Global stock markets tumbled in October. In the U.S., the S&P 500 finished the month 6.9% lower – leaving the index up just 1.4% for the year. Equities outside of the U.S. have fared...
Global stock markets tumbled in October. In the U.S., the S&P 500 finished the month 6.9% lower – leaving the index up just 1.4% for the year. Equities outside of the U.S. have fared even worse with the MCSI All Country World Index (excluding the U.S.) sliding 8.2% during the month. A number of factors have contributed to the sell-off: signals of tighter Fed policy, geopolitical tensions (China, Saudi Arabia, etc.), the upcoming U.S. mid-term elections, slowing global growth, and a re-rating of earnings expectations.
We see recent developments as part of a normal market correction (meaning a sell-off of at least 10%). Importantly, we do not see this as the end of the bull market, nor the end of the business cycle. Corporate profits, economic growth, and consumer sentiment each remain fairly robust. It is always difficult to identify a bottoming in equity markets, but we suspect that the latter months of this year will be more positive.
Citi Private Bank’s Global Investment Committee (GIC) remains slightly overweight global equities, but has reduced its exposure and is actively increasing portfolio quality. As part of this reduction, the GIC has reduced its weighting on small- and mid-cap U.S. stocks from neutral to a slight underweight. Preferred assets include short-duration U.S. Treasuries and corporate debt.
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||17.02x||16.06x|
|S&P 500 EPS Growth||11.7%||19.6%||6.0%|
Citi Research and Citi Personal Wealth Management as of October 31, 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 remains solid, but has slowed down a bit. Following a robust real GDP growth rate of 4.2% annualized in the second quarter, growth cooled off to a 3.5% annualized rate in the third quarter as net exports served as drag. Importantly, consumer spending remained robust. Moving forward, we expect growth to remain solid over the next couple of quarters and then to fade a bit as the fiscal stimulus boost from the recently passed tax cuts start to fade. A year-on-year growth rate of 2.9% seems likely in 2018.
Citi Private Bank’s Global Investment Committee continues to hold a neutral (or fully-invested) rating on U.S. stocks. Corporate earnings are tracking about 24% higher than a year ago and the consumer remains remarkably upbeat. However, the pace of earnings growth is likely to slow some next year as earnings will be compared to the stellar growth in 2018. In addition, a less accommodative Federal Reserve suggests that U.S. outperformance may fade a bit.
The Fed is likely to raise rates again at their December meeting – bringing the fed funds rate up from 2.25% to 2.50%. 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 looks relatively weak with Citi’s economists 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, growth estimates are being upwardly revised on the back of a potential fiscal boost from the upcoming FY2018 supplementary budgets. As such, Citi’s economists have bumped up their annual growth forecast for 2019 from 1.3% to 1.6%.
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% this year – the same pace as last year. However, economic activity in China has been slowing some. Citi’s economists expect China to slow to 6.4% year-on-year growth in the fourth quarter. Moving forward, we expect China to shift from deleveraging to stimulus – which should help the country to weather the recent trade skirmish.
Stocks (Slightly Overweight)
Forward returns in emerging market shares look increasingly attractive with emerging market earnings-per-share expected to rise by 11% in 2019 (versus 9.1% in developed markets). If trade fears ease further, emerging market shares should rebound. Particularly if the Fed blinks on future rate hikes and takes a pause in 2019. As such, the GIC remains slightly overweight emerging market equities.
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||2.25||-0.1||7.9||0.9||3.3||2.1||-0.3||-0.3||-1.3||10-Yr. U.S. Treasury||3.14|
|U.S.||3.54||-2.0||5.9||0.5||2.7||3.6||-0.8||-0.8||-2.4||30-Yr. U.S. Treasury||3.39|
|Europe||0.81||2.1||11.2||1.1||3.3||0.5||0.0||0.0||-0.5||1-Yr. CD Rate||1.17|
|EM Sovereign||6.06||-6.2||7.1||0.6||9.6||9.8||-2.0||-2.0||-5.5||30-Yr. Fixed Mortgage||4.75|
|U.S. High Yield||7.10||7.2||1.8||-5.6||17.8||7.0||-1.6||-1.6||1.1||Prime Rate||5.25|
Asset Class Returns (Sorted by Performance)