Balancing Risks and Opportunities As The Pandemic Escalates

Key Takeaways

• Citi’s Global Investment Committee (GIC) has moved Global Equities from Overweight to Neutral, reduced its Underweight in Bonds and increased its Overweight in Gold.

• The lockdown in response to the COVID-19 outbreak has delivered a severe shock to the global economy. In January, Citi analysts were forecasting 2020 GDP growth of 2.7%, similar to 2019. This has now been revised to -2.3%. As a result, global Earnings-Per-Share (EPS) could potentially fall 50% over 2020. At the start of the year, Citi analysts were expecting 4% EPS growth.

• While the immediate economic outlook is bleak, policymakers are taking extreme and unprecedented steps to limit the disruption’s long-term effects on economic vitality. Citi analysts see increasing signs that the acute crisis phase could be relatively short.

Negative global growth expected

Global GDP growth is expected to fall to -2.3% in 2020. The Euro area stands out, with ongoing quarterly contractions forecast for 2020, and a 8.4% drop predicted for the full year. Similarly, Japan has a full year of recession (-1.9%), although improving in Q4. The US is projected to contract 2.6% in 2020. Emerging Markets are expected to grow by 0.8% and China by 2.4%. As a result, global Earnings-Per-Share (EPS) could potentially fall 50% over 2020. At the start of the year, Citi analysts were expecting 4% EPS growth.

“Whatever it takes” monetary and fiscal policy responses

Governments have been driving unprecedented levels of fiscal and monetary stimulus globally. The US Federal Reserve cut rates on 15 March to the zero lower bound and has extended QE to unlimited amounts, pledging to purchase Treasuries and Mortgage Backed Securities “in the amounts needed” to support smooth market functioning and effective transmission of monetary policy. Interest rates across Developed Markets (DM) are now close to zero and may stay there for some time.

From a fiscal perspective, President Trump signed a US$2 trillion relief bill on 27 March, the largest in history. G20 governments have committed to inject more than US$5 trillion into the global economy and “do whatever it takes" to tackle the pandemic. While some of the announcements appear aggressive, Citi analysts estimate fiscal action amounting to some 5% of GDP may be needed to neutralize the current drag on global growth.

Equities

Emerging Markets - Asia is preferred

Asia is relatively resilient thanks to an earlier response to the COVID-19 crisis. Fed easing also alleviated the USD liquidity shortage that had hit the region. As China continues to gradually 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 COVID-19. Some risks include the new lockdown measures in India, Malaysia and Australia. Rebounding cases from visitors also raise some alarms in North Asia, though likely mitigated by a more prepared healthcare system. Citi analysts remain long-term optimistic on Asian consumption, technology and healthcare theme.

In EMEA, commodity prices are unlikely to recover strongly or quickly. As such, lower oil prices are likely to weigh on Middle East and other oil producing nations such as Russia.

US - Valuations have fallen sharply

Significant and rapid policy steps by the Fed and US congress have helped stabilize US markets after an initial steep drop. Sentiment is likely to continue to ebb and flow alongside headlines, but is approaching levels which typically mark attractive long-term entry points. Valuations have fallen sharply, but are not at crisis levels, likely reflecting expectations for the bounce back to be sharper than during previous recessions.

Europe and UK - Health of banking system remains key risk

European equities are stabilizing after tentative signs that the spread of COVID-19 is slowing in hard-hit Italy where lockdown measures have been the most aggressive. Monetary and more importantly, fiscal stimulus is getting unlocked across the region, including in Germany. The region is highly geared to global growth prospects, which may take some time to recover. The key risk for Eurozone equities remains the health of the banking system and its ability to boost activity.

UK equities with close to 70% overseas revenue exposure have been hit hard by a combination of the global slowdown and a delayed COVID-19 containment strategy. UK-Eurozone trade negotiations are unlikely to have progressed amid COVID-19 fears. Clarity on this or a delay in the trade deadline may boost sentiment.

Japan - Susceptible to downward pressures if COVID-19 escalates

Japanese large cap stocks sold off along with global markets but have rebounded more sharply, likely as a result of seemingly lower levels of COVID-19 spreading and less extreme economic shutdown measures as well as ample stimulus. However, if the case count surges and the situation escalates, then these are likely to present fresh downward pressure on the economy and markets.  

Fixed Income

US Treasuries - Overweight

Global “risk off” sentiment around COVID-19 has seen US yields drop to record low levels. Large scale fiscal packages have temporarily put a floor in long-dated yields around 1.0%, while the Fed has cut short-rates to zero, steepening the curve. Renewed asset purchases may limit how far yields can ultimately rise, and yields are likely to stay low for the foreseeable future.

Investment Grade (IG) - Overweight US

Credit spreads have widened to levels not seen since the global financial crisis. As volatility subsides from historically high levels, the need to raise cash in the highest quality of assets may also decline. Citi analysts continue to prefer US high quality corporate bonds given renewed cheapening of valuations.

High Yield (HY) - Neutral US

HY bond spreads at +1100bps are at the widest levels since 2008, while energy spreads are at the widest levels in history. While longer-term opportunities have been created, valuations may get cheaper with still elevated concerns over COVID-19.

Emerging Market bonds - Overweight

USD EM still offers some of the best relative value in global fixed income. However, Citi analysts stress the importance of global diversification when investing in EM, as idiosyncratic events occur from time to time.

Commodities

Gold - Overweight

Gold is negatively correlated with equities and as a portfolio risk hedge, its safe haven properties provides a cushion against market uncertainties.

Neutral Global Equities, Underweight Bonds and Overweight Gold

Citi’s Global Investment Committee (GIC) has moved Global Equities from Overweight to Neutral,  reduced its Underweight in Bonds and increased its Overweight in Gold.

The visibility on the economic outlook has been reduced by the latest COVID-19 spread. With markets reacting rapidly, a more neutral equity allocation appears appropriate. Nevertheless, while the immediate economic outlook is bleak, Citi analysts see increasing signs that the acute crisis phase could be relatively short.