The value of growth in a slowing economy

April 10, 2022

David Bailin

Chief Investment Officer and Head of Citi Global Wealth Investments

Steven Wieting

Chief Investment Strategist and Chief Economist

SUMMARY

We see a tug-of-war ahead between the US Federal Reserve – believing it must “normalize rates” and its balance sheet in rapid fashion – and the economy itself. Faced with this tussle, investors may consider defensive stocks over cyclicals.

The Fed has never stabilized inflation during periods of supply shocks and war. Yet it seems wholly committed to attack pandemic and war-driven inflation now – with both quantitative tightening and higher rates.

Investors do not believe the Fed will be able to sustain ever higher rates. They currently price bonds with a view toward an eventual easing cycle. There is precedent for their view. In seven Fed tightening cycles since 1980, the Fed has sustained its maximum policy rate for only 7 months on average before cutting rates.

That’s why we believe interest rates will peak in 2022 under both our RESILIENT and RECESSION scenarios (as we observed in our March 27, 2022 CIO Strategy Bulletin).

Just as Fed policy has been deemed late or behind the curve, many investors have become bearish on the economy and markets too early. The immediate prospects for the economy are by no means bleak, particularly when you look at jobs data and earnings growth.

Still, we have doubts that the underlying fundamentals of the US economy are stronger than they were in 2018. If the Fed follows its restrictive 2018 actions even more quickly this time, it may make a major policy error.

What should investors consider now? When growth becomes harder to achieve, it becomes valuable in portfolios. Therefore, our preferred way to play equities now is via defensive, quality growth. In a slowing economy, the value of companies with dependable, visible growth increases. To that end, we favor defensives over cyclicals. Examples include large cap healthcare, software, semiconductors and cybersecurity providers.

To identify companies and sectors that may likely to fare well as the Fed goes into tightening mode, we look at opportunities with particular characteristics, including dividend growth, buybacks, positive cash flow generation, and promising business models. These firms have potential to thrive after having their shares de-rated amid the Q1 rate shock of 2022.