A higher global GDP forecast

Citi Global Wealth Investments downgraded 2023 US growth estimates and increased those for China, the EU, UK and Japan. Therefore, we have raised our global GDP forecasts for 2023 to +2.0% from +1.7%. Most of this is driven by China’s earlier-than-expected move to end its Covid-zero policy and clear indicators that Europe’s energy shock is abating. As regional natural gas prices retreat, the scope of the income drag on the entire region is abating. While this won’t spark a European boom, it does mean bearish expectations were too bearish. This means the severity of a prospective global slowdown is lessening. But in the US, a likely contraction is coming a bit earlier than most expect. Recent data suggest the Fed’s heavy-handed monetary policy is impacting a broader set of economic factors more deeply month over month. The sharp rise in consumer goods and new home inventories this past year are leading, predictably, to reductions in construction, trade activity and industrial production. Once output in these sectors starts falling, it is likely that their declines will deepen. Therefore, labor markets could likely slow sharply into the spring.

The last really strong employment report

CIO believes the upcoming January employment report is likely to be the last to show large gains – a 200,000 gain is likely, primarily due to expected, seasonal distortions in the employment count. While the jobs data will be released just after the Fed’s February 1 press conference, CIO expects it to reinforce a hawkish message Chair Powell delivers. This is because financial markets have been countering the Fed’s tightening with rallies in bonds and equities this year. While the Fed is downshifting because of the weaker data, looking back at the inflation of the year past, Powell is likely to argue that the Fed’s work is not done. The start of 2022 has seen equity markets soar. The S&P 500 is up 5% and Nasdaq shares have risen by 11% in less than a month. Elsewhere, China shares and EU equities have risen 17% and 12%, respectively. The European rise is related to falling imported gas prices, lowering the input costs of firms, and reducing the scope of a shock to consumers and government budgets. The Asian rise can be attributed to a boom in economic activity in China post-Covid, not dissimilar to the one both China and other nations experienced in 2020. But in the US, the Fed will likely disregard slowing headline inflation until it sees “real” declines in US employment. And though the Fed knows falling US money supply is a strong predictor of future falling inflation, it will still stand firm against inflation. All this suggests global equity markets face near-term risks.

Recession-related slowdowns are at work

Residential housing contractions and slowing business investment could affect household spending. In fact, gravity is at work. Initially, much higher rates hit the most interest rate sensitive sectors like property. The recent US GDP report indicated that residential fixed investment was down by 27%. While peak negativity in real estate may have been reached, the damage follows in employment and personal income. We are likely seeing the very end of “Covid Cabin Fever” in the US, as well. While Americans were wealthier as government subsidies and “stay at home” savings grew, they are now being spent down. To remain in spending mode, households need to borrow more – surging credit card balances are evidence of this. But this is unsustainable. Gravity in markets works like this. Once producers overestimate the path for consumption and inventories rise, they cut back. Corporate profits fall and labor markets weaken together. Once unemployment starts to rise, it tends to keep rising until monetary policy eases and producers have cut “too much.” This is the “gravity of the recession” where cost cutting leads to lower investment and more unemployment.

Portfolio considerations

CIO sees the very long bull market in the US dollar and exceptional valuation divergence between US and non-US equities as a strong potential long-term opportunity for global equity portfolios over the coming decade. These regional equity markets have meager 2023 EPS growth expectations compared to the US and trade at less than 13x expected earnings vs 18x for the US. In short, we are only in the very early stages leaning into non-US equity markets. For now, CIO still thinks bonds have considerable value at turning points in the market. Market interest rates doubled from all-time lows in 2021. When they doubled again in 2022 into a likely economic slowdown, CIO saw opportunity. This remains today with short-term US interest rates above 4% and some short-term investment grade bond opportunities yielding as much as 8%.

Note: Past performance is no guarantee of future results. Real results may vary.