Mid-year Outlook: Investing in the Afterglow of a Boom

MID-YEAR OUTLOOK 2022

The first few months of 2022 have been trying. With the pandemic not yet over, rising inflation, interest rate hikes, slowing growth and geopolitical tensions have heightened the uncertainty. Amid these conditions, the question we hear more than any other is “what should I do now?”

Citi’s Mid-Year Outlook 2022 provides our answers, highlighting the potential opportunities and risks as well as actionable strategies. Against this backdrop, our message is to take positive action, by creating fully invested, dynamic allocations that focus on quality and resilience.

A NEW WORLD ORDER

2022 has seen a reset of the international world order and the end of boom conditions in markets. Despite uncertainties, the Chief Investment Office sees many reasons to be fully but wisely invested. Among the potential opportunities we see is in fixed income.

The Federal Reserve’s about-face from a provider of economic jet fuel to a beacon of sobriety, and the unexpected, prolonged and bloody war in the Ukraine marked the end of this boom market. In 2022, there was a “bucket of cold water” poured on the economy to fight the major consequence of the boom: excessive inflation.

Through this lens, the correction that began intermittently in the late summer of 2021 and accelerated mightily over the first five months of 2022 was a reset from the excesses of the prior two years.

With the unusual, joint collapse of bonds and equities in early 2022, positive real interest rates returned to the fixed income market, restoring the diversification benefits of a core asset class, as well as much needed portfolio income.

The speed of the correction that took the S&P 500 Index to near-bear market territory on 20 May appeared sharp and deep, but was more likely the mirror image of the rocket recovery of markets just after the pandemic began. However, investors do not see it this way. And they certainly do not feel it this way.

Investors are frozen with fear. Now, there are good reasons for some of that pessimism. During the first half of 2022, rapidly rising interest rates left investors more uncertain as to how to value financial assets.

Given a slowing cyclical backdrop, we see a much more compelling opportunity in fixed income assets for both overall portfolio construction and to earn income on surplus cash.

THE PERILS OF HOLDING EXTRA CASH

Despite the rise in interest rates, the owners of cash remain in much the same situation as before. After adjusting for inflation, rates in most leading economies remain deeply negative. In the US, consumer price inflation recently hit 8.5%, several points above most short- and long-term interest yields. While readings may not stay this extreme, interest rates below the rate of inflation could be a fact of life for some time to come. The effect of this for the owners of cash is painful. This is likened to the exploits of a cash thief, who silently steals your purchasing power year after year.

The cash thief’s exploits call for taking action. The preferred approach is to put cash to work in assets that may generate a positive real income for portfolios. In recent years, ultra-low yields on many bonds have left them as vulnerable as cash. A few months into 2022, however, and the situation now looks rather different. If you have been waiting for a rise in yields, we believe your wait is now over.

CITI'S VIEW ON FIXED INCOME

There is, of course, an emphasis on high-quality. In high-yield bonds, the strategy is to limit large allocations as a share of overall portfolios and large sector concentrations, particularly for the weakest credit ratings. Since the current tightening cycle is likely to hamper economic growth, Citi analysts do not prefer higher-yielding assets that take exposure to speculative credit.

RISKS

An underestimate of the extent of likely yield increases would mean fixed income assets could suffer further losses. However, Citi CIO’s view is that rates will peak in 2022.

ORDER ASIA'S MID-YEAR OUTLOOK 2022 

China’s aim is for domestic consumption to become its key driver of economic growth for the coming decades, rather than the external demand it has relied upon hitherto. COVID – and the strict lockdowns imposed by the Chinese authorities – have hindered this shift. Citi believes consumption’s potential is huge but realizing it will require further growth and difficult policy reforms mainly in three areas:

1.Broadening and deepening universal medical coverage as well as a pension system overhaul so that households may amass less precautionary savings.

2.More rural land reform for agricultural productivity and financial transactions

3.Further opening of Chinese financial markets to outsiders that would allow for more innovation

Elsewhere, Southeast Asia’s economic recovery from COVID shutdowns is well underway. Given its reliance on tourism, this region may see further recovery in services. Philippines and Thailand were among the earliest to reopen their borders, followed by Singapore, Vietnam, Indonesia and Malaysia.

Lastly, major commodity exporters such as Indonesia and Malaysia are benefiting from higher commodity prices induced by the Russia-Ukraine conflict. Indonesia has the world’s largest nickel reserves, a key material for electric vehicle batteries, and is attracting investments from leading battery makers.

WHAT CAN INVESTORS DO?

Amid heightened uncertainty, investors often find themselves frozen with fear. The resulting portfolio inaction can prove costly. Two of the most common mistakes are retaining a portfolio positioned for past conditions and holding excess cash.

The goal for our clients is to build quality, resilient portfolios for today’s environment. Citi Global Wealth Investments has already made important adaptations in our tactical asset allocation in 2022. These include an overweight position in natural resources and oil services equities.

Amid scarcity and supply shocks, these assets may help reinforce portfolios. CIO reiterates our conviction in a broad range of high-quality assets. Among equities, these include long-term leaders – companies with a variety of quality characteristics.

The current view is not arguing for some imminent new concentration holding in growth shares. However, at a time when markets are not delivering immediate positive returns, the foundations of future returns are at least being laid.

Examples include dividend growers and many equities related to our unstoppable trends  –Digitalization and the Rise of Asia. Another of our key calls focuses on high quality fixed income. With yields having risen significantly in 2022, we see greater potential in this asset class.

Across Southeast Asia, the Chief Investment Office favors investments linked to tourism, natural resources and industrial diversification away from China. The rise of Asia is set to continue.