Significant Sell-offs May Provide a Rare Window of Opportunity

Last week, the US reported a 1.4% annualized contraction in real GDP for the first quarter of 2022, its first decline since 2Q 2020. You will undoubtedly remember that in April 2020 the world shuttered economies to attempt, in vain, to stem the spread of Covid. Many are dismissing this 2022 “surprise” decline in GDP as an aberration. Citi analysts, however, aren’t.

The negative GDP print was led by a sharp decline in exports. But consumer spending also decelerated throughout the first quarter. Broad retail spending volumes in March were lower than the average pace in the first quarter. In short, consumers began curtailing their purchases meaningfully in the face of rising inflation. All this does not mean a recession is imminent. Employment grew throughout the first quarter as the production of goods and services rose. But in contrast to what many say, demand will not be stronger in the coming quarter. It will be weaker.

• In CIO’s view, the current consensus for US real GDP growth in 2022 of 3.2% needs revisiting. CIO’s  forecast for 1.9% growth this year anticipates moderating inflation and a recognition from the Fed that the boom is truly over.
• There may be a sliver of “good news” in all this. There remains a route to lower inflation without destroying economic growth. Lower demand, higher imports and a moderate Fed tightening cycle can, over time, lead to lower inflation while keeping the economic expansion intact.
• CIO does not think that the Q12022 GDP contraction will cause the Fed to back off its near-term guidance and raise policy interest rates by 50 basis points at one or more meetings in coming months. However, a highly likely slowing in US output (GDP) and lower employment growth makes us doubt whether the Fed can maintain its hawkish stance in the face of economic weakness to come.

Portfolio Considerations

• Even with steady earnings expectations, multiples on the S&P 500 have contracted 15% YTD. Citi does not believe long-term multiples are excessive relative to current interest rates. And when looking at valuations outside the US, current multiples are in line with historical norms. Thus, in the absence of a Fed-induced recession, CIO believes a bottom in bond prices is likely to provide support for equities.
• CIO’s view is that when investors see a peak in interest rates, a recovery in growth stocks may occur. While volatility in some of our Unstoppable Trends is higher than the broader market, CIO strategists have identified areas like fintech, clean energy, electric vehicles, and biotech that deserve high valuations due to their growth and long-term value creation. But CIO does not expect them to outperform quarter-to-quarter.
• In Citi’s view, significant selloffs among industry leaders in these thematic areas provide rare opportunities to add exposures at more reasonable valuations. Additionally, these firms tend to benefit from low rates. While “peak rates” may not coincide with a bottom in the shares of innovative leaders, CIO can foresee an opportune time to begin accumulating positions in secular growth leaders in the not-too-distant future.