The month of November kept many investors awake at night. Concerns about slowing global growth, ongoing trade tensions, Brexit negotiations, and imbalances in the oil complex held markets captive...
The month of November kept many investors awake at night. Concerns about slowing global growth, ongoing trade tensions, Brexit negotiations, and imbalances in the oil complex held markets captive. However, following a rally late in the month, the S&P 500 finished the month 1.8% higher. Equities outside of the U.S. were also largely positive with the MCSI All Country World Index (excluding the U.S.) adding 0.8% during the month.
Citi’s economists and strategists continue to believe that we are in a “late-cycle” phase, not an “end-of-cycle” phase. “Late-cycle” investing often means more market volatility and subdued equity market returns, but it doesn’t imply the onset of a U.S. recession in 2019.
Citi Private Bank’s Global Investment Committee (GIC) has been gradually reducing its exposure to global equities for some time and has been actively increasing portfolio quality. As part of this portfolio shift, the GIC has brought down its global equity overweight to +1.0%. This means that a Risk Level 3 blended portfolio without hedge funds would be comprised of 61.4% equities (an equity-neutral portfolio would hold 60.4% equities). On the fixed income side, preferred assets include short-duration, higher quality debt like U.S. Treasuries.
U.S. Stock Market and Economic Forecasts
|S&P 500 Target||2,674||2,800||3,100|
|S&P 500 P/E Ratio||20.79x||16.85x||15.87x|
|S&P 500 EPS Growth||11.7%||22.2%||6.2%|
Citi Research and Citi Personal Wealth Management as of November 23, 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.
The U.S. economy has cooled off some. After hitting a robust 4.2% rate of annualized growth in the second quarter, growth looks set to moderate to a 2.7% growth rate in the fourth quarter. Eventually, we expect to see the boost from tax cuts to fade, but it will likely not occur until the back half of 2019. Citi’s economists are forecasting that growth will slow to about 1.9% by the fourth quarter of 2019.
Citi Private Bank’s Global Investment Committee continues to hold a neutral (or fully-invested) rating on U.S. stocks. However, it should be noted that the Committee has lowered its allocation to small- and mid-cap shares to an underweight. In general, valuations appear reasonable, but the pace of S&P 500 earnings-per-share (EPS) growth is expected to slow next year, which is keeping us cautious.
The Fed is likely to raise rates at their December meeting – bringing the fed funds rate up from 2.25% to 2.50%. Beyond the December meeting, our economists are expecting just two more Fed rate hikes next year (in March and June). 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 this year. This was further confirmed in November with the ZEW Indicator of Economic Sentiment for the Euro Area falling to its weakest level since July 2012. Expectations for the next six months were also weak. Citi’s economists are forecasting that real GDP growth may slow to 1.0% annualized in the third quarter before picking up again in the fourth quarter (possibly to a level of 1.5%). In Japan, the upcoming FY2018 supplementary budgets may provide a boost to economic growth. Citi’s economists are forecasting that annual growth will climb from 1.0% in 2018 to 1.6% in 2019.
Stocks (Slightly Overweight)
The GIC maintains a modest overweight to European (ex UK) equities. Equity dividend yields easily eclipse corporate bond yields in the region, suggesting that equities are likely the better value. We remain neutral on the UK as Brexit risks are still material to the outlook. 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 on Japanese shares 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 4.7% in 2018 – the same pace as last year. However, economic activity in China has been slowing and remains somewhat worrisome. Moving forward, Chinese stimulus or a further de-escalation in trade tensions could help to soothe growth fears.
Stocks (Slightly Overweight)
Forward returns in emerging market shares look increasingly attractive with emerging market earnings-per-share expected to rise by 9.6% in 2019 (versus 8.3% in developed markets). If trade fears ease further, emerging market shares could continue to rebound. The GIC remains slightly overweight emerging market equities.
Bonds (Slightly Overweight)
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||3.8||3.7||3.0||3.3||3.7||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||2.28||-0.1||7.9||0.9||3.3||2.1||0.4||0.1||-0.9||10-Yr. U.S. Treasury||2.99|
|U.S.||3.56||-2.0||5.9||0.5||2.7||3.6||0.6||-0.2||-1.8||30-Yr. U.S. Treasury||3.29|
|Europe||0.80||2.1||11.2||1.1||3.3||0.5||0.3||0.3||-0.2||1-Yr. CD Rate||1.27|
|EM Sovereign||6.25||-6.2||7.1||0.6||9.6||9.8||-0.3||-2.3||-5.8||30-Yr. Fixed Mortgage||4.68|
|U.S. High Yield||7.41||7.2||1.8||-5.6||17.8||7.0||-0.9||-2.4||0.2||Prime Rate||5.25|
Asset Class Returns (Sorted by Performance)