Monthly Market Snapshot: July 2018
The U.S. equity market continues to recover from its February correction. In July, the S&P 500 climbed an impressive 3.6% to 2,816. If the index climbs an additional 2.0% or so it will match its all-time high reached back in January. Globally, the recovery has been a bit slower because of lingering trade tensions, but European shares did rally 4.0% during the month as the U.S. and Europe appeared to reach a “trade truce.” Emerging market shares also rallied in July as the U.S. dollar’s ascension versus other international currencies took a pause.
U.S. economic growth and corporate earnings growth remain strong. Real GDP accelerated to an annualized 4.1% in the second quarter and S&P 500 earnings-per-share growth is expected to rise by over 20% this year. Trade tensions remain relevant and may eventually start to weigh more heavily on investor sentiment, but growth seems to have the stronger pull on markets in the ongoing tug of war between growth and protectionism. At least for now.
Citi Private Bank’s Global Investment Committee (GIC) cuts its global equity allocation by 2.5% to a modest overweight of +1.5%. With trade tensions still elevated, the GIC decided to dial back a bit on risk with reductions being made to Canadian, Mexican, European, and Emerging Market shares. On the fixed income side, the GIC raised their allocation to short-term U.S. debt and inflation-linked debt (leaving the fixed income underweight at -1.5%).
U.S. Stock Market and Economic Forecasts
|S&P 500 Target||2,674||2,800||2,865 (Mid-Year)|
|S&P 500 P/E Ratio||20.79x||18.55x||17.62x|
|S&P 500 EPS Growth||11.7%||15.1%||5.2%|
Citi Research and Citi Personal Wealth Management as of July 31, 2018.There can be no assurance that these projections will be met. Actual results may differ materially from the forecasts/estimates. The above table reflects the views of Citi Investment Research and Analysis (CIRA). CIRA forecasts take into consideration underlying economic, demographic, political, and psychological forces that drive market behavior. CIRA looks for trends and markets that offer potential as long-term investment ideas. You should carefully consider investment objectives, risks, charges, and expenses before investing.
The U.S. economy grew at a robust 4.1% in the second quarter of 2018. Real consumer spending has rebounded strongly as consumers take advantage of their higher after-tax incomes. Citi’s economists believe that the growth may moderate a bit in the third quarter, but 3.0% growth in 2018 seems doable. As the fiscal stimulus works its way through the economy, the unemployment rate may reach the mid-3% range by the end of 2018.
Citi Private Bank’s Global Investment Committee continues to hold a neutral rating on U.S. stocks. Corporate earnings appear to be on track to rise by 20 plus percent this year due to the recently enacted corporate tax cuts. In addition, economic growth remains strong. However, pending trade decisions (auto tariffs, Chinese tariffs, and NAFTA renegotiations) are serving as an anchor on U.S. equity markets. If trade deals can be reached we expect to see a notable relief rally, but at this stage, most signposts suggest that relations between the U.S. and China might “get worse, before they get better.”
The Fed continues to signal that additional rate hikes are likely. With short-term rates looking more appealing, Citi has increased its allocation to short-term higher quality debt like U.S. Treasuries, U.S. corporate debt, and municipal bonds for U.S. tax-payers.
Europe and Japan
After months of disappointing economic data releases, the Euro area appears to have finally stabilized. As a result, our economists have left their real GDP forecasts for the Euro area unchanged for the first time this year – predicting 2.1% growth. In Japan, the economy looks likely to grow at a clip of about 1.1% in both 2018 and 2019 (according to Citi’s economists). However, it should be noted that U.S. tariffs on foreign autos could serve as a drag on Japanese growth if enacted.
Despite stabilizing growth and deescalating trade tensions, the GIC decided to reduce the size of its overweight (down to a +0.5% overweight) to European equities. As far as Japan, the region remains uniquely exposed to potential auto tariffs. While there’s no guarantee that auto tariffs will be put in place, we have lowered our weighting to neutral on Japanese large caps.
We still see the yields on most European and Japanese sovereign bonds as unacceptable. Corporate investment grade in Europe (ex UK) also remains an underweight.
Emerging market economies are expected to accelerate by 4.7% in 2018 (this is 0.1% lower than last month’s forecast). While still growing, Chinese growth is expected to slow to fall from 6.7% year-on-year in the second quarter to 6.5% year-on-year in the second half.
Emerging market shares have stabilized since the start of July (along with the U.S. dollar), but remain somewhat exposed to Fed tightening and international trade skirmishes. While emerging markets will likely provide the best returns over the coming decade, near-term exposures have led the GIC to reduce its overweight from +2.0 to +1.0% (bringing down its overweight by a full percentage point).
We are overweight emerging market fixed income – in line with our equity position.
Global Economic Forecasts
|Region||GDP Growth||CPI Inflation||10-Year Yields||Exchange Rate vs. USD|
|Based on PPP Weights||3.8||3.9||3.9||3.0||3.2||3.2||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||2013||2014||2015||2016||2017||MTD||QTD||YTD||Instrument||Current (%)|
|Global||2.09||-0.1||7.9||0.9||3.3||2.1||-0.1||-0.1||-0.6||10-Yr. U.S. Treasury||2.96|
|U.S.||3.37||-2.0||5.9||0.5||2.7||3.6||0.0||0.0||-1.6||30-Yr. U.S. Treasury||3.08|
|Europe||0.68||2.1||11.2||1.1||3.3||0.5||-0.2||-0.2||0.1||1-Yr. CD Rate||2.41|
|EM Sovereign||5.56||-6.2||7.1||0.6||9.6||9.8||2.5||2.5||-3.3||30-Yr. Fixed Mortgage||4.43|
|U.S. High Yield||6.66||7.2||1.8||-5.6||17.8||7.0||1.1||1.1||1.4||Prime Rate||5.00|
Asset Class Returns (Sorted by Performance)