In the first of a new regular feature, Citywire Selector’s Think Tank invites leading strategists to outline what topics are dominating investment thinking at major private banks and asset management companies.
Here Steven Weiting, head of global strategy at international giant Citi, writes exclusively for Citywire Selector on the firming-up of growth and the challenges posed by a summer slowdown.
Forecasts for world growth have been steady or strengthening for the coming two years. This follows a period of routine disappointment and negative revisions ever since 2011.
There are no signs of a broad-based growth boom. Risks of an unexpected shock are ever present. But the struggle to achieve growth through ever-more-desperate government policy props seems to have passed.
Central banks are messaging that their direct support for financial markets is ending. In 2018, it is plausible that reduced bond purchases by the European Central Band Federal Reserve could mean that private savers will have to replace roughly $1 trillion in central bank financing for governments.
Financial markets have been robust in the face of the central bank hints. In the past, “announcement effects” around changes in the monetary policy regime have created serious bouts of volatility.
Will the calm persist? Mid-year periods have been seasonally weak as market volumes falter with the summer months. Professional investors trade the markets, while end investors are no longer allocating new money as they do either late or early in the year. Vacations beckon instead.
The Q3 period is the only quarter that averages a decline in global equities. The quarter also marks the historically strongest quarterly return for high grade bonds and weakest returns for high yield however, the range of possible outcomes in Q3 is very wide.
At the extremes of Q3 performance, new recessions and new recoveries were responsible for unusual outcomes relative to the average quarter. Seasonality is far from iron clad.
If it occurs, we believe a summer correction would be counter to the ongoing trend. Unless we are approaching an absolute peak in the US and global economy, growth worries and most corrections in risk assets make for better return opportunities.
In the early years of the post-financial crisis recovery, we had to fight popular sentiment to somehow “prove” that the mid-year swoons were not the start of a return to economic crisis and contraction.
As confidence has grown with asset market valuations - and as future returns have fallen - investors seem less inclined to panic.
The extent of any correction is highly speculative, and long-term investors should be careful not to misalign portfolios from long-term goals if they endeavour to trade the seasonal pattern. Among other issues, we would highlight individual tax considerations for investors doing so.
This year, the most poignant question in US equities may be the one of “growth or value”. The S&P value index has hit a multi-year low relative to the growth index.
This is after a strong burst of performance for value in the aftermath of the US election on specific policy expectations from the new government. The outperformance of value ended very quickly in early 2017 as progress toward fiscal action was slower than expected.
Growth is itself a valuable attribute. The question of which types of equities will outperform going forward is really driven by the type of macroeconomic regime investors believe we are in.
In an environment of slow global growth, interest rates will remain low, and long-duration assets will retain- or rise in value.
These include equities that are outgrowing the broad economy, but derive the bulk of their present value from the promise of future rather than present profits.
This is often the opposite case for value stocks, which are deemed to have little future growth promise, yet have below average valuations on their current profits. If interest rates rise, long-duration growth stocks could lose value, just as long-duration bonds would.
With central banks reacting to the stronger overall growth outlook with less accommodative monetary policy, long-term interest rates could see a slightly-higher range.
Confidence in US fiscal policy action has been almost completely dashed, and could add a positive growth surprise with expectations now so low. Petroleum markets are also finally finding the needed support from Opec and its allies.
If the factors just mentioned assert, a rebound in cyclical shares could be at hand. However, this is not likely to be a lasting regime change in our view.
Beyond a rotation into cyclical shares for a quarter or two, we would expect secular growers - firms that are growing to dominate their industry and in the process outgrowing the world economy - to reassert strong performance.