Monthly Market Snapshot: August 2021
Despite investors’ concerns that a market correction may be nearing, the S&P 500 delivered its seventh straight month of consecutive gains in August. The wall of worry continues to be climbed. Even emerging markets, which suffered a 6.4% pullback mid-month, managed to close out the month 0.6% higher. Excluding China, emerging markets rose 2.5% in August. The 10 year U.S. Treasury yield rose modestly from 1.22% to 1.30%.
The Fed’s virtual Jackson Hole policy retreat drew lots of attention, but did not change the narrative much. The consensus still expects a tapering announcement to occur in the next meeting or two and for tapering to start by the end of 2021. The August employment report is due later this week and may hold the key on whether or not the tapering announcement comes in September. However, Chair Powell’s statement that, “We have much ground to cover to reach maximum employment,” suggests that policy will remain accommodative for some time and the first rate hike is likely at least a year away. Probably more.
Citi’s Global Investment Committee (GIC) left its allocation to Global Equities at a 8% overweight with a concentration in Global Healthcare and Fixed Income and Cash is a 8% underweight. The GIC recommends holding 10% of medium-risk portfolios in stocks with consistent dividend growth.
The U.S. economy expanded by an annualized rate of 6.6% in the second quarter, but is tracking closer to 5.1% for the third quarter according to the Atlanta Fed. This suggests that the economy may be starting to normalize after the initial reopening surge. As a result, Citi Research’s economists have lowered their 2021 forecast from 6.4% year-on-year to 6.0% year-on-year. Inflation remains elevated, but we expect peak inflation to be reached shortly with consumer price index inflation averaging 3.8% in 2021. Infrastructure talks continue to progress with two separate bills likely to be passed later this year.
Stocks (Overweight Large-Cap; Underweight SMID)
Citi’s Global Investment Committee (GIC) remains overweight on U.S. large-cap stocks, but maintains an underweight on small- and middle-cap (SMID) stocks. The GIC thinks U.S. large-caps show sustainable growth opportunities even at a higher-than-average valuations, but U.S. small-caps tend to underperform as the business cycle matures. That leaves the GIC underweight in SMID after holding it as an overweight during the majority of the past 16 months.
The GIC is underweight short-term U.S. Treasuries, neutral intermediate- and long-dated Treasuries, and overweight U.S. Treasury-Inflation-Protected Securities (TIPS). Later this year, we expect to hear from the Fed that they intend to taper asset purchases. The 10-year U.S. Treasury yield appears to have stabilized after four straight month of declines. With tapering on deck, we think that the 10-year yield may climb to trade in a range of 1.50% to 2.00% by year-end. For taxable U.S. investors, muni yields are attractive relative to other taxable high-quality bonds.
Europe and Japan
Economy (Europe: Recovering / Japan: Recovering)
As the region’s vaccination campaign continues at a steady pace alongside ample fiscal and monetary policy, we expect to see a resurgence in economic activity in the second half of this year. Citi Research is looking for the euro area to expand by 4.6% in 2021 and by 4.5% in 2022. In Japan, 2021 growth forecasts have been revised down slightly – from 2.2% to 2.1%. However, the 2022 growth forecast has been lifted from 3.8% to 3.9%.
Stocks (Europe: Overweight; Neutral SMID / Japan: Neutral)
The GIC maintains an overweight on UK equities, but is neutral Europe ex UK. The GIC is also neutral on Japan large-caps. Non-U.S. small- and mid-cap stocks (SMID) are considered a neutral or slight underweight as well. In the UK, valuations remain cheap and the FTSE 100 is largely comprised of value-oriented Energy and Financial names, which we think can recover further if rates eventually rise.
The GIC is maintaining a deep underweight on both European and Japanese sovereign bonds.
Citi Research’s 2021 growth forecast for emerging markets is 6.7%. This is slightly lower than the expectations for Asia, which is expected to grow 7.7% in 2021. Latin America is expected to grow by 5.9% in 2021 and by 2.6% in 2022.
Stocks (Overweight Asia (ex China) and China; Neutral Latin America; Underweight EMEA)
The GIC is overweight on emerging market Asia as it recently upgraded its allocation to China as the correction in Chinese tech shares have made valuations look attractive again. More broadly, Asian economies are positioned well for an industrial rebound expected later this year. Latin America remains at a neutral weighting.
Bonds (Overweight Asia; Neutral EMEA and Latin America)
The GIC maintains an overweight on emerging market fixed income, specifically Asia. In local bonds, future returns may be driven by foreign exchange movements.
U.S. Stock Market and Economic Forecasts
|S&P 500 Target||3,231||3,300||4,000|
|S&P 500 P/E Ratio||18.97x||27.43x||24.52x|
|S&P 500 EPS Growth||2.0%||-13.5%||39.1%|
Global Economic Forecasts
|Region||GDP Growth||CPI Inflation||10-Year Yields||Exchange Rate vs. USD|
|Based on PPP Weights||-3.3||6.2||4.3||2.8||4.2||3.4||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||2016||2017||2018||2019||2020||MTD||QTD||YTD||Instrument||Current (%)|
|Global||0.77||3.3||2.1||0.5||7.1||5.7||-0.1||1.2||-0.7||10-Yr. U.S. Treasury||1.31|
|U.S.||1.35||2.7||3.6||0.0||8.9||7.7||-0.1||1.0||-0.6||30-Yr. U.S. Treasury||1.93|
|Europe||-0.04||3.3||0.5||0.5||6.0||4.1||-0.1||1.5||-0.8||1-Yr. CD Rate||0.29|
|EM Sovereign||4.47||9.6||9.8||-4.1||14.8||5.4||1.0||1.5||-0.2||30-Yr. Fixed Mortgage||3.03|
|U.S. High Yield||4.69||17.8||7.0||-2.1||14.1||6.3||0.5||0.8||4.5||Prime Rate||3.25|
Asset Class Returns (Sorted by Performance)