Monthly Market Snapshot: July 2021
Investors experienced building crosswinds in July, but continued to drive equity indices higher. One of those crosswinds was the Covid Delta variant, which causes some investors to question whether or not the ongoing recovery might start to weaken. We don’t see it as derailing the economic recovery, though it could delay recovery in some regions / sectors. Despite these fears, the S&P 500 added 2.3%. The clear underperformer during the month was emerging markets (down 7.0%) as Chinese stocks plunged amid a regulatory crackdown.
A bi-partisan agreement on a “hard” U.S. infrastructure bill appears to have been reached. However, the larger, social-spending infrastructure component may need to be passed via a party-line reconciliation bill this fall. A key question that remains is if it be largely deficit-financed or paid for by higher corporate and individual taxes. Fed policy remains in question as well with investors eagerly awaiting an official announcement about the tapering of Fed asset purchases.
Citi’s Global Investment Committee (GIC) left its allocation to equities and fixed income unchanged. However, the GIC made several changes within the portfolio’s composition, including upgrading large-cap U.S. and China stocks at the expense of other emerging markets and real estate. 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 6.5% in the second quarter. Although the print came in below expectations it was largely due to a drawdown in private inventories. Personal consumption was remarkably strong, coming in at an annualized rate of 11.8%. Solid consumption should enable the expansion to continue at an above-trend pace for the next few quarters. Fears about the Delta variant are warranted and could pose a downside risk to growth, but a return to the lockdowns experienced in 2020 seems highly unlikely.
Stocks (Overweight Large-Cap; Underweight SMID)
Citi’s Global Investment Committee (GIC) increased its allocation to U.S. large-cap stocks, but maintained 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. The GIC’s underweight in SMID comes 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. Although the 10-year U.S. Treasury yield has been on the decline for four straight months, we still think that the economic backdrop argues for higher rates over time. Perhaps the 10-year U.S. Treasury yield trade in the 1.5%-2.0% 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, another state of emergency declaration in Tokyo led to a slight downgrade to 2021 growth forecasts – from 2.3% to 2.2%. However, the 2022 growth forecast has been lifted from 3.5% to 3.8%.
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.
The GIC is maintaining a deep underweight on both European and Japanese sovereign bonds.
Citi Research lowered its 2021 growth forecast from 6.8% to 6.7% slightly lower 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 ex China and China. The GIC 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 the trade and industrial rebound expected later this year. Latin America has been downgraded to neutral after the region’s largest market, Brazil, returned 63% in U.S. dollar terms since the GIC added it as an overweight in April 2020.
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||23.74x|
|S&P 500 EPS Growth||2.0%||-13.5%||29.2%|
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||0.76||3.3||2.1||0.5||7.1||5.7||1.2||1.2||-0.7||10-Yr. U.S. Treasury||1.22|
|U.S.||1.34||2.7||3.6||0.0||8.9||7.7||1.1||1.1||-0.5||30-Yr. U.S. Treasury||1.89|
|Europe||-0.07||3.3||0.5||0.5||6.0||4.1||1.6||1.6||-0.7||1-Yr. CD Rate||0.29|
|EM Sovereign||4.52||9.6||9.8||-4.1||14.8||5.4||0.5||0.5||-1.2||30-Yr. Fixed Mortgage||2.98|
|U.S. High Yield||4.68||17.8||7.0||-2.1||14.1||6.3||0.3||0.3||4.0||Prime Rate||3.25|
Asset Class Returns (Sorted by Performance)