Investment Outlook

Q3 2018 CIO Roundtable: The Normal Normal

Introduction

It’s not unusual to go through a hectic stretch of being overscheduled with places to go, people to see and family obligations to meet. Eventually life calms down and we’re grateful for the return to normal. The market’s extended period of relative calm after the Great Recession had the opposite effect on active managers. For us, people who are paid to manage risk and sift through a large universe of investment options to identify what should be a limited number of compelling opportunities, the market’s relatively smooth and broad-based advance was anything but normal.

The environment is changing in 2018. After holding interest rates at historically low levels since the financial crisis, the U.S. Federal Reserve (Fed) began raising rates in late 2015 and is now well down the path to normalization. We’re also seeing inflation creep back into the lexicon after an extended absence. When you add political turmoil, higher energy prices and a potential trade war to the mix, you get volatility. This choppier environment isn’t a new normal—it’s the normal normal.

When the market is volatile, the tendency of stocks to move together declines. Volatility also increases dispersion as the difference between top- and bottom-performing securities widens. We view these conditions as more fertile for active managers. We believe there are more opportunities to be rewarded through security selection and by portfolios that offer return potential commensurate with the risks we’re taking.

In this quarter’s Investment Outlook, our chief investment officers discuss the opportunities and risks their teams are encountering in this more normal environment. Our Global Fixed Income team projects that yields on 10-year Treasuries are closing in on their peaks for the next few months and expects continued policy divergence between the Fed and central banks in Europe and Japan.

With rates rising, our Global Equity managers are finding opportunities in select financials and limiting exposure to companies that were key beneficiaries of low rates. Higher oil prices and production efficiencies will likely benefit exporting countries and segments of the energy sector but hurt importers and pressure companies that can’t pass along higher energy costs to customers.

Finally, the impact of U.S. tax cuts is beginning to surface in corporate earnings. Some companies are benefitting more than others, but we’re watching all of them to see how they spend their tax savings.

We believe a return to a more normal market environment provides opportunities for investors to make portfolio strategy adjustments. We encourage investors to understand their market exposure and risk tolerance to ensure alignment with their long-term investment objectives.

Thank you for investing with us.

G. David MacEwen

G. David MacEwen

Co-Chief Investment Officer

American Century Investments

CIO, Global Fixed Income

 

Victor Zhang

Victor Zhang

Co-Chief Investment Officer

American Century Investments

  • Global Macroeconomic Outlook
  • Global Equity
  • Global Fixed Income
  • Multi-Asset Strategies
  • Key Takeaways
First Topic

Global Economy: Growth trend remains intact

U.S. Shows Upside Potential

We believe the U.S. economy should continue to expand at a modest and sustainable pace. Consistently solid growth data combined with fiscal expansion may push annualized GDP to the high end of our expected range of 2%-3% in the near to intermediate term.

Central Bank Policy Is Paramount

Concerns about political uncertainty in Italy and potential protectionist trade policies have clouded the global economic outlook, particularly in Europe. However, accommodative monetary policy should continue to drive modest growth in Europe and Japan, where significant fiscal expansion remains unlikely.

Emerging Markets Drive Global Growth

Growth in developed markets, relatively contained global inflation, and generally accommodative central banks should help fuel robust economic gains in emerging markets (EM). Despite trade war concerns, we continue to expect EM growth to outpace developed markets growth.

Second Topic

Inflation: Global inflation is uneven

Price Data Is Mixed

Overall, global inflation remains generally muted. Modest, yet steady, price gains continue to unfold in the U.S., while inflation trends in Europe and Japan recently reversed course. After reaching recent highs in late 2017 and early 2018, inflation data in the eurozone, U.K., and Japan have softened.

U.S. Inflation Approaches Target

For nearly a year, U.S. headline inflation has been trending higher, largely due to rising commodities prices coupled with solid global growth and modest wage growth. This suggests year-over-year core inflation (as measured by core personal consumption expenditures, or PCE), which was 1.8% in April, will likely hit the Fed’s 2.0% target.

