SUMMARY
Stock markets have rallied strongly from their April lows. We are concerned that investors may not be focusing enough on the risks ahead.
KEY TAKEAWAYS:
US equities are at the higher end of ranges justified by fundamentals
We see risks to economic data and to corporate earnings
The Federal Reserve remains focused on inflation rather than rate cuts
We remain neutral on equities, with a bias toward higher quality
We maintain our overweight to certain fixed income categories
Equity markets have had a spring in their step lately.
As of May 1, US equity indices had fully reversed the sharp losses they suffered following the announcement of sweeping tariffs on April 2.
And we don’t rule out this rally continuing for now.
Hopes of trade deals may help drive such upside. Another factor is company guidance pointing to more capital spending on technology.
However, we believe that many equity investors may be getting ahead of themselves.
The economy looks set to weaken
As 2025 progresses, we expect markets to encounter more challenges. Put simply, economic and corporate data look likely to worsen.
For now, economic sentiment data is sagging while activity data is holding up. A good example of the latter was the US payrolls report on May 2, which showed a relatively strong 177,000 jobs added.
At the same time, optimism about tariff de-escalation may be overdone. The outlook remains highly uncertain.
The current 90-day pause on US tariffs is set to expire July 8. Beyond that, there is little clarity on US trade policy’s possible path for the rest of President Trump’s term.
Various scenarios could produce extremely different market reactions.
Earnings forecasts may fall further
Some companies have notably beaten earnings per share expectations in the first quarter of 2025.
However, various key consumer bellwether companies have given worrisome forward-looking guidance.
Analysts have been slashing their forecasts for earnings. Indeed, downgrades have been outstripping upgrades at a near-record rate.
However, we don’t think we’ve reached the nadir of negativity yet.
Forecasts from analysts who look at individual companies still point to 8% earnings per share growth in the US this year.
This seems too high to us. Barring a rekindling of animal spirits and a decisive resolution to trade tensions, we expect further downward revisions.
Don’t count on a Fed rescue for now
Meanwhile, interest rate cuts from the US Federal Reserve may materialize more slowly than many would like.
After all, unemployment held steady at 4.2% in April. We believe this eases any pressure for the Fed to reveal when it may cut rates at its next meeting.
If the hard economic data weakens, rate cuts later this year will likely become appropriate.
For now, though, the Fed will probably remain preoccupied with inflation risks.
Our tactical asset allocation
Against this backdrop, Citi Wealth’s Global Investment Committee voted to maintain our existing tactical asset allocation on May 1.
We are currently neutral on global equities, 1% overweight global fixed income and 1% underweight cash.
Within equities, we see US equities at the top end of the range justified by fundamentals, following the bounce from April’s low. A full retracement to February’s highs is highly unlikely.
We thus reiterate our bias toward higher quality equities. We look to companies with the scale and robust balance sheets to weather a brewing macroeconomic storm.
Within fixed income, we see risks from tariffs for highly leveraged companies and countries. This points toward our underweighting high yield and emerging markets bonds.
For now, we are comfortable with our intermediate-duration overweight allocations to investment grade corporate bonds, structured credit, and preferred securities.
We are on guard for signs of further waves of the “sell America” trade, i.e., asset managers moving to diversify their fixed income holdings away from the US.
With the ongoing downside risks to growth and policy, we restate our message: “Now is not the time to add to risk.”
