The global stock market rout continued last week with the MSCI AC World Index falling 2.7% (it is down 13.4% year-to-date). In the United States, the S&P 500 tumbled 3.3% while the NASDAQ shed 3.9% on weaker-than-expected technology company earnings. Markets overseas were not spared with European stocks declining 2.6% and Japanese stocks slipping 1.4%. The nominal 10-year U.S. Treasury yield was little changed at 2.93% while the real 10-year U.S. Treasury yield turned positive at 0.1%. The recent sharp rise in the real 10-year U.S. Treasury yield has likely been a contributing factor to the dramatic sell-off in technology shares.
The Federal Reserve’s anticipated “fast and furious” monetary policy tightening cycle has upended financial markets with both stocks and bonds suffering losses year-to-date as investors weigh the prospects of a “hard landing” for the U.S. economy. Other headwinds like the ongoing conflict between Russia and Ukraine complicate matters further.
Rising uncertainty may be weighing on financial markets, but that does not mean that investors cannot have asset class convictions. In this short commentary, we provide a brief summary of how we think the economic outlook may unfold and the asset classes that we feel may be appropriate in the current environment.
Shawn Snyder
Head of Investment Strategy,
Citi Personal Wealth Management
Last Week's Closeof the main usa stock market indices
S&P 5004,132
(-3.3%index down 3.3 percent from last week)
DJIAdow jones industrial average32,977
(-2.5%index change down 2.5 percent from last week)
NASDAQ12,335
(-3.9%index change down 3.9 percent from last week)
Fast and Furious
Charlie Munger, who is the Vice Chairman of Berkshire Hathaway, once said, “If you’re not a little confused by what’s going on you don’t understand it. We are in uncharted territory.” 1 In our view, his quote accurately describes how investors are feeling right now with several different headwinds buffeting the global economy (including “fast and furious” U.S. central bank tightening, an ongoing conflict between Russian and Ukraine, renewed COVID-19 lockdowns in China, and elevated inflation). These headwinds have resulted in heightened market volatility with the Dow Jones surging by over 600 points one day and then falling by over 900 points the next (see figure 1).
Figure 1. Dow Jones Industrial Average (Daily Point Change)
This chart shows the daily point change of Dow Jones Industrial Average from April 25th to April 29th in 2022.
Sources: Haver Analytics and Citi Global Wealth Investments as of April 29, 2022. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. For illustrative purposes only. Past performance is no guarantee of future results. Real results may vary.
With the global economic outlook very murky right now, it is increasingly difficult to make predictions, but that should not prevent investors from having asset class convictions. Below is a summary of how we are viewing the U.S. economy and our recommended portfolio tilt:
The first quarter 2022 U.S. gross domestic product (GDP) print of minus 1.4% annualized was not a recession signal. The report was greatly impacted by a surge in imports and a deep trade imbalance that resulted in a minus 3.2% contribution to real GDP. Absent the trade imbalance, GDP would have been modestly positive with consumer spending rising 2.7% on an annualized basis and business spending on research, equipment, and development surging 9.2%. Leading economic indicators also suggest that a U.S. recession is not imminent (see figure 2).
Figure 2. U.S. Leading Economic Indicators (YoY%) vs. Periods of U.S. Recession
This line chart shows the percent of U.S. Leading Economic Indicators year-over-year versus the Periods of U.S. Recession from 1960 to 2022 year-to-date.
Sources: Haver Analytics and Citi Global Wealth Investments as of March 2022. Note: Shaded regions denote periods of U.S. recession.
Inflation may be plateauing. The personal consumption expenditure (PCE) price index rose from 6.3% in February to 6.4% in March – a touch below the consensus expectation of 6.7%. The core PCE price index also came in a tick under consensus expectations. This might mark a plateauing of inflation with business surveys like the Institute for Supply Management (ISM) manufacturing price paid component also suggesting that the pace of price gains may be leveling off (see figure 3). If accurate, this could take some pressure off the Fed in the back half of 2022 and result in smaller rate hikes than the 50-basis-point rate hikes that are currently being priced in.
Figure 3. ISM Manufacturing Prices Paid Index vs the PCE Price Deflator
This line chart shows the ISM Manufacturing Prices Paid Index versus the PCE Price Deflator from 2008 to 2022 year-to-date.
Sources: Haver Analytics and Citi Global Wealth Investments as of March 2022.
We see the probability of a U.S. recession at about 25%-30%. That probability will climb if the Fed follows its trajectory and inflation does not break, but the Fed may still pivot down the road in the face of likely economic weakness to come, which could raise the odds of a “soft landing.”
