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Citi

Excessive Worrying May Be Costly for Investors

Evergrande is one giant roller coaster of a real estate company. But why would its potential default spark a global selloff? The answer is worrying. In Citi’s view, worrying is a form of confirmation bias, the human tendency to aggregate information or “facts” into what must certainly happen next. This article assesses the worry points impacting investor’s thinking. 

 

One worry is that US equity valuations are “too high”. While US valuations are among the world’s highest, they have been propelled by record earnings that have legitimised this year’s stock performance. Even in the face of a small US corporate tax rate hike, the next two years are likely to see operating profits rise by 7-8% per year in the US and globally.

 

Looking back over 73 years of data, US equity total returns averaged 10.8% in the 12 months after an early-cycle growth peak. Returns were positive in 8 of 9 of those periods. In the second year of US economic recoveries, S&P 500 EPS have risen more than 10% in every case except one since 1960.

 

COVID-19 infections remain high in the US and world at large. However, the pandemic is generating less restraint on overall economic growth as people and businesses adapt. Even in the face of COVID-19, it is clear that people are returning to normal activities levels as is evident in the retail and recreation data. These activities show a 95% return to pre-pandemic levels.

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Unwinding Evergrande is unlikely to pose systemic risk in China, much less the world. Nonetheless, the declines for many market leaders have followed deliberate Chinese policy actions. Citi analysts see the outlook for Chinese macro and micro policy as somewhat less predictable than in the past 10 years. Citi analysts therefore prefer global diversification to concentrated over-weights in Chinese shares, even as macro policies may potentially restore economic growth within 2022.

 

These are the possible portfolio actions to avoid worrying and to diversify portfolios for the coming second stage of the global recovery: 1) Overweight the “high quality factor”; 2) Overweight healthcare; 3) For higher frequency opportunistic trades, financials may be a near-term beneficiary of Fed tightening views; 4) For China allocations, consider A-shares; 5) Overweight credit and inflation-linked assets in fixed income.

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