies of the incoming president would
funds rate. Why did they do so well, lead to increased growth and a potentially
given this headwind? significant pickup in inflation. But although
Mark Marinella: Several reasons, including the economy edged up slightly, inflation
the fact that the Fed has been really good was mild. It might tick up this year, but
at cluing the market into its decision- not enough to shake the market. So
making process and telegraphing where it’s there’s a very low risk of the Fed having to
headed. Equally important, the pace of rate abruptly jam on the brakes. That’s been
increases has been well spaced out. All of augmented by the Fed’s transparency. The
this prevented the type of surprises that can predictability of future Federal Reserve
shock investors. policy gives comfort to the market.
John Queen: It’s important to point out Queen: For those of us who’ve been in the
that the Fed is still quite accommodative market a long time, that’s new. It wasn’t
overall. In addition to boosting rates, the long ago that the
central bank is reducing monetary stimulus Fed not only didn’t
by cutting back on purchases of Treasury disclose what it
“THE SUPPLY-AND-DEMAND DYNAMIC FOR MUNICIPALS
HAS BEEN VERY FAVORABLE FOR BUYERS, AND WE HAVE
bonds and mortgage-backed securities. But was going to do, it
TAKEN ADVANTAGE OF THAT.”
that’s being done gradually, and the Fed is didn’t even reveal
what it had done. It COURTNEY WOLF
still a big buyer of both. Also, central banks
Fixed-Income Analyst
in Europe and Japan still have aggressive raised or lowered
bond-buying programs in hopes of lifting rates by adjusting
their economies. Finally, demand for U.S. the amount of liquidity in the system,
Treasury bonds remains high among both and the market had to figure out what
pension plans and overseas investors. happened. There were whole groups of
Though U.S. rates are low, they’re still much people who did nothing but watch the Fed
higher than what you can get in Europe to decipher if it had tightened or not. This
and Japan. new transparency has allowed for lower
Municipal bonds also fared well overall. volatility, which is better for the economy
Were you expecting more turbulence, and the financial markets.
given the cut in tax rates? As you look ahead to the rest of this year,
Courtney Wolf: Even though marginal rates what do you foresee for bonds?
were trimmed, the reduced deduction for Queen: I expect a continuation of what we
state and local taxes has made many high- have seen recently. We still have massive
income earners question whether their tax amounts of liquidity in the marketplace, and
bill will actually go down. That concern is global central banks are pumping in more
especially pronounced in high-tax states all the time. The Fed is likely to raise rates
like California and New York. In general, three times or perhaps even four. But that’s
of course, higher effective tax rates tend been well transmitted to the markets and
to increase demand for muni bonds. Also, will happen at a very measured pace. As
insurance companies and banks are heavy long as conditions don’t change too much,
buyers of municipal securities, and they such as a sudden
are likely to remain so, even with a lower breakout in inflation,
corporate rate. Corporations like investing
“WE HOLD A LOT OF SECURITIES THAT MATURE IN FIVE
it’s likely that rates
TO SEVEN YEARS. THESE SECURITIES CAN PROVIDE A BIT
in munis because they have tended to offer will rise a bit but not OF A YIELD ADVANTAGE COMPARED WITH SHORTER-
attractive risk-adjusted returns and have had that much. TERM SECURITIES.”
low correlation to some other asset classes.
Are you worried JOHN QUEEN
The fixed-income market is normally that the Fed might Fixed-Income Portfolio Manager
fairly stable, but volatility was hike rates at a
particularly low last year. How come? faster pace if tax
Marinella: One reason is the stable law changes spur additional growth?
economic environment. At this time last Queen: No, because any fiscal stimulus
Q U A R T E R LY I N S I G H T S WINTER 2018 11positioning. We want our clients to water and sewer bonds, utilities and
have the potential for protection in hospitals. Single-family housing has
case of an unexpected shock. We also been an appealing area as yields
hold a lot of securities that mature in have become more attractive.
five to seven years. These securities
What are some risks that could
can provide a bit of a yield advantage
disrupt your overall favorable
compared with shorter-term securities.
outlook?