Inflation Eases in Europe

Since late 2017, annual headline and core inflation in the eurozone have inched lower, ending April at 1.2% and 0.7%, respectively. Similar trends have unfolded in the U.K., where annual headline inflation was 2.4% in April, down from 3.1% in November, and in Japan, where year-over-year inflation climbed to 1.5% in February before falling to 0.6% in April. These trends suggest central bank policy will remain accommodative.

Third Topic

Monetary Policy: Central banks are on different tracks

Fed Continues to Raise Rates

Unlike other central banks, the Fed continues to pursue interest rate and balance sheet normalization. Following the June rate hike, the Fed suggested two more rate increases were likely by year-end. We agree with this forecast, but also believe the Fed may turn more hawkish if economic and inflation data accelerate.

Europe Holds Rates at 0%

The European Central Bank’s (ECB’s) benchmark interest rate remains at 0%, where it’s been for two years. Amid slower growth and subdued inflation, it appears likely the ECB will extend its bond-buying program beyond the September expiration date. Although slower growth also prompted the Bank of England to hold rates steady, an August rate hike remains a possibility.

Japan Abandons Inflation Target

Persistently weak inflation prompted the Bank of Japan to remove its fiscal-2019 target date for achieving 2% inflation. Japan’s central bank shows no signs of scaling back its stimulus efforts, which include monthly bond buying and holding short-term interest rates at -0.1% and the 10-year government bond yield near 0%.

Fourth Topic

Interest Rates: Rates rise in the U.S.; rates are mixed elsewhere

U.S. Treasury Yields Move Modestly Higher

Against a backdrop of heightened volatility, we expect Treasury yields to trend slightly higher. Given the potential for higher-than-expected inflation, which would push rates higher, and the possibility of domestic political and international geopolitical risks, which would drive rates lower, we expect the 10-year Treasury yield to remain in a range of 2.95%-3.25% through the next several months.

Rates Are Lower Outside the U.S.

Modest global growth, weak inflation, and ongoing central bank stimulus should keep interest rates relatively contained in Europe and Japan. Rates likely will remain relatively higher in the U.K., where inflation is higher and where the central bank has started tightening, albeit slowly.

Rate Divergence Is Widest in Years

Fed tightening and an increase in U.S. Treasury issuance is contributing to higher rates in the U.S. The yield difference between the U.S. and core eurozone and U.K. rates remains the widest in 30 years. We believe markets where rates are more likely to fall or remain stable, including Canada and select emerging markets, offer a way to diversify duration risk in the U.S. and Europe.

Victor Zhang: We’ve seen stock volatility pull back slightly after spiking early in 2018. Still, using the VIX as a barometer, volatility is notably higher than a year ago. Keith, what key factors are contributing to a noisier market?

Keith Creveling: Synchronized growth continues in many regions, keeping us optimistic about the prospects for global equities. However, recent macroeconomic and political trends have complicated the outlook over the past few quarters. After a prolonged period of high growth with low volatility, global markets are contending with the effects of higher interest rates and inflation in the U.S., the impact of U.S. corporate tax reform, trade conflicts, and rising energy prices.

With inflation driving rates higher in the U.S. and, to a lesser extent, in some non-U.S. markets, we are seeing opportunities in select financials positioned to benefit in a rising rate environment. In the U.S., we have identified regional banks benefiting from the normalization of U.S. rates and improving loan growth as economic activity continues to improve. Reduced regulation is also helping some of the financials in which we’re invested. We’ve also seen non-U.S. banks and insurance companies that are potential beneficiaries of gradually rising rates. On the other hand, higher rates may pressure earnings for REITs, but there are opportunities among companies providing services to real estate sector companies, whose earnings are less sensitive to rising rates.

Keith Creveling

Keith Creveling, CFA

Co-Chief Investment Officer

Global Growth Equity

Global markets are contending with the effects of higher interest rates and inflation in the U.S., the effects of U.S. corporate tax reform, potential trade wars, and rising energy prices.

- Keith Creveling

Kevin, what impact have rising rates made on our value portfolios?

