“EM economic projections continue to fall, this time noticeably in Turkey and Brazil. EM economies are suffering from a combination of a weak rise in DM imports, a related deterioration in EM current account balances, sticky inflation and slower growth expectations,” said the Citi Global Strategy and Macro Team in their January 2014 research note on Global Asset Allocation. “Furthermore, we remain very concerned about the reliance of China, and EM more widely, on what we see as an unsustainable credit boom.”
The note is dated January 23, the fateful day when China declared a worse-than-expected PMI number and set the stage for a global sell-off. China was suddenly in disfavour and Turkey, Argentina, and the Ukraine soon added to the panic. The ‘contagion’ quickly engulfed stock markets in developed markets, too.
What should investors do in 2014?
Citi provides direction in this graphic representation of their asset allocation strategy.
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GDP growth to support equity flows
Citi’s strategy clearly still favors equities and cash as the preferred targets for asset allocation during 2014.
Within equities, Citi have lumped together US and Emerging markets in the same boat (0 = neutral), ranking inferior to European and Japanese stocks (+1 = overweight). The chart below shows how equity flows are returning to Europe as investors rush to take advantage of the macro recovery.
“Reasonable valuations, improving GDP growth and forecast 9% global EPS growth in 2014 support our constructive equity view,” says Citi.
Key global positives are benign inflation and Citi’s estimate that global GDP could return to above trend in 2014 and 2015 by growing 3.3-3.4%. Taper worries are priced into asset prices, according to Citi. Moreover, interest rates are likely to be stable overall, barring cuts expected from the ECB. (However, interest rates could harden in New Zealand and the UK).
Overall, a decent environment for global equities that allows Citi to project a 13% return.
Here are Citi’s equity recommendations in more detail:
Rates: US yields will move higher in 2014
Citi analysts anticipate that 10-year US Treasuries could touch 3.3% yield by the year-end, driven primarily by the premia for higher terms. In the chart below the 10y premia is ruling far below the historical average.
UK rates are expected to rise considering the economic recovery in evidence which may result in policy action by 2014Q4, according to Citi. Emerging market yields will rise in sympathy with US yields and could return from 6-7% this year. Elsewhere, Citi do not expect major changes.
Citi expect low returns from US credit, much better in European credit, and non-existent returns in EM (dollar terms).
After a dismal performance in 2013 (see chart below), commodities are expected to rule weak through 2014 in view of weak demand and higher supplies. Specifically, Citi analysts expect petroleum prices to struggle in the future in view of new supply from non-traditional sources. Base metals are likely to suffer from lower growth in the Chinese economy, while precious metals are likely to rule soft. However, gold may not fall significantly given that it rules close to break-even production costs.