But if something goes awry — a
breakout in inflation, a rise in volatility Queen: There’s always the danger of
or an equity market decline — they have some kind of international incident or
tended to hold up better than issues geopolitical issue — North Korea, the
with longer terms. Middle East or Brexit. Any of these
Are there certain sectors you’re could throw a scare into the market.
particularly One of the more immediate issues
“THE FED HAS BEEN REALLY GOOD AT CLUING THE attracted to at could be China. We keep a close watch
MARKET INTO ITS DECISION-MAKING PROCESS AND the moment? on China to understand its economy.
TELEGRAPHING WHERE IT’S HEADED.”
Queen: We Marinella: I think it’s very unlikely to
MARK MARINELLA expanded occur, but runaway inflation would be
Fixed-Income Portfolio Manager
holdings in the negative for stocks and bonds.
energy sector.
An issue that’s drawn attention
Last year’s drop in oil prices allowed
lately is the possibility of a so-
us to find higher-than-market spreads
called inversion of the yield curve.
among energy companies. These are
Normally, longer-term Treasuries
analyst-driven ideas where we think
have higher yields than shorter-
there’s some real value. Through our
research, our team was able to identify term issues, but the differential
generated by tax cuts will probably just between short- and long-term yields
financially sound companies where
offset some of the monetary stimulus
we have not identified credit risk. We has narrowed. Inversion — in which
that the Fed is taking away. These two
also were drawn to offerings in the shorter-term securities actually yield
things should largely balance each
pharmaceutical sector, as well as in more than longer-term ones — has
other out, which could extend the low-
the asset-backed space, where we historically been a precursor to
volatility path we’ve been on.
found very high-quality assets offering recessions.
Courtney, what’s the outlook for the excess yield. Queen: An inversion would probably
municipal market in 2018?
Mark and Courtney, can you provide mean that the Fed has overtightened
Wolf: It’s a really exciting time to be in
a sense of how you are positioning — that inflation expectations haven’t
the muni market. Issuers that otherwise
municipal portfolios? increased at the same pace that the
might have done deals this year
rushed to do them in 2017 because Marinella: We have similar positioning Fed has raised rates. It could happen,
they were uncertain about the impact to what John mentioned and are but it doesn’t seem likely in the
of tax reform. That gave us a great sticking with very high-quality issues. short run. And while inversions have
opportunity to buy promising bonds We’re favoring shorter-term maturities, traditionally suggested a recession
for clients. Plus, that flood of issuance since you’re not being paid to go out is coming, it doesn’t tell you much
may result in lower supply this year, further on the curve right now. about the timing. In the 1990s, for
which would be another positive for instance, the curve was flat or inverted
Wolf: The supply-and-demand
muni valuations. for two or three years and we didn’t
dynamic for municipals has been
Given the current economic very favorable for buyers, and we get a recession until somewhat later.
backdrop, how are you positioning have taken advantage of that. We’ve Although the outlook can change, at
client portfolios in terms of taxable found opportunities across a range of the moment all the pieces seem to be
bonds? sectors. For example, I cover toll roads, in place for another pretty good year in
Queen: We’re pretty middle of where we’ve uncovered a number of the bond market, with attractive yields
the road, with relatively low-risk interesting deals. We’ve also added and relatively low volatility. g
12 C A P I TA L G R O U P P R I V AT E C L I E N T S E R V I C E Sexample, a family could pool two years’
worth of deductions into a single year,
itemizing in the year the donations are
made and claiming the standard deduction
in the following year when they’re not. You
can also consider using a donor-advised
fund, which allows taxpayers to contribute
money in a given year and take a deduction
for that amount but distribute the funds to
charities in regular intervals over time.
The much-debated estate tax was not
repealed, but estate holders will benefit
from a doubling of the lifetime estate,
gift and generation-skipping transfer tax
exclusion amounts. Though the top estate
tax rate remains 40%, lifetime exclusion
amounts have been raised to $11.2 million
for individuals. Families subject to estate
taxes should consider traditional wealth
transfer strategies and review existing plans
to fully assess the impact of the new law.
