Monthly Market Snapshot: September 30, 2022
U.S. stocks have declined for three consecutive quarters with the S&P 500 tumbling another 5.3% in the third quarter of 2022. The tech-heavy NASDAQ fared slightly better but still closed the quarter down 4.1% and is now down 32.4% year-to-date. European stocks and emerging market stocks were among the worst performers in the quarter as the U.S. dollar continued to surge. European shares were off 10.0% in the quarter while emerging markets stocks shed 12.5%. Global fixed income markets did not fare much better with U.S. Investment Grade debt sliding 4.8% in the quarter as yields soared on rising expectations for aggressive central bank tightening.
Investors remain squarely focused on central banks. Inflation remains extremely high across many developed markets, and central banks are responding with aggressive rate hikes. The unanswered question is whether a global recession will occur in 2023 or not. We believe the odds of a U.S. recession in 2023 are now about 70%. Investors will look for signs of a weak labor market with hopes that it could force a Fed pivot.
Citi Global Wealth Investments’ (GGWI) Global Investment Committee remains defensive with a slightly underweight global equity position and a modestly overweight global fixed income position.
Economy (Likely Headed Towards Contraction)
After two consecutive quarters of negative growth in the first half of 2022, the U.S. economy appears to be rebounding some with the Atlanta Fed’s GDPNow tracker estimating 2.7% growth in the third quarter. However, we expect the economy to slow to an annual pace of 0.7% in 2023 as the Federal Reserve’s rate hikes take their tolls. We put the odds of a U.S. recession at about 70%. Avoiding one would likely require either an abrupt pivot from the Fed or a rapid improvement in global supply chains.
Stocks (Slightly Overweight Large-Cap; Underweight SMID)
CGWI’s Global Investment Committee (GIC) is maintaining a defensive tilt with a preference towards higher quality stocks like dividend-growers, healthcare, and consumer staples. While a potential recession has been largely priced into stocks already (perhaps 2/3 of the downside is in) it would be unusual to see the market bottom prior to the actual onset. We remain underweight small- and mid-cap stocks as the style factor tends to be more sensitive than large-cap stocks to economic downturns.
The GIC is overweight intermediate- and long-duration U.S. Treasuries (such as the 30-year tenure). While still slightly underweight short-term U.S. treasuries, we see the asset class as more attractive now that yields have risen sharply. We also remain overweight U.S. Treasury-Inflation-Protected Securities (TIPS) and like preferred stock as we lean into quality fixed income.
Europe and Japan
Economy (Europe: Headed Towards Contraction / Japan: Expanding)
With Russian energy supplies significantly curtailed, Europe is facing a difficult situation. While gas storages are nearly full and prices have come down, leading economic indicators remain weak and suggest that a recession remains the likely outcome. CGWI is forecasting that growth could slip from 3.0% year-on-year in 2022 to minus 0.5% in 2023. The United Kingdom’s economy may contract by 1.0% in 2023. We expect Euro Area growth to rebound in 2024. In Japan, an expected pickup in consumer demand has led our colleagues in Citi Research to raise their forecast from 1.2% in 2023 to 1.4%.
Stocks (Neutral UK; Underweight Europe ex UK; Underweight SMID / Underweight Japan)
The GIC maintains an underweight position on Europe ex UK and Switzerland that was put in place in early March. We expect growth to weaken materially as rising energy costs take their toll. Fiscal stimulus and price controls may be needed to reduce the burden on consumers. We also remain underweight on non-U.S. small- and mid-cap stocks (SMID) and Japanese stocks as the region grapples with a slowing in major trade partners (China and the United States). We remain neutral on UK equities as the composition of the FTSE 100 is somewhat defensive in nature.
The GIC maintains a deep underweight on both European and Japanese sovereign bonds.
Citi Research’s economists expect emerging market economies to slow from 6.8% year-on-year in 2021 to 3.5% year-on-year in 2022. Growth may rebound in 2023 if China’s stimulus takes hold, but China’s fragile property sector and youth unemployment bears watching. CGWI still believes that year-on-year growth in China will climb from 3.5% in 2022 to 4.5% in 2023.
Stocks (Overweight China; Neutral Asia ex China and Latin America; Underweight EMEA)
The GIC is overweight China stocks on hopes that improving supply chains and stimulus will help to turn the economy around. We are neutral on Emerging Market Asia ex China. We are also neutral on Latin America and underweight Emerging Europe, Middle East, and Africa (EMEA).
Bonds (Overweight Asia; Neutral EMEA and Latin America)
The GIC maintains an overweight on Emerging Market Asia fixed income. In local bonds, future returns may be driven by foreign exchange movements.
U.S. Stock Market and Economic Forecasts
|S&P 500 Estimate||3,756||4,766||4,000|
|S&P 500 P/E Ratio||27.43x||21.6x||16.8x|
|S&P 500 EPS Growth||-22.1%||46.9%||6.4%|
Global Economic Forecasts
|Region||GDP Growth||CPI Inflation||10-Year Yields||Exchange Rate vs. USD|
|Based on PPP Weights||6.2||3.1||3.0||4.4||8.8||6.6||N/A||N/A||N/A||N/A||N/A||N/A|
|Equity Returns (%)||Valuations||Div. Yld. (%)|
|Fixed Income Returns (%)||Other Key Rates|
|Fixed Income||YTM||2017||2018||2019||2020||2021||MTD||QTD||YTD||Instrument||Current (%)|
|Global||3.91||2.1||0.5||7.1||5.7||-2.1||-3.9||-4.5||-14.4||10-Yr. U.S. Treasury||3.83|
|U.S.||4.77||3.6||0.0||8.9||7.7||-1.6||-4.4||-4.8||-14.9||30-Yr. U.S. Treasury||3.78|
|Europe||3.04||0.5||0.5||6.0||4.1||-2.9||-3.7||-4.6||-16.1||1-Yr. CD Rate||1.50|
|EM Sovereign||9.24||9.8||-4.1||14.8||5.4||-2.8||-7.1||-4.9||-25.3||30-Yr. Fixed Mortgage||7.06|
|U.S. High Yield||9.73||7.0||-2.1||14.1||6.3||5.4||-4.2||-0.7||-14.4||Prime Rate||6.25|
Asset Class Returns (Sorted by Performance)