Stocks across most markets experienced material gains in May with the MSCI All Country World Index posting an impressive 4.1% gain. In the United States, the S&P 500 climbed 4.5% higher while the tech-heavy NASDAQ jumped 6.8%. The NASDAQ...
Stocks across most markets experienced material gains in May with the MSCI All Country World Index posting an impressive 4.1% gain. In the United States, the S&P 500 climbed 4.5% higher while the tech-heavy NASDAQ jumped 6.8%. The NASDAQ has returned 5.8% year-to-date. Outside of the U.S., emerging markets underperformed with just a 0.6% gain. Gains in Europe and Japan were just shy of 6.0%. The 10-year U.S. Treasury yield was little changed during the month – rising just 2 basis points to 0.65% at month-end.
Massive amounts of stimulus, news on potential COVID-19 treatments, and evolving plans to reopen the economy have lifted stock prices sharply. There are early signs that the U.S. economy may have bottomed in mid-April. This may lead to a rotation into stocks that are more sensitive to the economic cycle like banks, homebuilders and small-cap shares.
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. Since making that change, the Russell 2000, which is a small-cap stock benchmark, has rallied about 18%. On the fixed income side, the GIC increased its holdings of both Eurozone and U.S. investment-grade corporate debt.
The U.S. economy is likely already in a deep, but short recession with second quarter growth set to plunge by about 27% on an annualized basis according to Citi’s economists. Fortunately, the economy has likely already bottomed in either mid-April or early May. Third quarter growth should surge as states begin to reopen, but a full recovery in GDP levels may take well into 2021. The unemployment rate will likely peak around 18% before starting to decline as some furloughed workers return to work.
Stocks (Neutral; Overweight SMID)
Citi Private Bank’s Global Investment Committee maintains a neutral position on U.S. stocks. However, the Committee is overweight on U.S. small- and mid-cap shares (SMID). Small cap shares may play “catch-up” to large-cap shares when the economy exits recession. Smaller companies are also less exposed to rising U.S. – China political tensions. Citi’s mid-year 2021 S&P 500 target is 3,160, suggesting further upside, but we think that road ahead may be bumpy and the odds of a pullback along the way are rising alongside valuations.
The Federal Reserve’s balance sheet has expanded at a pace of about $1 trillion a month. After the Global Financial Crisis, it took early six years to expand the balance sheet by about the same amount as the Fed has just done in about three months. While maintaining an overweight to U.S. Treasuries, the GIC is neutral on long-duration Treasuries. The Committee recently increased 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 upgraded their 2020 Euro Area growth forecast from -8.3% to about -7.0% as a lifting of restrictions should accelerate the rebound in the second half of 2020. In Japan, 2020 growth has been revised further downward from -4.7% to -7.1% as the nation’s state of emergency was extended.
Stocks (Europe: Underweight / Japan: Neutral)
The GIC is underweight European (ex-UK) stocks. Recent stimulus from the European Central Bank should be helpful to the region, but the health of the banking system is a risk and we see better opportunities elsewhere. In Japan, lower levels of virus spread is supportive of the region’s equities, but we think that the impact of stimulus in the region may be more limited as bond purchases may be moderated by yield curve control.
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 -1.3% (versus -5.4% for industrial countries). In Latin America, which is struggling to contain COVID-19, declines are likely to be steep. Mexico’s GDP is expected to decline by -9.0% in 2020 while Brazil’s economy may decline by -6.5%. China may grow by just 2.5% this year.
The GIC is overweight 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. Latin America valuations have improved after a deep selloff. We 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||24.20x|
|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||3.1||-3.1||5.8||3.2||2.8||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||0.82||0.9||3.3||2.1||0.5||7.1||0.3||1.8||3.4||10-Yr. U.S. Treasury||0.65|
|U.S.||1.26||0.5||2.7||3.6||0.0||8.9||0.5||2.3||5.5||30-Yr. U.S. Treasury||1.41|
|Europe||0.34||1.1||3.3||0.5||0.5||6.0||0.1||1.5||0.2||1-Yr. CD Rate||0.57|
|EM Sovereign||5.69||0.6||9.6||9.8||-4.1||14.8||6.4||8.7||-5.5||30-Yr. Fixed Mortgage||3.52|
|U.S. High Yield||7.64||-5.6||17.8||7.0||-2.1||14.1||4.9||8.6||-5.6||Prime Rate||3.25|
Asset Class Returns (Sorted by Performance)