Chief Investment Strategist and Chief Economist
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Leading indicators of global growth are stronger now than at any time since 2010’s rebound.
The Citi Private Bank Global Investment Committee (GIC) left its asset allocation unchanged at its meeting on 13 December.
Global equities remain 4% overweight, with US equities remaining at a full (neutral) allocation. Fixed income remains 4% underweight, with developed markets bonds apart from the US comprising the largest underweight. US high yield, Emerging Markets (EM) local and hard currency bonds remain overweight.
Continuing a trend seen since early November, US tax cut prospects have driven significant global market movements. With the separate passage of a large corporate tax cut in both chambers of the US Congress, we see a very high probability that a reconciled tax bill will be signed into law before the end of 2017.
Since just prior to the November 2016 US election, an index of US firms paying high effective corporate tax rates has outperformed a basket of low-rate payers by about 23 percentage points. Given a sizeable increase in broad US equity market valuations over the past two years, we believe US tax cuts have largely been discounted in financial markets. As such, failure to pass the cuts would likely elicit a sizeable negative impact on US asset markets.
While we acknowledge the high absolute valuation of US shares and impact of the one-time US tax boost, we continue to fully allocate to US equities given a solid “organic” pace of US earnings growth which is likely to be sustained through 2018. US bond yields are historically low and credit trends are improving, which are favorable indicators for future equity performance. However, further increases in valuation coupled with significant further US monetary policy tightening could see us reduce the US equity allocation in the future.
The GIC continues to see non-US equities as a substantial opportunity. Leading indicators of global growth are stronger now than at any time since the world economy began a rebound in 2010. We see few growth constraints in most economies, and expect another year of low double digit EPS gains ex-US in 2018. Non-US equities still trade at a near-record 35% valuation discount to the US, with emerging markets (EM) equities more than 40% below, on our preferred valuation measure.
US equities remain near a record high 50% share of global equity market capitalization. Measured in USD, emerging market equities have enjoyed just 1/4th the return of US equities when measured over the past five years.
While we hold all of our global equity overweight outside the US, we acknowledge the high correlation between various international equities markets and also high yield US bonds poses a portfolio risk. We addressed this with increases in high quality short- to intermediate US bond holdings last month.
We would also advocate hedging portfolios with implied volatility near an all-time record low cost level. A transition to gradually tighter monetary policy in developed markets and local political events remain challenges for markets in 2018. Signs of speculative excesses appear to be increasing in certain financial products. Nonetheless, we see global credit and banking sectors as significantly more durable than prior to the 2007-2008 events.
Nonetheless, with a variety of local challenges, we advocate for portfolios that are highly diversified across regions and asset classes. We would note the significantly-lower correlation between EM equities markets compared to DM equities in key regions. Our favored EM equity region remains Asia, while Latam is somewhat more promising for fixed income prospects (please see our Outlook 2018 report for more.)