The tax overhaul that takes effect this year under contract before December 15, 2017. Business owners and independent
will have wide-ranging impacts on high- Interest on home equity loans is no longer
contractors with so-called pass-through
net-worth families. While they stand to deductible.
income may benefit from the new law. This
benefit from lower tax brackets, higher Among the most significant changes refers to income that is not taxed at the
estate tax exemptions and a less stringent is a $10,000 cap on state and local tax business level but instead passes through
alternative minimum tax, high-income deductions. That is likely to weigh heavily to the owner’s personal income tax return.
earners face new limitations on some on those in high-tax states such as New
favored deductions and notable revisions Taxpayers may be able to take a 20%
York and California, where combined
in charitable write-offs. deduction from their AGI for qualified
income and property taxes often far
business income. In addition, there is no
Here is a quick overview of some of the exceed that threshold.
limit on deductions for business-related
more significant changes, along with The new law retains the controversial
state and local taxes. The top rate of 37%,
broad strategies for approaching the alternative minimum tax. But it raises
combined with the 20% deduction, makes
new tax rules. We’ve also included a exemption amounts and the income
the effective maximum rate on qualified
handy planning guide that details the levels at which those exemptions phase
business income 29.6%.
new brackets and other information, on out, so fewer families are likely to be
page 20. ensnared by it. There is increased flexibility for 529
The top tax rate has been lowered from education-savings accounts, which were
The law affects charitable giving in several
39.6% to 37% and the income level at previously limited to college-related costs
ways. Previous rules capped deductions on
which that rate is triggered has been but can now be used for K-12 expenses,
cash donations to public charities at 50% of
raised. For couples filing jointly, the adjusted gross income (AGI). That’s been up to a limit of a $10,000 per year. Rules on
maximum rate now applies to income raised to 60%, but families must itemize tax-deferred retirement accounts, including
topping $600,000, up from $470,700 in to claim specific write-offs. Given that the 401(k)s, individual retirement accounts and
2017. Rates on qualified dividends and standard deduction has been raised to SEP-IRAs, remain the same.
long-term capital gains remain the same. $24,000 for married couples filing jointly, Because we don’t provide legal or tax
The mortgage interest deduction has some households may not have enough advice, we highly encourage you to discuss
been capped at loans of no more than deductions to make itemizing worthwhile. all of these planning strategies with your
$750,000, although the previous $1 million It may be helpful in such situations to tax advisor to determine which ones might
limit remains in effect for home purchases “bunch” deductions in certain years. For work best for you. g
Q U A R T E R LY I N S I G H T S WINTER 2018 13ANALYST PERSPECTIVES
Each year, a relative handful of dynamics technological advances of the past, the maturation of
have an outsize impact on the economy and AI is likely to usher in a wave of innovation that will
investment markets. Though some are fleeting, have a profound impact across the business world.
others can have long-lasting effects. With “We are at an inflection point, in which advances in AI will
2018 officially underway, here are two themes underpin a technological revolution,” predicts Jared Franz,
a Capital Group economist who closely studies the topic.
that Capital Group analysts believe may be
especially noteworthy in coming months. AI and its close cousins, machine learning and neural
networks, refer to computers that are designed to mimic
ARTIFICIAL INTELLIGENCE human reasoning and logic. Initially, AI has helped
Despite its futuristic-sounding
moniker, artificial intelligence has
PROJECTED REVENUES FROM ARTIFICIAL INTELLIGENCE
been around since the 1950s,
The market for AI is expected to soar in coming years.
and may be best known today as
$59,749
the brain behind digital assistants
such as Siri and Alexa. Despite $46,520
that, AI has never quite lived up to
expectations, with the technology $34,382
Millions
repeatedly falling short of the hype.
$24,162
That is rapidly changing thanks to $16,242
the convergence of sophisticated $10,529
$6,629
algorithms, lightning-fast $1,378 $2,420
$4,066
computer speeds and the sheer
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
explosion of data across the
digital terrain. As with major Source: Tractica via Statista
14 C A P I TA L G R O U P P R I V AT E C L I E N T S E R V I C E Scompanies boost efficiency by automating
mundane tasks. But increasingly, SURGE IN E-COMMERCE
machine learning is enabling in-depth Online shopping has claimed an increasing share of the retail market.
pattern recognition and predictive $700 20%
analysis, with broad applicability in
such sectors as health care, finance,
Percentage of Retail Sales
$500 16%
transportation and manufacturing.
$ Billions
In medicine, for example, computers are
becoming able to handle patient intake $300 12%
at hospitals, scan medical records for
early detection of health problems and
$100 8%
help to design resulting treatment plans.
