Investors sought out “safe-havens” towards the end of February as the coronavirus spread beyond the borders of China. In the United States, the S&P 500 plunged 8.4% while the Dow Jones tumbled 10.1%. The 10-year U.S. Treasury yield plummeted from 1.51% at the end of January to 1.15% at the end of February...
Investors sought out “safe-havens” towards the end of February as the coronavirus spread beyond the borders of China. In the United States, the S&P 500 plunged 8.4% while the Dow Jones tumbled 10.1%. The 10-year U.S. Treasury yield plummeted from 1.51% at the end of January to 1.15% at the end of February.
The coronavirus continues to cloud the economic outlook. Prior to the virus, the global economy was starting to stabilize after a manufacturing-led slowdown, but a “supply-side” shock from disruptions to supply chains and a “demand-side” shock from self-quarantines now pose a risk to growth that is hard to quantify. Past viruses suggest that this will likely take a quarter or two to play out.
On February 24th, Citi Private Bank’s Global Investment Committee (GIC) decided to reduce its exposure to global equities by moving from an +3.0% overweight position to a neutral position. Those reductions in equity exposures are being offset by a reduced underweight in global fixed income (from -4.0% to -2.0%; essentially adding to the overweight position in U.S. Treasuries) and an increase in the gold position (from +1.5% to 2.5%). While the GIC reduced its equity rating, Citi’s year-end target for the S&P 500 remains 3,375.
The U.S. economy grew by an annualized rate of 2.1% in the fourth quarter of 2019. However, growth in the first quarter of 2020 is likely to be weak with a series of factors like the coronavirus and stalled aircraft production likely to weigh on growth. We suspect that growth will rebound in subsequent quarters as these factors start to fade. Citi’s economists are still looking for year-on-year growth of around 2.0% in 2020, but risks remain tilted towards the downside.
Citi Private Bank’s Global Investment Committee decided to move from an overweight on U.S. stocks to a neutral position. The move is in response to the potential earnings hit that companies will likely take in response to the coronavirus. Assuming the outbreak of the virus eventually comes under control, we should see a noticeable rebound in equities with the S&P 500 averaging a return of 15.9% in the six months following previous virus-related market bottoms.
The Federal Reserve issued an emergency rate cut of 50 basis points in response to the coronavirus. Safe-haven assets like U.S. Treasuries have been serving as a ballast in portfolios with yields down sharply. While already overweight U.S. Treasuries, the GIC increased its overweight by 2.0% across all sub-asset classes (short-, intermediate-, and long-duration) in U.S. Treasuries.
Europe and Japan
Economy (Europe: Slowing / Japan: Slowing)
An economic contraction in the Euro Zone in the first half of the year seems highly likely, but not necessarily the start of a recession. Movements on the monetary policy front may be forthcoming and direct fiscal policy assistance could help to support a rebound in the second half of 2020. In terms of Japan, growth estimates have been revised down from 0.2% year-on-year to 0.0% in 2020. The economy appears to be experiencing a technical recession.
Stocks (Europe: Neutral / Japan: Neutral)
The GIC has moved to a neutral position on both European (ex-UK) and Japanese stocks. While we do not feel that the fall in European equities marks the beginning of a lasting bear market, we would recommend a “wait and see” approach. Signs of a stabilization in the virus will likely mark a turning point. In Japan, exposure to slowing trade with China and a potential recession is keeping us at bay for now.
The GIC is maintaining a deep underweight on both European and Japanese sovereign bonds.
Emerging Asia economies are uniquely exposed to the abrupt slowdown in China. Citi’s economists have revised down their annual growth forecasts for the region by 0.4% from 5.2% to 4.8%. We now expect China’s economy to downshift from 6.0% year-on-year growth in the fourth quarter to 3.6% in the first quarter. Other regional forecasts remain broadly unchanged, but downside risk remains should the virus continue to spread. Growth should eventually rebound once the virus is contained.
The GIC reduced its weighting on emerging markets from overweight to neutral. However, we did add a tactical overweight to Greater China markets. Equity markets in the region were impacted quickly and appear to be on the mend with large amounts of monetary and fiscal policy being implemented to help offset the expected slowing. We believe this provides an opportunity.
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||3,375|
|S&P 500 P/E Ratio||15.43x||18.97x||17.09x|
|S&P 500 EPS Growth||22.5%||1.0%||-0.2%|
Global Economic Forecasts
|Region||GDP Growth||CPI Inflation||10-Year Yields||Exchange Rate vs. USD|
|Based on PPP Weights||3.1||3.1||3.6||3.2||3.3||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||1.37||7.9||0.9||3.3||2.1||0.5||1.9||1.9||1.9||10-Yr. U.S. Treasury||1.51|
|U.S.||2.32||5.9||0.5||2.7||3.6||0.0||2.0||2.0||2.0||30-Yr. U.S. Treasury||2.00|
|Europe||0.12||11.2||1.1||3.3||0.5||0.5||2.1||2.1||2.1||1-Yr. CD Rate||1.08|
|EM Sovereign||5.24||7.1||0.6||9.6||9.8||-4.1||1.7||1.7||1.7||30-Yr. Fixed Mortgage||3.63|
|U.S. High Yield||6.36||1.8||-5.6||17.8||7.0||-2.1||0.0||0.0||0.0||Prime Rate||4.75|
Asset Class Returns (Sorted by Performance)