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Citi

Positioning in a New Economic Cycle

Key Takeaways

  • Global markets face greater uncertainty with the looming US election and no clarity as to its outcome. Furthermore, there is a risk of rising COVID-19 infection rates as winter approaches, with many areas already experiencing second waves.
  • Despite these two near-term uncertainties, a supportive macroeconomic policy backdrop and a better-prepared health sector suggest the challenges may not be nearly as severe as COVID-19’s initial global shock. Citi’s Global Investment Committee (GIC) thus increased its Overweight in Equities, and increased its Underweight in Bonds. Gold and Real Estate Investment Trusts (REITs) remain Overweight while Cash remains Underweight.
  • After the COVID-19 collapse, massive stimulus has laid the foundations for a new economic cycle. Citi’s strategy is to maintain a long-term commitment to our “Unstoppable trends” in healthcare, digital disruption, and Asia. They also favor selected cyclical sectors such as Industrials, Financials, and REITs and Global small/mid cap which may outperform over the next 12-18 months when markets normalize.

 

Negative 2020 global growth before rebounding in 2021

After plummeting in the first half of 2020, global economic activity has rebounded as lockdowns eased. Citi analysts expect global GDP to contract by 3.9% in 2020, followed by a rebound of 5.4% in 2021.

As a result, Citi analysts believe that global Earnings-Per-Share (EPS) could contract by 25% in 2020, followed by a 20% rebound in 2021. Consensus on the other hand is more optimistic and expects a 18% contraction in 2020, followed by a 28% rebound.

 

Central Banks providing support

Central banks reacted to collapsing markets in March by announcing an aggressive expansion in Quantitative Easing (QE) policies. Notably, the Federal Reserve (Fed) said that it would buy both investment-grade and high yield corporate bonds/ETFs, something not even done back in the 2008 financial crisis.

Recent changes in unconventional monetary policies of major central banks mean that net 12 month rolling central bank asset purchases are expected to exceed US$6trn, nearly 3x previous peaks. This measure is expected to roll over in February 2021.

 

Equities

Emerging Markets - Asia is favored

Chinese shares, particularly those in the technology and internet sector have risen sharply in recent months. While there may be some consolidation near-term, after such a sharp rally, Citi analysts remain long-term optimistic on Asian consumption, technology and healthcare themes.

In Latin America (LatAm), valuations have improved sharply after a deep selloff. Given the severe underperformance relative to other markets, Citi analysts believe the region may have room to perform. The correction has adjusted real exchange rates to levels not seen since the 1990s and may provide a cushion to economies and may help equities recover. However, Citi analysts are cautious on the long-term outlook beyond the potential global equity rebound.

In EMEA, a brighter cyclical outlook for oil, and a likely prolonged period of easing by the European Central Bank (ECB) and Fed could provide support. Nevertheless, Citi’s still small underweight in EMEA is driven by a higher conviction in both Asia and LatAm.

 

US - Preference for US Small and Mid Caps

Rapid policy steps from the Fed and US congress have boosted markets after a significant drop in March. Broad market valuations are no longer cheap – even when pricing in recovery from the COVID-19 shock. However, this is largely a function of the powerful rally in IT-related shares, with the NASDAQ composite up 29% year-to-date as of 9 October 2020.

While TMT (Tech, Media, Telecom) fundamentals are strong and improving, Citi analysts prefer COVID-19 cyclical sectors such as Industrials, Financials, and REITs as well as small and mid-cap stocks, as they have been oversold and may be poised for recovery.

Investors should also keep an eye on the upcoming US election in November as that could be a source of volatility. Given the very high expected number of mail-in ballots across the US, it is possible that the results of the US election may not be known on election day and, if it is a close election, for weeks thereafter.

Implied volatility in US equity markets is priced about 12% higher by the November 3rd US election day and then rises another 3% in the month beyond.

 

Europe and UK - ECB providing support to stimulate growth

The European Union has unified around a stronger fiscal expansion. The European Central Bank (ECB) may now have a source of credit demand growth to stimulate economic activity. A weaker USD and weakening of COVID-19 infections in the region relative to the US may provide support to depressed equity markets.

With close to 70% of overseas revenue exposure, UK equities have been hit hard by a combination of the global slowdown and a delayed virus containment strategy. UK-Eurozone trade negotiations are unlikely to have progressed amid COVID-19 fears. However, clarity on this or a delay in the trade deadline (currently year-end) could boost sentiment and lift a weak sterling.

 

Japan - A softer Yen may help boost equities

Japanese large cap stocks sold off in March along with global markets but have rebounded more sharply, likely as a result of seemingly lower levels of virus spreading and less extreme economic shutdown measures as well as ample stimulus. The JPY has fallen since March, following Fed measures to restore global liquidity, removing a key headwind.  

 

Fixed Income 

US Sovereign bonds - Neutral

The yield on US Treasuries has fallen to about 0.2%. While still higher in yield than other developed market government bonds, their low price sensitivity to changes in interest rates (duration), provides little diversification in the event of a correction.

 

Investment Grade (IG) bonds - Neutral

US: Citi analysts look for opportunities in sectors that have been hit by COVID-19, but where fundamentals still remain intact.

Europe: Yield differentials versus the US have narrowed and Citi analysts prefer cyclical sectors.

 

High Yield (HY) bonds - Overweight US

US: “Fallen Angels” (HY downgraded to IG) offer an interesting opportunity.

Europe: Spreads are cheap, though growth may contract severely. ECB purchases could end up indirectly supporting prices.

 

Emerging Market (EM) bonds - Overweight

USD: Fundamentals have deteriorated, but a lot has been priced in. Citi analysts favor Asia and LatAm.

Local currency: Yields have fallen to lowest levels on record, though EM FX remains volatile. Unhedged returns may eventually benefit from a prolonged period of Fed easing and USD weakness.

 

REITs - Overweight

Against a backdrop of sharply lower interest rates, central bank credit easing steps and a likely rebound in social engagement, Citi analysts think many real estate assets may be pricing in fairly extreme pessimism and this could present opportunities.

 

Commodities

Gold - Overweight

Given dramatic declines in global bond yields, Citi analysts continue to see gold as a hedge during volatile markets.

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Overweight Global Equities and Underweight BondsGold and REITs remain Overweight while Cash remains Underweight.

After the COVID-19 collapse, massive stimulus has laid the foundations for a new economic cycle. Citi analysts believe this is a new economic cycle and it is just six months old. The larger economic recovery is still almost entirely ahead.

Citi’s strategy is to maintain a long-term commitment to Unstoppable trends” in healthcare, digital disruption, and Asia. They also favor selected cyclical sectors, and Global small/mid caps which may have stronger returns over the next 12-18 months when markets normalize.

 

 

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