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Wealth Insights | Economy | Asset Allocation

A Predicted Slowdown is Unfolding with Less Than Predictable Results

Though markets have rallied on hopes that central banks won’t crush the economy, it’s too late to avoid a sharp economic slowdown. CIO expects the slowest global growth rate in 40 years in 2023, apart from 2009 and 2020. Global trade should weaken, impacting many regions. CIO’s base case view has shifted to a 50% recession probability, 40% slow growth, and 10% for a strengthening expansion over the course of next year.

Key changes the Global Investment Committee (GIC) made last week:

  • Raised 2022 global GDP and S&P 500 EPS estimates marginally
  • Cut 2023 global real GDP estimate from +2.7% to +1.7%
  • Cut 2023 US real GDP estimate from +2.0% to +0.7%
  • Expect S&P 500 EPS to fall nearly 10% next year from a record high in 2022
  • Expect a recession or “stall” in the world economy will not be severe
With the unwinding of stimulus, US goods inventories are now accumulating at a record pace by some measures. This will cause global trade to contract and some domestic industries to curtail production and employment in the coming year. This year’s further gains in corporate profits reflect the lingering positives of 2021, not the culmination of them, which will hit in 2023.
 
Of course, markets are aware of the darkening growth outlook from central bank tightening steps. Taken in isolation, the drop in the S&P 500 in the last six months seems to anticipate more of a slowing in business activity than has occurred already. That’s the way markets work – they anticipate the future. For the same reason, Citi analysts don’t believe riskier equities should be rallying back if central banks actually deliver on their promises to continue to tighten in the period ahead. Just as equity markets predict further slowing in cyclical businesses, following through on this has routinely generated periods in which the US bond market has outperformed equities.
Chart: Citi Global Wealth Investments Revised Real GDP Forecasts

Portfolio Considerations

With a 300-basis-point leap in 2-year US Treasury yields over the past year and the Fed inverting the yield curve, the GIC added 2 percentage points to its Global Fixed Income allocation last week. The addition was split evenly between short-term US Treasuries and short-term US investment-grade corporate bonds.
 
Short-duration investment-grade US corporate yields are above the yield of those volatile sovereigns. Irrespective of “recession” semantics, the Fed has made very low-risk and less-volatile bonds a compelling relative value. To make the allocation change, the GIC reduced exposure to assets it considers “inflation hedges,” exiting an overweight in global natural resources.
 
Recessions have been particularly painful when they occur amid hubris and denial. The 2001 recession hit especially hard for a “new economy” suffering from reckless corporate spending. During the housing bubble period, many denied there was a macroeconomic problem. Today, confidence is already depressed, and recession forecasts are ubiquitous. This suggests weakness won’t come suddenly, like a thunderbolt from the sky.
 
Past performance is no guarantee of future results. Real results will vary.