Stocks across most markets experienced astonishing gains in April with the S&P 500 posting its best monthly return since 1987. It was the best April performance since 1938. Outside of the U.S., emerging markets...
Stocks across most markets experienced astonishing gains in April with the S&P 500 posting its best monthly return since 1987. It was the best April performance since 1938. Outside of the U.S., emerging markets rose 9.0% while shares in Europe and Japan rose 4.9% and 5.4%, respectively. The 10-year U.S. Treasury yield was little changed during the month – falling just 4 basis points to 0.64% at month-end.
Incoming economic data have been horrible. However, massive amounts of stimulus, news on potential COVID-19 treatments, and evolving plans to reopen the economy have lifted stock prices sharply. While the rebound in stock prices appears “V-shaped,” the underlying economy may take longer to recover. Particularly on the services-side of the economy.
On April 22nd, Citi’s Global Investment Committee (GIC) moved from a neutral weighting on U.S. small-cap and mid-cap shares to an overweight. Small-caps have lagged, but the GIC is expecting these shares to “play catch-up” if the economy starts to reopen. On the fixed income side, the GIC increased its holdings of both Eurozone and U.S. investment-grade corporate debt.
The U.S. economy contracted by an annualized rate of 4.8% in the first quarter of 2020. The second quarter is likely to be much worse due to the coronavirus-led lockdown. Citi’s economists are expecting an annualized drop of about 30% in the second quarter and a 23% annualized rebound in third quarter. With many states likely to be partially reopen by the end of June, we should see a boost in economic activity. The manufacturing-side of the economy may recover faster than the services-side.
Stocks (Neutral; Overweight SMID)
Citi Private Bank’s Global Investment Committee maintains a neutral position on U.S. stocks. However, the Committee lifted its weighting on U.S. small- and mid-cap shares (SMID) from neutral to overweight. After lagging behind, we think that they may play “catch-up” to large-cap shares once the U.S. economy reopens. Large-cap shares have come a long ways in a short period of time. We are optimistic on the outlook for 2021, but a neutral position seems warranted given that the rally may have overshot a bit.
The Federal Reserve has brought out much of its arsenal to support the economy. This also added some stability to the bond market. While maintaining an overweight to U.S. Treasuries, the GIC moved to a neutral stance on long-duration Treasuries. The Committee also decided to increase its exposure to U.S. short- and intermediate-duration investment grade debt. The GIC remains neutral on municipal bonds.
Europe and Japan
Economy (Europe: Slowing / Japan: Slowing)
Citi’s economists cut their 2020 Euro Area growth forecast by 7% to -8.3% as a result of the coronavirus. Lifting restrictions should foster a meaningful rebound in the second half of the year, but it may take two years to return to pre-COVID GDP levels. In Japan, 2020 growth has been revised down by 3.2% to -4.7% as the country declared a state of emergency. Second quarter growth will likely be deeply negative.
Stocks (Europe: Underweight / Japan: Neutral)
The GIC has moved from a neutral position to an underweight position on European (ex-UK) stocks. Monetary and more importantly, fiscal stimulus is getting unlocked across the region, including in Germany, but the key risk remains the health of the banking system and the Eurozone’s ability to boost activity. Japanese large cap stocks have rebounded on seemingly lower levels of virus spread and less extreme shutdown measures. However, the case count is surging again so we remain neutral.
The GIC is maintaining a deep underweight on both European and Japanese sovereign bonds.
The economic outlook for emerging markets looks better than many advanced economies, but growth is still forecast to decline by 0.5% year-on-year. Emerging Asia has seen downgrades across all economies with 2020 growth now expected to be 1.4% year-on-year. China may grow by just 2.4% this year. Latin American economies may face steep declines with Mexico’s GDP expected to decline by 9% in 2020.
The GIC has moved from a neutral to an overweight on emerging markets (specifically Asia and Latin America). As China continues to climb out of the economic declines seen in February, equities in Asia are likely to remain somewhat more resilient, while the world continues to battle the virus. Latin America valuations have improved sharply after a deep selloff. Given the severe underperformance relative to other markets, we would expect the region to perform well when the global rebound comes.
We are overweight emerging market fixed income as U.S. dollar-denominated debt valuations reflect poor fundamentals, but also long-term opportunities and attractive risk adjusted returns.
U.S. Stock Market and Economic Forecasts
|S&P 500 Target||2,507||3,050||2,700|
|S&P 500 P/E Ratio||15.43x||18.97x||23.30x|
|S&P 500 EPS Growth||22.5%||2.0%||-24.0%|
Global Economic Forecasts
|Region||GDP Growth||CPI Inflation||10-Year Yields||Exchange Rate vs. USD|
|Based on PPP Weights||3.0||-2.2||5.3||3.2||2.9||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||2015||2016||2017||2018||2019||MTD||QTD||YTD||Instrument||Current (%)|
|Global||0.9||0.9||3.3||2.1||0.5||7.1||1.5||1.5||3.2||10-Yr. U.S. Treasury||0.64|
|U.S.||1.34||0.5||2.7||3.6||0.0||8.9||1.7||1.7||5.0||30-Yr. U.S. Treasury||1.28|
|Europe||0.39||1.1||3.3||0.5||0.5||6.0||1.3||1.3||0.1||1-Yr. CD Rate||0.62|
|EM Sovereign||6.85||0.6||9.6||9.8||-4.1||14.8||2.1||2.1||-11.2||30-Yr. Fixed Mortgage||3.52|
|U.S. High Yield||8.82||-5.6||17.8||7.0||-2.1||14.1||3.6||3.6||-10.0||Prime Rate||3.25|
Asset Class Returns (Sorted by Performance)