Inside the mind of a confused market

July 3, 2022

David Bailin

Chief Investment Officer and Head of Citi Global Wealth Investments

Steven Wieting

Chief Investment Strategist and Chief Economist

SUMMARY

Dual fears of inflation and recession are being blamed for market declines in the first half of 2022. But it is the Fed’s abrupt pivot from being unusually accommodative to severely hawkish that has set the steep decline in motion. We are likely to become more optimistic on high-quality growth tech stocks once a convincing peak in US interest rates is clear.

There is a high likelihood that we will have seen two consecutive quarters of negative US GDP growth in 2022. Yet, the rule of thumb that two quarters of consecutive GDP declines marks a recession is incorrect. Recessions are self-reinforcing, with net job losses measured in millions.
At the moment, the US economy is slowing but a recession has not arrived. US manufacturing data shows new orders slowing, but the overwhelming majority of companies are still hiring. We see a period where evolving conditions are unlikely to provide more conviction about the economic outlook in the US and globally.
So, is another 8-10% drop in US equities warranted? A lot depends on future profitability. What can one now expect from corporate profits in 2023? We think a drop of 3% is likely for 2023 in a Resilient (slow growth) scenario, -20% in a Recession scenario, and +10% in a Robust scenario. Unless interest rates retreat, markets have not yet fully priced a material earnings decline.
Combining bonds with dividend growth shares and tax efficient strategies for beaten-down equities and bonds offers a lower-risk approach for today’s uncertainties. With this strategy, investors need not expect a strongly growing economy to generate moderate returns over the next year or two.
After a massive surge higher in US and global corporate profits in 2021, it will be hard for profits to make net gains of any magnitude in 2022-2023. This leads us to invest in the most durable demand industries, and particularly in the shares of firms with the most consistent track record of dividend growth. Such firms need to over-earn their dividend to sustain higher payouts. This points us to so-called dividend aristocrats, firms with the strongest track record of growing dividends. These shares have solidly outperformed this year already.
Markets have punished growth shares more than industrials and cyclicals since the beginning of the year. We are likely to become more optimistic regarding the prospects for high-quality growth equities in technology-related sectors once a convincing peak in US interest rates is clear.
Twenty years ago, investors who did not have the patience to wait or the courage to re-engage with the investments responsible for true growth and innovation missed out on the strongest returns of the two decades past. Today, we don’t advocate a wild swing towards such investments or away from them. We consider accumulating shares in beaten down secular growth industries such as cyber security software, which has fallen 20% in 2022 even with no loss of business activity.