Monthly Market Snapshot: October 31, 2022
Stocks surged globally in October with the MSCI All Country World Index jumping 6.0%. In the United States, the Dow Jones Industrial Average rallied 14.0% - its largest one-month gain since 1976. Most other developed markets posted strong gains as well, but emerging markets struggled with a 3.2% loss. More stable fiscal policy in the UK, hopes of a downshift in the size of Fed rate hikes, resilient corporate earnings, and an easing of the upward pressure on bond yields each helped to push equities upward. It should not be ignored that this rally is also coming on the back of an extremely poor performance in September.
The strong performance is refreshing, but we hesitate to fully embrace risk with a potential U.S. recession in 2023 still on the horizon. It is quite rare that equity markets bottom before a recession has even begun. Though we do believe that equities have de-risked significantly and that potential opportunities will arise in 2023 as investors begin to look past economic weakness and towards an eventual economic recovery in 2024.
Citi Global Wealth Investments’ (GGWI) Global Investment Committee has repositioned fully invested diversified portfolios towards potentially reliable sources of income – investment grade bond income and dividends paid by industry leading firms.
Economy (Likely Headed Towards Contraction)
The U.S. economy accelerated in the third quarter of 2022 with annualized quarterly growth rising by 2.6% (up from minus 0.6% annualized in the second quarter). However, a look under the hood showed a slowing in consumer spending and a contraction in residential investment. In addition, leading economic indicators continue to suggest a further slowing of the U.S. economy. Absent an abrupt pivot from the Fed or a sharp, persistent drop in the pace of inflation, a recession in 2023 seems more likely than not.
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 equity markets have de-risked significantly from the start of the year, it would be unusual to see a market bottom prior to the actual onset of a recession. 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 added further to short-duration U.S. Treasuries, which have seen yields jump by approximately 75-basis-points since the GIC’s meeting in September. While longer-duration Treasuries will likely rally as the economy slows (we remain overweight), short-maturities may provide higher income over the next 12-18 months. We also remain overweight U.S. Treasury-Inflation-Protected Securities (TIPS).
Europe and Japan
Economy (Europe: Headed Towards Contraction / Japan: Expanding)
The Euro Area remains on track for a recession amid high inflation and deteriorating leading economic indicators. While gas storage is nearly full and downside risks from the energy crisis have eased some, tightening financial conditions are a notable headwind. 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 1.9% 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 1.4% in 2023 to 1.5%.
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 as tighter financial conditions weigh on economic activity. 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 deepened its underweight to European investment graded bonds. Japanese sovereign bonds remain a significant underweight as well.
Citi Research’s economists expect emerging market economies to slow from 6.8% year-on-year in 2021 to 3.6% year-on-year in 2022 as China’s economy decelerates from 8.1% growth to 3.5%. Growth may rebound in 2023 if China’s stimulus takes hold, but China’s fragile property sector and youth unemployment bears watching. The GIC believes that growth in China will climb 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 less strict COVID policies 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 (Neutral Asia and Latin America; Underweight EMEA)
The GIC moved to neutral on non-USD emerging market Asia and Latin America fixed income and an underweight on emerging market European, Middle Eastern, and African local currency bonds.
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||17.6x|
|S&P 500 EPS Growth||-22.1%||48.4%||6.0%|
Global Economic Forecasts
|Region||GDP Growth||CPI Inflation||10-Year Yields||Exchange Rate vs. USD|
|Based on PPP Weights||6.3||3.2||2.9||4.4||8.9||6.8||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||3.98||2.1||0.5||7.1||5.7||-2.1||-0.6||-0.6||-14.9||10-Yr. U.S. Treasury||4.05|
|U.S.||4.94||3.6||0.0||8.9||7.7||-1.6||-1.3||-1.3||-15.9||30-Yr. U.S. Treasury||4.16|
|Europe||3.03||0.5||0.5||6.0||4.1||-2.9||0.1||0.1||-16.0||1-Yr. CD Rate||1.91|
|EM Sovereign||9.21||9.8||-4.1||14.8||5.4||-2.8||1.1||1.1||-24.5||30-Yr. Fixed Mortgage||7.22|
|U.S. High Yield||9.13||7.0||-2.1||14.1||6.3||5.4||3.1||3.1||-11.8||Prime Rate||6.25|
Asset Class Returns (Sorted by Performance)