Beyond that, pharmaceutical companies
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
could harness neural networks to identify
the most promising areas of research with Sources: U.S. Census Bureau (2010-2016) and Capital Group research (estimates for 2017-2020)
the greatest odds of clinical success. In
ills in the retail industry. But store closures if they try to buttress their margins through
finance, AI will help banks reduce loan
and bankruptcies have spiked, forcing heavy discounting and underinvestment
losses by analyzing credit risks more
retailers to grapple with the reality that in both stores and online capabilities.
quickly and effectively. Not surprisingly,
there are simply too many physical stores This disruption underscores the need
in the era of online shopping. What began for investment selectivity, not only in
AI HAS HELPED with the shuttering of malls in outlying retailing but in spillover industries such
COMPANIES BOOST suburbs is extending to upscale shopping as property development, banking
EFFICIENCY BY districts in major cities, with once-thriving and transportation. There is long-term
AUTOMATING shops now bearing vacancy signs. It’s a potential for online retailers in distinct
MUNDANE TASKS. trend that is bound to continue, says Jon niches, as well as for traditional retailers
Keehn, a Capital Group retail analyst. making digital headway, Keehn says. But
“There is no quick fix,” Keehn observes.
big tech companies and a bevy of start- “This isn’t a case of simply weeding out a THERE ARE SIMPLY
ups are all putting huge resources into AI. few weak companies. The U.S. has far more TOO MANY PHYSICAL
“We’re going to look back on this retail space per capita than other countries, STORES IN THE ERA OF
in 10 years and say, ‘Wow, that was and it needs to decline meaningfully.” ONLINE SHOPPING.
transformative,’” Franz predicts.
E-commerce has jumped from roughly
Incidentally, Franz will be the keynote 1% of total retail sales in 2000 to about
speaker at our client luncheon this 12% today. Keehn believes that number it’s essential to be extremely selective
spring, which will delve into the impact
could top 25% longer term. The plight of and to avoid businesses that are
of artificial intelligence. You’ll find more
traditional retailers could be made worse vulnerable to the online juggernaut. g
details about this event on page 5.
MOUNTING PRESSURE
ON TRADITIONAL
U.S. RETAILERS
Call it the “Amazon effect.” The depth of
the threat from e-commerce — primarily
from the online colossus — accelerated in
2017, and the strains on traditional brick-
and-mortar retailers are likely to become
even more acute in the next several
years. Even well-known companies with
previously unassailable business models
have failed to stem market share losses.
Historically, economic growth and surging
consumer confidence have cured many
Q U A R T E R LY I N S I G H T S WINTER 2018 15L IF E E NH ANC E M E NTS
Pictured above; When it comes to selecting a vacation spot, Mark’s Square, are now more than three feet below
Venice Grand Canal you no doubt consider a number of factors — sea level, and the once-occasional high tides that
cultural attractions, online reviews and general drench this iconic city have become more common.
convenience, to name a few. It may be time to add
To maximize enjoyment and minimize environmental
another: whether a destination is endangered or
impact, Trifoni recommends sojourns during winter
disappearing soon. Unfortunately, many of the
months. “The atmosphere is really wonderful and
world’s natural and architectural wonders are
there are far fewer people than in summer,” she
imperiled by threats ranging from climate change
says. “Don’t go in May or June because it’s really
to overdevelopment to the simple ravages of time.
packed with people.”
Preservation efforts have offset some of the most
immediate hazards. But if you’d like to experience For visitors well acquainted with the grand cities
the full grandeur of these locales, you may want to of Europe, the Danube River Delta is like stepping
reshuffle your future travel plans. into a different world. Located in Romania and
Travel writer Jasmina Trifoni, author of Places to Visit
Before They Disappear, recommends the following THESE DESTINATIONS STAND
dozen destinations in Europe, Africa, Asia and the OUT FOR BOTH THEIR BEAUTY
Americas, which stand out for both their beauty and
AND THE MAGNITUDE OF
the magnitude of threats facing them.
IMPENDING THREATS.
EUROPE
Of the world’s many “at risk” sites, few have drawn
more attention recently than Venice, which is
contending with rampant tourism, excessive boat part of Ukraine, the delta is a 2,200-square-mile
traffic and the sustained effects of climate change. constellation of lakes, marshes, beaches and islands.