Kevin Toney: We don’t think this is a good time to be overexposed to rate-sensitive names. Interest rates sat at historically low levels for years following the Great Recession and investors chased yield wherever they could find it. They bid up prices we couldn’t justify in areas such as real estate and utilities. At that time, being underweight hurt our performance relative to value benchmarks with substantial positions in these sectors. Now, with rates moving higher, we’ve seen rate-sensitive stocks lag, which is weighing on the indices. It’s also worth noting this is hurting passive value investors who are stuck with those big exposures to real estate and utilities. Meanwhile, we’re actively focused on areas, such as energy, where we believe fundamentals are strong and valuations are attractive.

Kevin Toney

Kevin Toney

Co-Chief Investment Officer

Global Value Equity

The underlying story for us in energy has to do with improving returns on invested capital, and our belief that many energy companies were under-earning relative to historic profitability levels in 2017.

- Kevin Toney

Energy has delivered strong returns thus far in 2018. Could it continue?

Toney: We believe so, but it’s important to note that crude oil prices and the energy sector are inherently volatile. Recent geopolitical events, including the re-imposition of U.S. sanctions on Iran and chaos in Venezuela’s national oil company have boosted crude oil and energy stock prices. However, given the unpredictable nature of global politics, the underlying story is improving returns on invested capital and our belief that many energy companies were under-earning relative to historic profitability levels in 2017.

This year’s recovery helped many of the team’s energy holdings to advance significantly, and we’ve trimmed some positions to capture the gains. Even after trimming, our portfolios are still generally overweight in the sector because the risk/reward profiles of our holdings remain attractive. If the energy sector continues to outperform, we will selectively harvest gains in an effort to lock in profits. We will opportunistically add to our positions if prices pull back and relative risk/rewards in the sector remain intact or become more attractive.

What are some downsides to higher energy prices?

Creveling: We expect pressure on earnings in those sectors exposed to consumer or general economic activity, such as retail and travel, and those with direct exposure to oil prices, such as trucking and airlines. We are monitoring these impacts, determining which are material at current price ranges.

Regionally, higher oil prices should also pressure Europe and Japan, which are net oil importers. In EM, net oil importers, such as South Africa and India, are vulnerable to higher prices, while net oil exporters such as Russia and Saudi Arabia, should benefit.

Greg, we’ve heard about energy from the growth and value perspectives. Where are you finding opportunities?

Greg Woodhams: We continue to favor information technology, which has outperformed significantly driven by good fundamentals. Large-cap companies have reported some of the strongest earnings growth of any sector in recent quarters. Furthermore, performance has broadened out from the FANGs (Facebook, Amazon, Netflix and Google parent Alphabet) and a few related industries to include the semiconductor and capital equipment groups. This has resulted from capital investment in cloud computing, artificial intelligence, self-driving cars, and display technologies.

At the same time, we’re being more cautious in telecommunications where we see competition intensifying again as a recently announced mega-merger could result in higher capital spending, lower free cash flow, lower valuations, and lower margins for many companies. We are also underweight materials, where fundamentals vary widely by industry group. We are biased toward chemical companies that feed into consumer demand trends and can improve their portfolios by restructuring or offloading their commodity chemical operations. Agriculture-related companies need to demonstrate that they can add value in a challenging price environment for corn. Packaging companies face sluggish end markets, while many metals companies appear unattractive given retrenchment in capital spending among EM companies.

Greg Woodhams

Greg Woodhams, CFA

Co-Chief Investment Officer

Global Growth Equity

Strong information technology performance has broadened out from the FANGs and related names to include the semiconductor and capital equipment groups.

- Greg Woodhams

Spring 2018 marked the second corporate earnings season since the enactment of sweeping U.S. corporate and individual tax reform. What did you hear about the impact of tax cuts during calls with corporate management teams?

Creveling: Both U.S.-based companies and non-U.S. names with U.S. operations are reporting benefits resulting from lower corporate tax liabilities. They are reinvesting in their companies or workforces, increasing capital spending, increasing dividends, or buying back shares. U.S. regional banks and small-cap names are among the top beneficiaries, given their relatively higher tax burdens relative to global or multinational large-cap peers. We are investing in companies with exposure to the U.S. consumer; we expect those to benefit from increased consumer and economic activity resulting from individual tax cuts.

