The challenges presented in the first half of 2022 has created uncertainty and concern for the global economy but a fully invested portfolio has the potential to improve outcomes across difficult macro environments, say the analysts from Citi Global Wealth Investments at the bank’s mid-year outlook briefing on June 28. They believe the worst of US consumer price inflation has already passed, while China remains ahead of the curve in global economic recovery.
Steven Wieting, chief investment strategist and chief economist of Citi Global Wealth Investments, says given the market volatility of the past few months, many investors are now “frozen in a state of indecision”.
“Ultimately, being fully invested in a globally diversified allocation remains the best course of action as keeping portfolios static, positioned for conditions in previous years remains a top risk for investors. Our view is that this is a time for taking positive action, while avoiding certain costly mistakes.”
The shock of Covid-19 — the resulting shutdowns, the unprecedented stimulus packages by governments and supply chain disruptions — has already prepared the global economy for the comparable aftershock of Russia’s invasion of Ukraine. While US inflation is now at its highest levels in four decades, the Citi analysts believe that inflation has already peaked and will trend down to around 3.5% in 2023.
Still, Wieting warns that inflation will not recede to the familiar range of 1% to 2% and that it will be difficult for investors, too used to abundance of funds and produce, to get “comfortable” again.
“We’ve adapted for a world of scarcity, allocating capital to produce more of the commodities of greatest need. We’ve made important adjustments in our tactical asset allocation in 2022 to position for the risks and potential opportunities that we see ahead, believing the global economy can weather the storm,” Wieting explains. “Some signs and reasons why we would hold out some optimism that we could get through this period, with some market adjustments, is the fact that consumer goods spending has fallen to about 3%.”
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Additionally, domestic production of consumer goods is up about 4.5% over the last 12 months, with imports rising about 12%, a significant increase in unit terms. Some US retailers are reporting that their inventories are now bloated, while retailers struggled to meet demand last year due to supply chain disruptions, notes the analyst.
So, how should investors position themselves? Cyclical stocks, in the face of recessionary prospects, have come under pressure. For investors inclined to bet on these sectors for an eventual rebound, Citi’s view is the timing is “not ready” for now. Instead, the non-cyclical sectors — even though they have outperformed — are the ones favoured by Citi.
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The analysts believe that bonds have become much more relevant to portfolios as both a risk management tool and an alternative to cash as an income source. Bonds at today’s interest rate levels have the potential to add both income and diversification to portfolios. They recommend municipal bonds, US investment grade bonds, US preferred securities and select emerging market US dollar denominated bonds in this inflationary environment.
Moreover, the analysts warn that investors sitting on excess cash will likely be left poorer over time with the repercussions of inflation. They liken negative real interest rates to a “cash thief” that reduces purchasing power year on year.
“The recent rise in interest rates is good news for investors with too much cash. US Treasury yields have doubled across all maturities in the past year. With this, fixed income has become a relevant asset class for many types of investor objectives,” they write.
China one step ahead in economic recovery
Looking across to Asia, the analysts see rebound potential given the distressed valuations of Chinese equities as China’s slow but progressing recovery continues. While it is not likely to be a smooth ride, this turnaround for China will be different from previous false starts, as policies are starting to be supportive to growing the economy prior to China’s Party Congress this coming October, writes head of Asia investment strategy Ken Peng in a press release.
“Since the middle of March, China has had a parade of policy pronouncements to support the economy and markets that seem to have taken hold since June. This process is a step ahead of the world,” he says. “Tightening happened early and for longer periods, and now when the rest of the world is tightening, China is easing.”
Given Chinese equities’ distressed valuations, the analyst sees rebound potential this year. Among the areas Citi finds most attractive are those linked to economic reopening, green energy and technology more broadly.
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Retail sales — a main economic indicator — remains fairly weak because of lockdowns and has seen limited progress in consumption recovery. But certain parts of consumption are doing “wildly” well, argues Peng. “Back in May, before the full reopening, there was a doubling in electric vehicle sales and those tax cuts kicked up another notch in the month of June,” he says. “We’re likely to see more strength in this space, and that will drive a portion of the consumption recovery.”
Other economic sectors marking a turning point from depressed market levels include China’s weekly box office revenues and tourist activity during recent public holidays. Beijing’s easing tech regulations mark a potential tipping point, as tech shares in China had only reversed a tenth of the index value lost over the last one and a half years and remain below pre-pandemic levels, despite leading the recent rally.
“Tech sector regulations are also coming to a conclusion, allowing for more IPOs and a way for companies to plan forward,” says the analyst, who expects revenues of major Chinese tech companies to rebound in 2023. One such listing is possibly Ant Group: The Jack Ma-linked fintech giant’s IPO was spiked in November 2020, but could be revived soon.
Digital revolution and SEA’s opportunities
While many growth-oriented investments have struggled this year, the analysts see a compelling long-term case for the digital disruptors that are reshaping the world. “Just as businesses need to embrace this disruptive process if they are to survive and thrive, investors should seek it in their portfolios,” they write.
Despite the wider and growing pessimism towards the tech sector, the Citi analysts see the potential to add portfolio holdings through selective exposure to cybersecurity — including cloud, identity and data security — as well as to leaders in the payments subsector, where profitability and higher dividend yields are more typical.
For suitable investors, Citi recommends digitalisation-related strategies from venture capital, growth equity and hedge fund managers.
Closer to home, Peng believes that US-China polarisation will benefit Southeast Asia (SEA) economies, as they stand to win more business from multinational companies diversifying their supply chains away from China. He expects to see SEA doing more business with China while favouring investments linked to tourism, natural resources and industrial diversification away from China.
In a Q&A session with journalists, Peng says that the infrastructure segment in SEA is “interesting” as the region chooses among sources of foreign direct investment (FDI) from larger economies like China, Japan and the US.
Wieting notes that the long-term opportunities associated with the region’s development as capital deepens and the middle class of these countries grows in relation to FDI influx. “That plays out to a higher level of trend growth gradually over 10 years, and probably greater regional investment by global investors over a longer period of time.”