The lowest lying points in Venice, including St. Rich with wildlife and majestic vistas, it is one of
16 C A P I TA L G R O U P P R I V AT E C L I E N T S E R V I C E SFLORIDA EVERGLADES with differing religious beliefs attests to the water’s tantalizing greenish
from constructing churches hue. An awe-inspiring volcano is perched
with durable materials such as on the area’s southern tip and two million
stones and brick. The native flamingos regularly fly overhead.
people responded by crafting ASIA
wooden edifices featuring such
Many edifices in this part of the world face
architectural details as two-tier
JAISALMER FORT challenges, including the Great Wall of
roofs and magnificent spires that
China and Taj Mahal. A lesser-known gem
jut into the sky.
is Jaisalmer Fort in northwest India. Erected
The passage of time has exacted in the 12th century, it is one of the only
a toll on many of these such fortified cities in which residents still
structures, but more than live. The sandstone buildings and three-
100 remain. Aided by ringed outer walls served double duty as
preservation efforts, some a military fortress and way station for the
churches feature splendidly merchants traversing the Silk Road trading
restored interiors and routes. Though Jaisalmer Fort now sports
elaborate frescoes. modern hotels and restaurants, it retains an
AFRICA ancient feel.
Virunga National Park in “You experience a kind of medieval life in
WOODEN CHURCHES OF ROMANIA the 21st century,” observes Trifoni.
the Democratic Republic
of Congo is the oldest such After withstanding the elements for
LAKE TURKANA REGION park in Africa. It’s also one centuries, walls have started chipping and
of the most imperiled. The the foundations of buildings have shifted.
3,000-square-mile expanse of dense forests Conservationists blame a poorly designed
and wide-open savannahs is home to water drainage system and monsoons that
roughly 300 mountain gorillas, about one- have been intensified by climate change.
third of the worldwide total. Yet Virunga Restoration efforts have been launched,
and its gorillas are threatened by poaching, but they have been slow, given the scale of
deforestation and recurring armed conflict repairs that are needed.
between fractious guerrilla groups.
THE AMERICAS
the largest natural habitats in Europe, with The preserve has its own cadre of armed
Several locations in North and South
more than 300 species of birds, including rangers patrolling the forests to ward off
America are grappling with the
Dalmatian pelicans and white-tailed eagles. poachers. For safety purposes, only 10% of
combination of climate change, natural
the park is open to tourists. Yet, Trifoni says,
“It’s very rural and still mostly disasters and heavy tourism. Among them
seeing the animals, who share 98% of their
underdeveloped from a tourist point of are the Everglades in Florida, Glacier
DNA with humans, is transformative.
view,” Trifoni says. “You can really see the National Park in Montana and Denali
“It’s one of the most touching experiences National Park in Alaska.
lives of the people living with the river. It’s
from wildlife I’ve ever had in my life,”
still an adventure.” Off the beaten path, Trifoni recommends
she marvels.
Potosí, an idyllic village at the foot of a
Nonetheless, the delta is confronting the
For a different climate experience, Lake mountain in the Andes. Situated in what is
effects of industrial pollution, including
Turkana in northern Kenya is the world’s now Bolivia, the mountain has been mined
fertilizer runoff and waste from the growing
largest desert lake, with shores ringed by for silver since the 16th century. The area
number of ships that traverse it. It’s been
volcanic rocks and flat dunes. Devastating once produced so much of the precious
denuded further by the construction of droughts and the construction of a metal that Potosí became the biggest city in
dams and canals that have shifted the mammoth dam in neighboring Ethiopia the New World and a hub of cutting-edge
natural flow of water, and especially by threaten the lake and nearby environs, industrial activity. Centuries of heavy mining
a Ukrainian project to widen a section of including the livelihoods of indigenous have taken a toll, with the peak of the
the waterway to accommodate a major tribes who rely on the water supply. mountain collapsing a few years ago and
shipping channel. further buckling expected.
Accessing the area requires a somewhat
Elsewhere in the region, Trifoni arduous journey. But the locale is Still, Trifoni insists, Potosí is well worth a trip.
recommends a series of Romanian fascinating for its raw beauty, unique Pitched against the backdrop of the mountain,
wooden churches, many located in the geology and anthropological history, the city is a tableau of baroque architecture,
northern region of Maramures. Beginning according to Trifoni. An abundance of with vividly colored buildings topped by a
in the 13th century, the area was ruled by human fossils have been unearthed in canopy of red-tiled roofs. “It is one of the
Hungarian monarchs, who prohibited those the area, and its nickname, “sea of jade,” world’s great landscapes,” she enthuses. g
Q U A R T E R LY I N S I G H T S WINTER 2018 17You can also read
