Equity market performance in December was dismal. In the United States, the S&P 500 plunged 9.2% and the Dow Jones tumbled 8.7%. The indices closed out the year with 6.2% and 5.6% declines, respectively...
Equity market performance in December was dismal. In the United States, the S&P 500 plunged 9.2% and the Dow Jones tumbled 8.7%. The indices closed out the year with 6.2% and 5.6% declines, respectively. While the worst performance in a decade, U.S. markets outperformed international markets with European, Japanese, and Emerging Market shares finishing the year with declines of 18.5%, 14.5%, and 16.6%, respectively.
The uptick in market volatility in 2018 was not a surprise, but the weak equity market performance against a backdrop of generally solid economic data was. While global growth has indeed been slowing, we believe that the economic backdrop remains more positive than equity markets are currently suggesting. As a result, our Chief U.S. Equity Strategist Tobias Levkovich is setting his year-end 2019 S&P 500 target at 2,850 (about a 14% upside from today’s levels).
Citi’s Global Investment Committee (GIC) has been reducing its exposure to global equities and has been increasing portfolio quality. The GIC has a global equity overweight of +1.0% with modest overweights on Europe, Emerging Asia, and Emerging Latin America. On the fixed income side, preferred assets include short-duration, higher quality debt like U.S. Treasuries.
The U.S. economy appears to be in decent shape, but may begin to slow as we move past peak stimulus from fiscal policy (tax cuts). After growing at 2.9% in 2018, our economists expect real GDP to moderate to a softer pace of 2.8% in 2019. However, this forecast is a bit misleading, as we expect growth in the first half to remain robust and then to decelerate to about 2% by year-end.
Citi Private Bank’s Global Investment Committee continues to hold a neutral (or fully-invested) rating on U.S. stocks. In general, valuations appear reasonable, but the pace of S&P 500 earnings-per-share (EPS) growth is expected to slow next year and geopolitical concerns (trade policy, etc.) are keeping us cautious. That said, we do think that equities will rebound from today’s levels as incoming economic data eventually confirm that the U.S. economy is not slipping into recession.
The Fed raised rates again at their December meeting, but lowered their forecast for 2019 rate hikes to just two (consistent with our economists’ expectations). Moving forward, each Fed meeting will be closely scrutinized with many expecting the Fed to eventually announce a pause in rate hikes. With short-term rates looking more appealing, Citi prefers short-term, higher quality debt like U.S. Treasuries, U.S. corporate debt, and municipal bonds for U.S. tax-payers.
Europe and Japan
Euro area economic activity has disappointed. In 2018, we witnessed multiple growth downgrades and upside inflation surprises. Heading into 2019, we still see risks as skewed to the downside with growth easing from 1.9% in 2018 to 1.5% in 2019. In Japan, we see growth as rising from 0.8% in 2018 to 1.1% in 2019. However, we would note that this has been revised down from an original 2019 forecast of 1.6%. While external demand has slowed, sustained business fixed investment and front-loaded demand ahead of a planned consumption tax hike in October 2019 should help to maintain growth.
Stocks (Slightly Overweight)
The GIC maintains a modest overweight to European (ex UK) equities. While growth has slowed, economic fears appear exaggerated and valuations remain attractive. However, Italy’s debt profile and Brexit remain as risks. As far as Japan, the region still remains exposed to potential auto tariffs. While we see some attractive areas like robotics and automation, we believe that a neutral weighting is still warranted.
Even though monetary policy remains accommodative in both the European Union and Japan, we still see the yields on most European and Japanese sovereign bonds as unacceptable.
Emerging market economies as a whole are expected to grow by 4.5% in 2019 – about the same pace as 2018. However, economic activity in China has been slowing and remains worrisome. If enacted, 25% tariffs on $250 billion of Chinese goods could cause export growth to weaken visibly. Fiscal stimulus and monetary easing could help, but there are various constraints on the government.
Stocks (Slightly Overweight)
The GIC remains slightly overweight emerging market equities. Forward returns in emerging market shares look increasingly attractive with emerging market earnings-per-share expected to rise by 8.2% in 2019 (versus 7.3% in developed markets). In addition, a more stable U.S. dollar and a less aggressive Fed could benefit emerging market shares in the year ahead.
Bonds (Slightly Overweight)
We are overweight emerging market fixed income – in line with our equity position.
U.S. Stock Market and Economic Forecasts
|S&P 500 Target||2,674||2,507||2,850|
|S&P 500 P/E Ratio||20.79x||15.32x||14.43x|
|S&P 500 EPS Growth||11.7%||22.2%||6.2%|
Citi Research and Citi Personal Wealth Management as of December 11, 2018. Note: The S&P 500 P/E ratio is based on trailing four-quarter S&P 500 operating earnings-per-share. 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.
Global Economic Forecasts
|Region||GDP Growth||CPI Inflation||10-Year Yields||Exchange Rate vs. USD|
|Based on PPP Weights||3.8||3.6||3.6||3.2||3.3||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||2014||2015||2016||2017||2018||MTD||QTD||YTD||Instrument||Current (%)|
|Global||2.12||7.9||0.9||3.3||2.1||0.5||1.4||1.1||0.5||10-Yr. U.S. Treasury||2.68|
|U.S.||3.34||5.9||0.5||2.7||3.6||0.0||1.9||1.6||0.0||30-Yr. U.S. Treasury||3.01|
|Europe||0.74||11.2||1.1||3.3||0.5||0.5||0.7||0.9||0.5||1-Yr. CD Rate||1.29|
|EM Sovereign||6.11||7.1||0.6||9.6||9.8||-4.1||1.7||-0.7||-4.1||30-Yr. Fixed Mortgage||4.51|
|U.S. High Yield||8.19||1.8||-5.6||17.8||7.0||-2.1||-2.3||-4.7||-2.1||Prime Rate||5.50|
Asset Class Returns (Sorted by Performance)