After a strong start to the year, global stocks pulled back sharply in May as U.S. – China trade tensions once again started to escalate. Globally, stocks finished the month 6.2% lower (although it should be noted that even with the losses, global stocks are still up 8.0% year-to-date). In the United States, stocks experienced similarly-sized losses with the S&P 500...
After a strong start to the year, global stocks pulled back sharply in May as U.S. – China trade tensions once again started to escalate. Globally, stocks finished the month 6.2% lower (although it should be noted that even with the losses, global stocks are still up 8.0% year-to-date). In the United States, stocks experienced similarly-sized losses with the S&P 500 losing about 6.6% in the month. The areas most exposed to trade were the tech-heavy NASDAQ and emerging markets, which slipped 7.9% and 7.5%, respectively.
Thus far, financial markets have been far from panicked and have been experiencing a fairly orderly unwind. There remains an element of faith in the market that trade deals can be reached. However, the longer that trade tensions linger (or expand to Mexico and Europe), the higher the chance that investors’ faith (along with economic growth) starts to wane.
As a result, Citi’s Private Bank’s Global Investment Committee (GIC) has decided to move to an underweight on global stocks for the time-being. After the decision, the GIC’s global stock allocation is now 2.0% underweight, global fixed income is 1.5% overweight and cash is 0.5% overweight.
After growing at a rate of 2.9% in 2018, our economists are now expecting the U.S. economy to grow by 2.7% in 2019. Slower, but still above-potential. We do think that the ongoing trade tensions pose a downside risk to U.S. growth, but the majority of the impact would likely occur in 2020. This may mean that there is some window of time where the negative impact from tariffs could still be mitigated. We will be watching business sentiment very closely to see if the trade tensions are negatively impacting sentiment. A sharp downturn in business sentiment would be worrisome.
Citi Private Bank’s Global Investment Committee has decided to move to an underweight on U.S. large-cap stocks. The U.S. stock market is currently being driven by headline news and not economic fundamentals. We acknowledge that sentiment can turn on a dime, but the negative impact of tariffs on corporate earnings may prove deeper-than-expected. We are also not convinced that a Fed rate cut can completely mitigate the impact of tariffs as monetary policy often operates with a significant lag.
The Fed remains on pause, but there is an increasing chorus of voices calling for a rate cut. We do not think that economic data warrant a cut, but financial markets are now pricing in a greater than 50% chance that the Fed cuts rate by the end of July. As an offset to its reduction in global equities, the GIC has increased its overweight to cash and short-, intermediate-, and long-duration U.S. Treasuries.
Europe and Japan
Improving financial conditions and signs of growth stabilization in China suggest that a growth rebound could occur later this year (assuming that a U.S. – EU trade conflict can be avoided). However, for the full year, euro area growth is likely to slow from 1.8% in 2018 to 1.2% in 2019. In Japan, growth estimates have risen slightly – increasing 0.1% from 0.6% to 0.7% for 2019. The outlook for 2020 remains uncertain as Prime Minister Abe’s decision on whether or not to postpone a tax hike in October is dependent on U.S. – China trade developments. Currently, Citi is looking for just 0.1% growth in 2020.
Stocks (Europe: Neutral / Japan: Slight Underweight)
The GIC has moved to a neutral stance on European (ex-UK) stocks. Even though valuations look reasonable, European exporters may be exposed to the ongoing U.S. – China trade tensions. As an example, exports account for about 47% of Germany’s total output. In Japan, there may be opportunities in certain sectors like robotics and automation, but selectivity is key.
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 are expected to slow from 4.5% in 2018 to 4.3% in 2019. China has ramped up stimulus in order to support growth, but that stimulus may not be sufficient to offset the absence of a U.S. – China trade deal. As a result, Citi’s economists are cautioning against excessive optimism towards China. On the flipside, Korea and Taiwan may benefit from a shift in supply chains.
Stocks (Slight Overweight)
The GIC is overweight emerging market equities. Even though emerging markets remain exposed to trade tensions and a stronger U.S. dollar, long-term growth prospects and valuations appear much better than in developed markets. We believe investors should focus on long-term trends like Healthcare.
Bonds (Slightly Overweight)
We are overweight emerging market fixed income – specifically in emerging Asia and Latin America.
U.S. Stock Market and Economic Forecasts
|S&P 500 Target||2,507||2,850||Mid-Year: 3,000|
|S&P 500 P/E Ratio||15.43x||16.21x||15.1x|
|S&P 500 EPS Growth||22.5%||5.6%||5.0%|
Citi Research and Citi Personal Wealth Management as of May 22, 2019. 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||3.4||3.6||3.9||3.2||3.2||3.1||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||1.67||7.9||0.9||3.3||2.1||0.5||1.4||1.4||4.1||10-Yr. U.S. Treasury||2.12|
|U.S.||2.70||5.9||0.5||2.7||3.6||0.0||1.8||1.8||4.8||30-Yr. U.S. Treasury||2.57|
|Europe||0.42||11.2||1.1||3.3||0.5||0.5||0.9||0.9||3.4||1-Yr. CD Rate||1.46|
|EM Sovereign||5.51||7.1||0.6||9.6||9.8||-4.1||0.5||0.7||6.8||30-Yr. Fixed Mortgage||4.03|
|U.S. High Yield||7.00||1.8||-5.6||17.8||7.0||-2.1||-1.3||0.0||7.3||Prime Rate||5.50|
Asset Class Returns (Sorted by Performance)