Kevin, how is your team seeing tax reform play out?

Toney: We have been analyzing how companies and industries might benefit and respond to the tax package within their specific competitive environment. For instance, tax cuts might inspire heightened competition, and if tax relief is distributed evenly across companies in an industry they could compete away their tax savings. They might reduce prices, spend on enhancing the customer experience or service, employ higher-cost labor, upgrade facilities, or add capacity. Others may choose to increase dividends and buy back shares. We don’t necessarily make judgments on the actions they take, but we evaluate the impact of those actions on fair values and downside risk.

U.S. hospital operator HCA Healthcare provides a good example. It has seen its corporate tax rate decline from 35% to 25%, a $500-million net benefit for 2018. However, earlier in the year its management team announced plans to increase capital spending by almost 30% through 2020. We believe the lower corporate tax rate gave the incentive to allot a substantial portion of HCA’s tax relief toward future opportunities rather than increasing dividends or buying back stock. These important management decisions helped us reassess the company’s fair market value and downside risk. In this example, HCA’s free cash flow and our fair value assessment was mostly unchanged even though the company realized an exceptional benefit.

Trade talks have been a rollercoaster ride. How does this affect your thinking?

Creveling: It’s difficult, if not impossible, to predict the ultimate outcome of potential global trade conflicts. The headlines change every day, and it’s hard to separate legitimate threats from negotiating tactics. Nevertheless, we continue to monitor the situation and do not believe a clear winner would emerge in the event of an all-out trade war.

The first round of the U.S./China tariff disputes have centered on steel companies. We’re watching this situation closely because many companies in which we invest use steel as a raw material to manufacture goods ranging from power tools to industrial machinery to airplanes. In meetings with company management teams, we have learned that many of them are employing hedging strategies to insulate against rising steel prices in the short term. As with other raw material inflation pressures, we favor companies with the pricing power to pass on higher input costs with minimal impact on sales. We have no direct investment in non-U.S. steel or aluminum producers that we believe may not fare as well in these tariff conflicts as their U.S. counterparts.

How are these market trends affecting the outlook for EM?

Creveling: Rising U.S. Treasury yields and a stronger U.S. dollar contributed to the recent sell-off among EM stocks. However, we believe most EM countries are better positioned to withstand the effects of a dollar rally than in the past. EM growth is stronger, current account balances have improved, and EM inflation is tracking central bank targets. Muted inflation is key; amid currency weakness, central banks are less likely to take action that would disrupt EM growth. That said, we are concerned about conditions in Argentina, Brazil, and Turkey, where local currencies are seriously pressured.

Meanwhile, lingering concerns about U.S./China trade are making investors uneasy and many have reduced their positions in China. We believe this dispute will have little impact on the country’s overall economy, which shows little sign of imminent slowdown. Therefore, we are maintaining our positive outlook on China.

Sustained global GDP growth remains a key fundamental supporting our positive outlook for EM equities. The growth differential between EM and developed markets still favors EM. Earnings growth forecasts remain robust and valuations are reasonable. However, if we saw a period of structurally lower growth, EM equity index returns would likely be constrained, with higher volatility. Dispersion of returns among EM countries could be high as well.

Vinod, what’s the significance of China A-shares’ recent addition to the MSCI Emerging Markets Index?

Vinod Chandrashekaran: We think this development should be understood as part of the ongoing evolution of the Chinese economy and financial system. Incorporating mainland Chinese stocks into key market indices recognizes the progress China has made over the last decade in opening its financial markets to foreign investors.

It also reflects the increasing depth and breadth of the Chinese economy—China is the world’s second-largest economy and second-largest equity market. The inclusion of A-shares in broader market measures presents a significant opportunity for non-Chinese investors to tap the return and diversification potential of the growing Chinese market. But investors should be mindful of the unique complexities and risks of investing there. Various regulatory hurdles help explain the myriad share classes and listing arrangements for Chinese companies.

