Stocks across most markets experienced impressive gains in August with the MSCI All Country World Index surging 6.0%. In the United States, the...
Stocks across most markets experienced impressive gains in August with the MSCI All Country World Index surging 6.0%. In the United States, the S&P 500 powered forward with a 7.0% gain and the tech-heavy NASDAQ climbed another 9.6%. Emerging markets underperformed, but still returned 2.1%. The 10-year U.S. Treasury yield jumped 18 basis points to 0.71%.
Worries that a surge of COVID-19 cases in July would cause the economic recovery to stall seem to have been misplaced. U.S. economic data have continued to surprise to the upside with third quarter U.S. real gross domestic product (GDP) tracking at just under 30% annualized. Combined with better-than-expected corporate earnings and an extremely supportive Federal Reserve, U.S. stocks seemed to be desensitized to risk. However, recent market action suggests that investors may be trimming positions in high-flying sectors.
Citi Private Bank’s Global Investment Committee (GIC) raised its global equity overweight by increasing its allocation to non-U.S. equities, particularly Europe and global small- and mid-capitalization shares. To fund the increase, the GIC reduced short and intermediate duration U.S. Treasuries from an overweight to neutral and slightly reduced its exposure to U.S. equities.
The U.S. economy continues to recover. Incoming economic data point towards a strong rebound in the third quarter with growth tracking just shy of 30% annualized. Although growth will likely slow some in the fourth quarter as the initial reopening rebound fades. The unemployment rate should continue to trend lower over time as businesses recover from the COVID-19 pandemic; however, some temporary layoffs will likely become permanent. Growth should be above trend in 2021.
Stocks (Neutral; Overweight SMID)
Citi Private Bank’s Global Investment Committee slightly reduced its position in U.S. large-cap stocks, but remains overweight U.S. small- and mid-cap shares (SMID). Small-cap shares have rallied sharply, but remain below previous highs. Over the 12 to 18 month time horizon, we expect cyclical industries like industrials to recover further. In August, investors showed interest in cruise lines, air lines, and other travel-related stocks as vaccine developments and a decline in COVID cases increased optimism.
The Federal Reserve is not expected to raise rates for a long time, which should keep rates “lower for longer.” With yields already quite low, Citi’s GIC decided to shift from an overweight on short- and intermediate-duration Treasuries to neutral. The Committee remains overweight investment grade corporate bonds and U.S. residential REITS and commercial mortgage REITS.
Europe and Japan
Economy (Europe: Recovering / Japan: Recovering)
Citi’s economists left their 2020 Euro Area growth forecast unchanged at -6.7%. With only a few restrictions left in place following the lockdown, the region should see a strong rebound in the second half of 2020. Citi’s growth forecast for 2021 is 6.5%. In Japan, growth looks like it may fall by -5.2% in 2020 before rebounding by 2.5% in 2021.
Stocks (Europe: Neutral; Overweight SMID / Japan: Neutral; Overweight SMID)
The GIC is neutral on both Europe and Japan large-caps, but overweight SMID. Over the next year or two, we expect global SMID to catch up in performance to U.S. large-cap shares. In general, SMID seems more favorably positioned across the world coming out of this crisis.
The GIC is maintaining a deep underweight on both European and Japanese sovereign bonds.
The economic outlook for emerging markets looks better than many industrial economies with 2020 growth likely to fall -1.5% (versus -5.1% for industrial countries). However, Citi’s economists revised down their growth forecasts for China – from 6.2% to 5.9% in the second half. While the trade outlook may improve as the world exits lockdown, consumer spending may be held back due to an uncertain future.
The GIC is overweight emerging markets (Asia and Latin America). Chinese shares, particularly those in the technology and internet sector, have risen sharply in recent months. While we may see some consolidation near-term after such a sharp rally, we remain long term optimistic on Asian consumption, technology and healthcare themes. Latin America could perform well coming out of this crisis. However, we maintain a cautious stance longer-term. We see it as a recovery trade.
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||3,231||3,300|
|S&P 500 P/E Ratio||15.43x||18.97x||26.50x|
|S&P 500 EPS Growth||22.5%||2.0%||-20.1%|
Global Economic Forecasts
|Region||GDP Growth||CPI Inflation||10-Year Yields||Exchange Rate vs. USD|
|Based on PPP Weights||3.0||-3.3||5.9||3.2||2.7||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||0.62||0.9||3.3||2.1||0.5||7.1||-0.8||0.4||4.4||10-Yr. U.S. Treasury||0.70|
|U.S.||1.04||0.5||2.7||3.6||0.0||8.9||-0.9||0.7||6.9||30-Yr. U.S. Treasury||1.47|
|Europe||0.05||1.1||3.3||0.5||0.5||6.0||-0.6||0.5||1.8||1-Yr. CD Rate||0.45|
|EM Sovereign||4.34||0.6||9.6||9.8||-4.1||14.8||0.3||4.1||1.4||30-Yr. Fixed Mortgage||3.10|
|U.S. High Yield||6.12||-5.6||17.8||7.0||-2.1||14.1||1.0||6.0||0.9||Prime Rate||3.25|
Asset Class Returns (Sorted by Performance)