It is likely no surprise that U.S. and Chinese trade relations remain strained. However, the outperformance of U.S. equity markets in the face of rising tariffs may have surprised some investors...
It is likely no surprise that U.S. and Chinese trade relations remain strained. However, the outperformance of U.S. equity markets in the face of rising tariffs may have surprised some investors. During the third quarter, U.S. equities pushed powerfully higher with the S&P 500 returning 7.2% - the best quarterly gain since late 2013. Excluding the U.S., global equities were flat. However, the fourth quarter tends to be a positive one for risk assets. We would not be surprised to see global equities (particularly non-U.S.) rebound during this period.
Global growth remains strong across the board, but the U.S. has been exceptionally strong. Citi’s economists expect global real gross domestic product (GDP) to expand by about 3.3% in both 2018 and 2019. We expect global growth to slow heading into 2020, but remain fairly positive overall.
Citi Private Bank’s Global Investment Committee (GIC) remains modestly overweight global equities and slightly underweight global fixed income. Preferred equity market regions include Germany, France, and emerging markets (particularly Asia). On the fixed income side, the GIC prefers short-term U.S. debt and inflation-linked debt. Underweights include most European and Japanese sovereign bonds.
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||18.33x||17.29x|
|S&P 500 EPS Growth||11.7%||19.6%||6.0%|
Citi Research and Citi Personal Wealth Management as of September 28, 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 robust, but the pace of growth is likely to taper off a bit. Citi’s economists believe that real GDP will moderate from 4.2% annualized in the second quarter to 3.2% annualized in the third quarter. We still expect consumer spending to remain strong, but the one-time surge in exports ahead of recently announced tariffs is unlikely to repeat. The labor market also remains strong with the unemployment rate at just 3.9% - a level last seen in 2000.
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 with about 1/3rd of the gains related to the reduction in the corporate tax rate. However, this boost in earnings is becoming increasingly priced in and puts some limitations on future gains. U.S. outperformance may fade a bit.
Bonds (Slightly Overweight)
The Fed decided to raise the fed funds rate from 2.00% to 2.25% at their September meeting. We expect them to raise rates again in December with a market-implied probability of 70%. 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 slowed noticeably with growth slipping from 2.7% in the back half of 2017 to 1.5% in the first half of 2018. However, we think that growth should pick up in the second half (to 1.8%). In Japan, a series of natural disasters (a hurricane, flooding, and earthquake) are likely to weigh on growth. As such, Citi’s economists are predicting that growth may slip from 3.0% annualized in the second quarter to -0.5% in the third quarter. However, once reconstruction begins, growth should rebound.
Stocks (Slightly Overweight)
The GIC maintains a modest overweight to European equities. We believe that trade-related risks have caused investors to be excessively fearful. With the outlook for future corporate profits remaining upbeat, financial asset prices should eventually start to recover. As far as Japan, the region remains exposed to potential auto tariffs. It is starting to look like a trade deal between the U.S. and Japan will be reached, but we believe that a neutral weighting on Japanese shares is warranted until we get more clarity.
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.
Even though there have been pockets of weakness (Turkey, Argentina, China), emerging market economies as a whole are still expected to grow by 4.7% this year – the same pace as last year. Activity has been weak in China and trade tensions remain a concern, but a broad policy mix of fiscal policy, monetary policy, and currency policy should help growth in China to stabilize in the second half.
Stocks (Slightly Overweight)
Forward returns in emerging market shares looking increasingly attractive with emerging market earnings-per-share on pace for 15% growth in 2018. If trade fears ease further, emerging market shares should rebound. Particularly if the Fed starts to adopt a more dovish tone in 2019. As such, the GIC remains modestly 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||3.9||3.7||3.0||3.3||3.5||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||2.22||-0.1||7.9||0.9||3.3||2.1||-0.5||-0.4||-0.1||10-Yr. U.S. Treasury||3.06|
|U.S.||3.47||-2.0||5.9||0.5||2.7||3.6||-0.7||0.0||-1.6||30-Yr. U.S. Treasury||3.21|
|Europe||0.81||2.1||11.2||1.1||3.3||0.5||-0.3||-0.8||-0.5||1-Yr. CD Rate||1.13|
|EM Sovereign||5.78||-6.2||7.1||0.6||9.6||9.8||2.1||2.3||-3.5||30-Yr. Fixed Mortgage||4.57|
|U.S. High Yield||6.62||7.2||1.8||-5.6||17.8||7.0||0.6||2.4||2.7||Prime Rate||5.25|
Asset Class Returns (Sorted by Performance)