Vinod Chandrashekaran

Vinod Chandrashekaran, Ph.D.

Chief Investment Officer

Disciplined Equity

An active approach may provide the best opportunities to profit from Chinese growth while managing risk and maximizing return potential.

- Vinod Chandrashekaran

You manage core equity portfolios that straddle the growth/value divide. What’s the relationship between growth and value stocks now?

Chandrashekaran: Growth stocks continue to look very expensive relative to history. If we use the Russell 1000 Growth and Value indices as proxies for growth and value, we find that the performance disparity between the two landed in the 95th percentile through 2017 (i.e. fewer than 5% of all trailing 12-month periods showed more extreme growth outperformance than what we just witnessed). Growth has continued to outperform value amid more volatility in 2018, but by less severe margins.

Our analysis shows that after periods of extreme factor outperformance, we typically see significant corrections. Historically, according to our research, when the growth/value spread has been above the 90th percentile, growth has underperformed value by an average of 5.2% over the next 12 months. Of course, it’s impossible to know if or when this snapback will occur. Recall that former Fed Chair Alan Greenspan famously spoke of “irrational exuberance” in December 1996, but the dot-com bubble didn’t burst until March 2000.

So rather than encourage investors to lean heavily one way or the other, we think it makes sense to continue to have exposure to multiple factors, including both growth and value. This approach should provide better risk-adjusted returns over time, reflecting the diversification benefit of having exposure to many different uncorrelated factors.

Greg, you have the final word. What should investors expect from active managers in this environment?

Woodhams: Rising interest rates, trade jitters and a more volatile commodity environment have coincided with a return of market volatility. We believe this return to more normal levels of market volatility is favorable for active managers that rely on individual security selection. Related to this is higher dispersion of returns among securities in the market. Both higher dispersion and higher volatility imply a larger opportunity set of security selection-based strategies, affording active managers with greater opportunities relative to passive benchmarks.

Victor Zhang: U.S. interest rates have increased steadily year to date, and the 10-year Treasury note recently topped 3% for the first time in more than four years. Does the Fixed Income team see this trend continuing?

G. David MacEwen: With the Fed gradually tightening monetary policy since December 2015, U.S. interest rates have been on a slow path to normalization for more than two years. That path hit faster terrain in early 2018, largely due to the combined effects of U.S. tax reform and improving U.S. and global growth. At the same time, inflation remained relatively tame until mid-2017, when it started a modest upward trend. Absent a significant spike in inflation, we believe interest rates are approaching their peaks for the next several months and will remain range-bound. Specifically, we expect the 10-year Treasury yield to move between 2.95% and 3.25% and the two-year Treasury to trade between 2.45% and 3.00%.

Absent a significant spike in inflation, we believe interest rates are approaching their peaks for the next several months and will remain range-bound.

- G. David MacEwen

The Fed continues to pursue a notably different course than its peers in Europe and Japan. Does the team expect central bank policy to converge any time soon?

MacEwen: We expect continued divergence in central bank policy, interest rates, and inflation, as central banks in Europe and Japan maintain their accommodative policies and the Fed continues to normalize.

Earlier this year, it appeared the European Central Bank would join the Fed on the road to normalization. The ECB began tapering its bond purchases in January, with the goal of ending the program in September. However, growth in Europe recently has shown signs of slowing. This development, combined with political unrest in Italy and trade war concerns, has raised the likelihood of the ECB’s extending its stimulus program beyond September.

Meanwhile, the key lending rate in Europe remains 0%, and core inflation is well below the ECB’s 2% target. The Bank of Japan shows no signs of scaling back its stimulus program, as growth in Japan is slowing and inflation recently fell to less than 1%. The exception is the U.K., where headline inflation topped 3% in November 2017, prompting the Bank of England (BoE) to raise interest rates for the first time in a decade. However, the BoE has held rates steady at 0.50% since then, as headline inflation declined to 2.4% in April.

Stable U.S. Treasury yields and extended weakness in the U.S. dollar helped drive robust returns among EM bonds over the last few years. With rates on the rise and the dollar on the rebound, should investors in EM bonds be concerned?

