Chief Investment Strategist and Chief Economist
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We are maintaining our constructive tactical stance in the face of the latest international public health scare.
The Citi Private Bank Global Investment Committee left our asset allocation unchanged at our February meeting. On our 12-18 month tactical horizon, we remain 3% overweight Global Equities, 4% underweight Global Fixed Income, and 1.5% overweight Gold as a risk hedge. We stay 0.5% underweight Cash.
We expect financial market volatility to increase in the immediate future, as the impact of significant disruptions to China’s economy becomes clearer. The coronavirus has resulted in an immediate drop in transport into and out of China, along with factory supply shortages that will have global ramifications. A spread of the virus outside China remains a risk.
Discretionary spending in China – and to a lesser degree in nearby countries – has weakened owing to both state-imposed and voluntary citizen efforts to limit possible exposure to the virus. However, as with previous health scares and natural disasters, we do not see the present disruption causing a permanent loss of output.
China’s economy will likely slow severely in the first half of 2020, but with a proportionally stronger rise in the second half of 2020. The largest negative effects are likely to unfold within the first quarter.
Financial markets are adjusting as swiftly as possible to incoming information, while keeping past health scares such as the SARS epidemic of 2003 in mind. The global crude oil price has dropped 17% in 2020 to date, almost exclusively on the coronavirus news. This month’s massive declines in oil demand led by jet fuel consumption could represent 3%-4% of world petroleum consumption. This has a large negative impact on commodity prices over the near-term as inventories rise. However, the impact on commodity prices over coming quarters is likely to be far more muted.
The effects extend well beyond oil. As China is the world’s largest commodity consumer, industrial inputs like metals and agricultural goods have seen sharp price falls. We expect them to rebound as economic activity normalizes over the course of 2020. We look for support for this rebound from fiscal stimulus in China once the authorities’ immediate focus shifts beyond containment of the virus.
Last month, we added modestly to our China and Hong Kong equity allocations by reducing our overweights in other Asia-Pacific markets and the US. Greater China was the only global equity region to post double-digit price declines from already depressed valuations. These holdings will likely see a rebound as the virus threat passes, in line with the experience of previous episodes
Globally, we have a somewhat higher degree of concern for equity markets over the near term. Industrial output and trade were merely poised to rebound within 2020, while equity markets priced in uninterrupted recovery. To be clear, data from both the US and Asia were fully as strong as we anticipated in January. The Institute for Supply Management’s indicators of US manufacturing returned to expansionary readings at the start of the year. There were broad, if modest, gains in similar reports from other regions ahead of the coronavirus outbreak. Meanwhile, global consumer demand has remained solid, and will benefit marginally from energy price declines. We have been optimistic about a rebound in trade and industrial activity this year, since goods consumption and production must ultimately be at the same level. China’s disrupted first quarter will probably represent a mere delay in global manufacturing’s recovery process.
The historical precedent for rebounds from natural disasters – including from global health threats – appears to have insulated many equity markets from further declines. This is particularly true for US equities, which are benefiting from ‘safe haven’ inflows. However, at today’s higher price levels, equity markets may find it harder to look beyond negative surprises that may arise from the coronavirus impact. That said, we still see a high probability of being contained and that economic normalization in China will swiftly follow, perhaps as soon as the second quarter of 2020. The significant decline in interest rates since the start of 2020 has also made it less appealing to reallocate to fixed income markets in the meantime. That is true even given the prospect of greater equity market volatility ahead. Against this backdrop, it is our view that relative market valuations and return prospects still favor our current allocations for the time being.