Despite headlines that would normally lead to bouts of market volatility (loss of Saudi Arabian oil production, U.S. Presidential impeachment inquiries, etc.), global equities markets quietly crept higher in September. In the United States, the S&P 500 added 1.7% with year-to-date gains now equaling 18.7%. In Europe, shares...
Despite headlines that would normally lead to bouts of market volatility (loss of Saudi Arabian oil production, U.S. Presidential impeachment inquiries, etc.), global equities markets quietly crept higher in September. In the United States, the S&P 500 added 1.7% with year-to-date gains now equaling 18.7%. In Europe, shares rose 3.1% as the European Central Bank eased monetary policy (year-to-date gains now 13.4%). Japanese shares rose by 3.2% (year-to-date gains now 8.9%).
U.S. economic data have been coming in slightly better-than-expected since mid-July. This mild improvement has lifted tracking estimates of third quarter real GDP from about 1.5% to just north of 2.0%. While the manufacturing sector appears to be solidly in recession, the U.S. consumer has been keeping the much larger services sector afloat (which account for 70% of the economy) thus far. We will be watching future readings of the services sector closely.
Citi’s Private Bank’s Global Investment Committee (GIC) is maintaining a neutral position on global stocks, including U.S. large capitalization shares. Following a sharp rally in global bond yields, the Committee has moved from a neutral stance on global fixed income to an underweight.
The U.S. economy has been resilient to the global economic slowdown, but it is not entirely immune. While the consumer remains healthy, business investment has softened due to rising trade policy uncertainty. Overall, some leading economic indicators like the yield curve and the ISM manufacturing index are signaling caution, but a U.S. recession does not yet appear imminent with year-on-year growth trending around 2.0%.
Citi Private Bank’s Global Investment Committee decide to lift its allocation to U.S. large-cap stocks from underweight to neutral. We think that monetary policy and trade policy were the two primary recession risks and each appear to be moving in a slightly less troubling direction. We think that stocks can likely move higher from here, but market volatility may rise as we approach the U.S. Presidential election.
The Federal Reserve decided to cut rates once again at its September meeting – bringing the fed funds rates down by 25 basis points (or 0.25%). The market is currently pricing in one more rate cut in October, but Citi’s economists think that the Fed may hold off if the labor market remains healthy. Following the sharp rally in bond yields, the GIC decided to reduce the size of its overweights in short-term U.S. Treasuries and some short- and intermediate-duration investment grade corporate bonds.
Europe and Japan
Disappointing GDP growth, the persistence of downside risks to economic activity, and a delay in the return of inflation have forced the European Central Bank to return to quantitative easing. Accommodative financial conditions should help, but the lack of a fiscal policy response is less than ideal. Citi’s economists believe that annual growth rates should bottom out in 2020 at a rate of about 0.8% year-on-year. In terms of Japan, Citi’s economists have revised up their growth estimates by 0.2% to 1.0%. In 2020, they see growth easing to an annual rate of just 0.1%.
Stocks (Europe: Neutral / Japan: Slight Overweight)
The GIC maintains a neutral stance on European (ex-UK) stocks. Even though valuations look reasonable, European exporters like Germany appear exposed to the ongoing trade tensions. Brexit risks have receded some as a law has been passed forcing Prime Minister Johnson to ask the European Union for an extension if Parliament doesn’t agree on a deal. In Japan, the Committee has moved from a slight underweight to a slight overweight on a modest uptick in growth.
The European Central Bank decided to cut interest rates and renew it bond purchasing program. On the flipside, the Bank of Japan has signaled a reduction in its monthly bond buying in order to bring bond yields back up to its loose targets (0.2% to -0.2% on 10-year bonds). In general, we still European and Japanese sovereign bond yields as unacceptable.
Emerging market economies are expected to slow from 4.5% in 2018 to 4.0% in 2019. In China, our economists have revised down their growth forecast for 2019 to 6.2% (vs. 6.6% in 2018). Accommodative fiscal and monetary policy should help, but it may not be able to offset the decline in production.
The GIC has lowered its stance on emerging market equities from a slight overweight to a neutral position. However, there are some regional differences. We are underweight the EMEA region while overweight emerging Asia. 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||3,050||3,300|
|S&P 500 P/E Ratio||15.43x||17.92x||17.09x|
|S&P 500 EPS Growth||22.5%||2.0%||4.8%|
Global Economic Forecasts
|Region||GDP Growth||CPI Inflation||10-Year Yields||Exchange Rate vs. USD|
|Based on PPP Weights||3.2||3.4||3.7||3.1||3.2||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||1.29||7.9||0.9||3.3||2.1||0.5||-0.6||2.4||8.1||10-Yr. U.S. Treasury||1.66|
|U.S.||2.30||5.9||0.5||2.7||3.6||-0.0||-0.5||2.4||8.7||30-Yr. U.S. Treasury||2.11|
|Europe||-0.02||11.2||1.1||3.3||0.5||0.5||-0.6||2.9||8.5||1-Yr. CD Rate||1.31|
|EM Sovereign||5.14||7.1||0.6||9.6||9.8||-4.1||-0.1||1.3||12.4||30-Yr. Fixed Mortgage||3.72|
|U.S. High Yield||6.43||1.8||-5.6||17.8||7.0||-2.1||0.2||1.0||10.9||Prime Rate||5.00|
Asset Class Returns (Sorted by Performance)