MacEwen: The dollar’s strength is largely a reflection of the policy divergence among global central banks. While the Fed continues to tighten, other central banks remain cautious and accommodative, which has contributed to the dollar rally. Unlike previous periods of U.S. dollar strength, we believe most EM countries are positioned to better withstand the effects.

Of course, there are exceptions, including Argentina, Turkey, and other countries with high current account deficits. A high current account deficit is viewed as negative during times of rising U.S. rates and a strengthening U.S. dollar due to mounting pressure on local currencies and higher borrowing costs for foreign governments. Turkey and Argentina each have deficits of more than 5% of GDP and double-digit inflation, which are notably higher than other EM countries that have been more cautious about current account deficits since the “Taper Tantrum” of 2013.

Cleo, we’ve seen more volatility in the stock and bond markets this year. While investors tend to think about alternative investments as hedges against equity volatility, shouldn’t they also think about hedging risk with alternatives in their bond portfolios?

Cleo Chang: Yes, we think they should. Looking ahead, rising interest rates and higher inflation are among the key challenges facing fixed income investors. We do not expect rates or inflation to rise dramatically, but the backdrop of historically low rates and inflation—a scenario that supported extended gains for traditional bonds—is changing. Fixed income investors looking to hedge against these risks may want to consider alternative income sources, which typically deliver performance uncorrelated with traditional bonds.

Many of these securities, including bank loans, collateralized loan obligations, and asset- backed securities, reside in niche or overlooked areas of the fixed income market, where specialized insight and due diligence are crucial. The securities generally have durations shorter than those of traditional bonds, and their yields typically reset along with prevailing interest rates. These features could help hedge a traditional bond portfolio from the effects of rising rates and mounting inflation.

Cleo Chang

Cleo Chang

Head of Investment Solutions

The features of bank loans, collateralized loan obligations, and asset-backed securities can help protect a traditional bond portfolio from the effects of rising rates and mounting inflation.

- Cleo Chang

Sector Outlook

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U.S. Treasuries


We expect the 10-year Treasury yield—a benchmark for mortgage and other lending rates— to settle in a range of 2.95% to 3.25% for the next 12 months. If inflation rises faster than expected, yields may climb to the upper end of our range. Conversely, certain risks, such as global trade tensions and political uncertainty in Italy and other countries, could cause investors to seek the perceived “safe haven” of Treasuries, which could cause yields to fall near the bottom of our range. Against this backdrop, we expect to underweight Treasuries in favor of more attractive opportunities in other sectors.

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U.S. TIPS


We continue to believe current inflation will edge higher. Meanwhile, the bond market’s expectations for longer-term inflation remain below historical averages. This suggests securities offering a hedge from inflation, including Treasury inflation-protected securities (TIPS), offer better relative value than nominal Treasuries

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U.S. Securitized


We continue to believe certain mortgage-backed and other securitized bonds offer better yield and total return opportunities than Treasuries and other high-quality securities. With interest rates on the rise, we are focusing on floating-rate securities, which offer yields that reset with prevailing interest rates, and shorter-duration securities, which are less sensitive to price movements associated with interest rate changes than longer-duration bonds.

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U.S. Credit


Although corporate fundamentals and earnings remain positive, we believe much of the positive implications of tax reform are already priced into bonds. We believe corporate bonds appear relatively expensive compared with historical averages, and we have therefore reduced our overweight exposure in favor of a neutral position. We continue to find value among select high- yield corporate bonds, but we continue to avoid the riskiest segments of the high-yield sector.

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U.S. Municipal


Against a backdrop of improving economic data, state and local finances across the country are generally healthy. We expect municipal (muni) issuance to remain slower than in 2017, largely due to the effects of federal tax reform. Meanwhile, demand for tax-exempt munis, particularly from high-tax states, should remain healthy. We continue to favor securities in the higher education, transportation, and hospital sectors. Additionally, given our generally favorable economic outlook, we have a slight bias toward higher-yielding securities and sectors (securities with credit ratings at the lower end of the investment-grade universe, and sectors such as charter schools and special tax).