Our global equity overweight is largely in commodity hedges like natural resources, oil field services, and other defensive equities. Hedges are designed as insurance…one hopes that they don’t need it. However, if Europe embargos Russian oil and natural gas, then investors may benefit from owning these types of hedges. Away from commodities, we prefer companies with a solid track record of earnings and dividend growth. While the S&P 500 is down 14.3% year-to-date and the NASDAQ is down 21.5% year-to-date, our preferred strategy of Dividend Growers is down just 6.9% year-to-date (see figure 4). We also believe that investors may wish to consider adding long-duration Treasuries (such as the 30-year U.S. Treasury) with yields likely to peak in 2022. We think that this type of defensive portfolio tilt will likely remain appropriate until investor uncertainty fades. Several events could cause this to happen including a resolution of the Russia / Ukraine conflict or an end to China’s lockdowns, but we suspect that the most important factor to turn investor sentiment will be a sense that the Fed’s “fast and furious” approach to the rapid rise in inflation is starting to slow.
Figure 4. Year-to-Date Returns of Various U.S. Equity Market Indices
This line chart shows the Year-to-Date Returns of S&P 500 Dividend Artistocrats, S&P 500, and NASDAQ from January 2022 to May 2022.
Sources: Bloomberg and Citi Global Wealth Investments as of May 2, 2022. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. For illustrative purposes only. Past performance is no guarantee of future results. Real results may vary.
What Should U.S. Investors Watch in the Week Ahead?
The Federal Reserve will announce its rate decision on Wednesday at 2PM EST. It is widely expected that the Fed will raise the federal funds rate by 50-basis-points and signal its intent to move “promptly and quickly” to stem the rise in U.S. inflation. It will be interesting to hear their assessment of the current economic environment, but we doubt that the Fed will express serious concerns about the U.S. economy at this stage. Investors will also receive the April employment report, which is expected to the show the economy adding 391,000 jobs during the month. The unemployment rate is expected to fall from 3.6% to 3.5%. Most signs continue to point to an extremely tight labor market.
Figure 5: U.S. Stock Market Returns and Select Assets
Index
Weekly Chg change in percent
YTDyear to date change in percent
12 Months12 month change in percent
Div. Yield division yield in percent
Dow Jones
-2.5%
-9.2%
-3.2%
2.0%
S&P 500
-3.3%
-13.3%
-1.9%
1.5%
NASDAQ
-3.9%
-21.2%
-12.4%
0.8%
Instrument
Weekly Chgchange
YTDyear to date
12 Months12 month change
Level
10-Year Treasury Yield (%)
3.4 bps
142.3 bps
129 bps
2.93%
Gold ($/Oz.)
-1.8%
3.7%
7.0%
$1,896.9
Oil ($/bbl)
1.6%
36.0%
61.0%
$104.69
❮ Swipe left for more
This table shows returns for various USA equity markets and select assets, in weekly, year-to-date and 12 month changes.
Figure 6: International Stock Market Returns
Index
Weekly Chg change in percent
YTD year to date in percent
12 Months12 month change
Div. Yield division yield in percent
Global
-2.7%
-13.4%
-7.7%
2.0%
Europe
-2.6%
-13.6%
-9.7%
3.0%
Japan
-1.4%
-15.6%
-15.9%
2.3%
Emerging Markets
0.1%
-12.2%
-19.3%
2.7%
❮ Swipe left for more
This table shows the US Stock Market Returns and Select Assets and International Stock Market Returns.
Sources: Bloomberg and Citi U.S. Wealth Management as of April 29, 2022. Note 1 (Equities): Global = MSCI All Country World Index (USD); Europe = MSCI Europe (USD); Japan = MSCI Japan (USD); Emerging Markets = MSCI Emerging Markets (USD). The equity index returns shown here are based in U.S. dollars. Returns for a non-U.S.-based investor can differ significantly depending on the effects of foreign currency exchange. Note 2 (Instrument): Gold = U.S. dollars per Troy ounce; Oil = West Texas Intermediate crude at Cushing, OK. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Past performance is not indicative of future returns. Real results may vary.
The Week Ahead
Figure 7: U.S. The Week Ahead
Date
Time
Event
Period
Consensus
Prior
5/3
10:00
JOLTSJob Openings and Labor Turnover Survey Job Openings
MarMarch
11200kthousand
11266kthousand
5/3
10:00
Wards Total Vehicle Sales
AprApril
14.1mmillion
13.33mmillion
5/4
8:15
ADP Employment Change
AprApril
385kthousand
455kthousand
5/4
10:00
ISMInstitute for Supply Management Services Index
AprApril
58.5
58.3
5/4
14:00
FOMCfederal open market committee Rate Decision (Lower Bound)
5/4/2022May 4, 2022
0.8%
0.3%
5/5
8:30
Nonfarm Productivity
1Q Pfirst quarter period
-5.0%
6.6%
5/5
8:30
Unit Labor Costs
1Q Pfirst quarter period
10.0%
0.9%
5/6
8:30
Change in Nonfarm Payrolls
AprApril
391kthousand
431kthousand
5/6
8:30
Unemployment Rate
AprApril
3.5%
3.6%
5/6
8:30
Average Hourly Earnings YoYyear-over-year
AprApril
5.5%
5.6%
This table lists a number of key economic events, analysis reports and forecasts from influential institutions.
Sources: Bloomberg and Citi Global Wealth Investment as of April 29, 2022.
Shawn Snyder
Head of Investment Strategy,
Citi Personal Wealth Management