Fed to Proceed Cautiously
What happened last week?
- The S&P 500 gained 0.82%
- The Dow Jones fell 0.45%
- The Nasdaq rose by 2.26%
Nvidia posted stronger-than-expected results and provided an upbeat outlook for the AI sector.
At Jackson Hole, Fed Chair Powell said the Fed would be proceeding cautiously but the economy might not be cooling as much as previously thought.
He reiterated the central bank’s 2% inflation goal and that they would keep at it until the job was done while also acknowledging that there could be economic drag lurking in the pipeline from past Fed tightening.
3 Things to Know
Citi Forecasts, Portfolio Positions Updated
Reflecting our forecast updates, our Global Investment Committee (GIC) shifted its equity allocations from specific non-US markets to the US. Our weighting in China equities moved to neutral and we eliminated over-weights in Hong Kong, Australia and Brazil, some of the most directly impacted markets.
Simultaneously, we raised our allocation to US equities by an equal 2.5 percentage points. This leaves our allocation to Global Fixed Income overweight by 1 percentage point (highly concentrated in high quality US bonds), Global equities neutral and Cash underweight by 1 percentage point.
The implementation of our changes will not be in the typical fashion. We have elected to add an “Equally-Weighted” S&P 500 position reflecting our view that valuations matter more given the market action of 2023.
A New Equal-Weighted S&P 500 Position
An equally-weighted Index is a bit more active than a passive Index selling winners and allocating more to “losers”. Therefore, it is a mean-reverting, contrarian strategy.
It is intrinsically diversifying. Nonetheless, it is not boring. There is meaningful research to suggest that such equally-weighted strategies have the potential to, for substantial periods, outperform market-weighted indices.
We are avoiding adding additional concentration to the US Mega Cap shares that have led the rally. Just 10 companies now comprise a record 31% of S&P 500 Index.
While the so-called “Magnificent 7” have surged to a forward valuation of 36X, the Equal-Weight S&P Index trades at its largest valuation discount to the market cap-weighted Index since 2010.
The Equal-Weight S&P 500 Index has posted a mere 3.6% gain this year, and we continue to see a likely broadening in global equity performance in the year to come, once investors look beyond the near-term challenges we’ve highlighted.
2024 Outlook: The US Is Likely to Slow
Higher US yields reflect the view that US monetary policy can remain sustainably tight. This is not our view for 2024, as we see softening employment, a slower US economy and exported deflation form China as likely to reduce pressure on yields in 2024.
We remain committed to equities with a 12–18-month outlook.
We expect a broadening performance in global equities over time, even though our expectation of the benefits of a falling US dollar have been delayed. We are mindful that the impact of tighter monetary policy in the US will increase in 2024.
Higher rates must impact employment growth negatively even as services and manufacturing settle into more normal ranges.
Moreover, Fed Chairman Powell’s speech at Jackson Hole, Wyoming (August 2023) continued to emphasize the need for cooling labor markets almost regardless of their direct impact on inflation measures.
Citi forecasts a slowdown in 2024 for the United States, especially for US labor markets. Eventually, bearish bond investors will cover record high short positions in US Treasuries as much as equity investors did in early 2023.
See our weekly CIO Strategy Bulletin for more details