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European Sovereign


The European Central Bank is keeping European government bond yields at unusually low and relatively unattractive levels. However, European growth trends are generally positive, and we believe inflation and rates likely will head upward. In this environment, we are underweighting European government bonds, preferring to focus on select emerging markets (EM) where yields and inflation trends are more attractive.

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European Credit


We continue to find solid opportunities in the financials sector, particularly in the banking and insurance industries. We also favor select bonds in the industrial sector.

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Emerging Markets Debt


We continue to reduce exposure to U.S. dollar-denominated EM debt in favor of select bonds issued in local currency. These securities generally are less vulnerable to rising U.S. Treasury yields and a stronger U.S. dollar. We remain mindful of global trade policy and its likely impact on EM countries, specifically Mexico and Russia.

Victor Zhang: You manage both shorter-term tactical allocation portfolios and longer-term retirement portfolios. What are your short- and long-term views on stocks?

Rich Weiss: In the near term, rising yields make bonds and cash more attractive; however, the recent sell-off in stocks coupled with very strong corporate earnings help to support earnings yields and valuations. As a result, we don’t see a compelling case either way and so maintain our neutral allocation to stocks/bonds/cash.

By region, relative valuations and interest rate changes lead us to favor stocks of developed Asian and European markets over the U.S. Having said that, a significant pickup in volatility overseas might well argue for a move back to large-cap U.S. equities. But for now, we remain overweight non-U.S. developed market equities. Within the U.S., we continue to favor large- cap stocks over small, as our market and economic momentum and sentiment indicators favor large-caps. Finally, we maintain our long-running overweight in growth stocks relative to value, although the recent rise in volatility and breakdown in momentum make this trade less compelling than in the past.

Looking out over the next several years, we are more cautious on stocks. What we find is that low points in unemployment in an economic cycle are strongly correlated with poor stock returns in future years. This makes sense because a low unemployment rate (signifying a strong job market) is also often associated with peaks in economic growth, as well as rising interest rates and inflation. As a result, we are modestly underweight equities in portfolios for investors in or approaching retirement. These investors typically have larger account balances and are drawing down their accounts, so a market decline would be particularly painful for them. But for younger investors far from their savings goals and who are still making contributions to their accounts, then it makes sense to maintain higher equity exposure.

Rich Weiss

Rich Weiss

Chief Investment Officer

Multi-Asset Strategies

Relative valuations and interest rate changes lead us to favor stocks of developed Asian and European markets over the U.S. However, if there was significant pickup in non-U.S. volatility we could argue for a move back to large-cap U.S. equities.

- Rich Weiss

How should investors react to the recent volatility in stock and bond markets?

Weiss: Our mantra is “Do not naively or reflexively buy on the dips.” That’s because we just don’t believe that the next three, five, or 10 years are going to be like the last three, five, or 10 years. The extraordinary monetary and financial conditions of the post-financial crisis period simply don’t exist today in the way they did over the last decade.

At that time, interest rates were at record lows; today, the Fed is reducing its balance sheet and raising short-term rates, while the 10-year U.S. Treasury yield is at its highest level in years. Back then, we were worried about deflation and economic recession; today, we are in one of the longest-running economic expansions in history, and we’re beginning to worry about potential wage inflation. Back then, stocks were recovering from a dramatic sell-off; today, stock markets are in the neighborhood of all-time highs.

It seems safe to say that allocations or strategies that worked best in a one-way, rising market are not the strategies likely to work best in a choppy market with much greater volatility and dispersion of returns both within and among asset classes. But people are creatures of habit, so they are conditioned to buy the dips and pursue the same strategies that have worked over the last decade, even though those conditions no longer hold.

So just because stocks trade off, or bond yields jump, it doesn’t make them automatic buys. The best strategy should be determined in the context of your total portfolio and your specific financial situation—if you are close to retirement or another goal, your answer will be different than that of someone with 20 or more years until their own financial finish line.

