Chief Investment Strategist and Chief Economist
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We expect stronger returns from our positions as a result of the rapid equity market correction
The Citi Private Bank Global Investment Committee left its asset allocation unchanged in February.
We remain 4% overweight Global Equities, with US Equities still at a full – or neutral – allocation. We also remain 4% underweight Fixed Income, with non-US Developed Markets the largest underweight.
With a rapid, but historically-moderate equity market correction unfolding in early February, we expect stronger returns from our positions over the next 12-18 months than we did one month ago.
We recommend clients with abnormally high cash allocations take advantage of lower valuations in equities and certain bonds to allocate fully. Our global economic outlook has not changed in the last two months, except that we now look for somewhat stronger corporate earnings and slightly higher-than-expected US interest rates.
We see a rise in US wage growth and the modest rise in inflation as “later cycle” signals, but the slow pace of the increases is unlikely to cause the Federal Reserve to move to a significantly restrictive monetary policy.
Equity markets rallied very sharply on signs of stronger growth in the first four weeks of 2018, leaving them vulnerable to short-term profit taking. However, particular strategies speculating upon persistently low volatility suffered a severe shock when related investment products failed to perform as some users had expected. This created a technical cascade of equity weakness that was isolated to this asset class.
While there are some uncertainties for equity investors as to interest rates, the recent market dislocation is likely to reverse over time. We actively expected a new regime of higher volatility in 2018 due to the changing monetary policy landscape. The Fed is shrinking its balance sheet by $400 billion in 2018, reducing monetary stimulus, while the US Congress has added fiscal stimulus to the US Economy by approving tax cuts and spending increases.
The decline in the US dollar in recent months even as US interest rates have risen suggests the US is not attracting foreign savings as easily as it once did. The decline in the US dollar largely benefits our positions in non-US equities in our current allocation.
While global diversification is proven to be effective for long term investors, in the past two weeks we have seen fears within the equity asset class can spread across regions over the short-term. We see an elevated risk of foreign exchange and interest rate volatility rising. Over the coming year, we look for a wider dispersion of regional equity returns owing to the differing stages of economic and monetary policy cycles internationally. This may allow us to make further allocation changes, probably taking somewhat less US dollar risk and greater international asset market risk. However, the full implications of the rise in US interest rates and the declining dollar may not have been fully felt in global asset markets in the near-term.
The US expansion cycle is both strengthening and likely to endure through 2019. We see rising profits as a reason to allocate fully to US equities, despite their relatively high valuation. However, the extended nature of the economic cycle and tighter US monetary policy keep us from overweighting the asset class relative to global benchmarks at present.