Lastly, it is never a wise investment strategy to react to volatility and risk after the fact. Rather, one’s portfolio should be properly positioned to the appropriate risk level before the impact of geo-political or financial shocks. If it is not, then the strategy should be adjusted accordingly.

The underlying theme of your comments seems to be that context is king, that no investment decision should be made in isolation.

Weiss: Let’s be clear—the single-most important determinant of success of any long- horizon investment goal is an investor’s savings rate. There is no asset allocation or trading strategy that can make up for a lack of saving. But if we assume reasonable savings rates, then asset returns, and by extension asset allocation (i.e., mix of stocks, bonds, and cash), play important roles in determining financial outcomes. The implication is that developing and sticking to a saving and investing plan is likely the best thing any investor will do to further financial success.

Yes, context is king—and the context we should all keep in mind is how we are progressing toward our goals. So, when market volatility strikes, we’re not faced with difficult choices or paralyzed by uncertainty. Having a plan, knowing your needs and financial situation, allows you to make informed decisions about the right times to de-risk and rebalance your portfolio—that is, sell assets after gains and buy others after losses.

This sort of approach—where investors make decisions in a structured way around core positions determined by their own financial goals and risk tolerances—is vastly superior to naively reacting to market volatility by “buying the dips,” or selling out of fear.

Do not naively or reflexively buy on the dips because we don’t believe the next three, five, or 10 years are going to be like the last three, five, or 10 years.

- Rich Weiss

Key Takeaways

  • Rising interest rates, trade jitters, and higher energy prices are fueling a more volatile environment that we believe plays to the strengths of active managers.
  • We believe interest rates are closing in on their peaks for the next several months and expect the 10-year U.S. Treasury yield to remain range-bound between 2.95% and 3.25%.
  • Our multi-asset models continue to favor growth over value, although the trade is becoming less compelling. Momentum and sentiment indicators continue to favor large-cap stocks over small caps.
  • We are seeing select opportunities to invest in regional U.S. banks and non-U.S. banks and insurance companies positioned to benefit from rising rates.
  • We believe this is the wrong time to be overexposed to real estate and utilities that benefited from an extended period of historically low interest rates. Passive value investors may be stuck with large exposures to these overvalued sectors.
  • Energy producers remain attractive thanks to higher commodity prices, technology-driven production efficiencies, and improving returns on invested capital.
  • Higher energy prices may be headwinds for consumer-oriented businesses such as retail and travel, and for industries directly affected by higher energy prices, including trucking companies and airlines.
  • Information technology remains attractive in our view as strong performance has expanded to FANGs and a few related industries, including semiconductor and capital equipment companies.
  • The most recent earnings reports confirm regional banks and small-cap companies are key beneficiaries of U.S. tax reform given their high tax burdens compared to multi-national large-cap peers.
  • We are uncertain of how far the parties are willing to escalate, but we believe no clear winners would emerge in a full-scale trade war.
  • Our outlook for EM remains positive. Though rising Treasury yields and a stronger dollar contributed to a recent sell-off, we believe EM nations are better positioned to withstand a dollar rally than in the past.
  • Chinese A-shares offer the opportunity to benefit from the return and diversification potential of the world’s second largest economy, and an active approach makes sense for navigating this emerging market’s significant complexities and risks.

Investment Outlook Brochure

Q3 2018 CIO Roundtable

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Investment Outlook Presentation

Q3 2018 CIO Roundtable

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The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.

International investing involves special risks, such as political instability and currency fluctuations.

Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.

References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

American Century Investments uses a multifactor stock-ranking model incorporating a variety of stock attributes, which fall into four categories or factor families: valuation, growth, quality, and sentiment.

Diversification does not assure a profit nor does it protect against loss of principal.

Alternative mutual funds that hold a variety of non-traditional investments also often employ more complex trading strategies than traditional mutual funds. Each of these different alternative asset classes and investment strategies have unique risks making them more suitable for investors with an above average tolerance for risk.

As with all investments, there are risks of fluctuating prices, uncertainty of dividends, rates of return and yields. Current and future holdings are subject to market risk and will fluctuate in value.