The US Is In A “Rolling Recession”, But Citi’s Got A Plan To Roll With It

The US economy is in the midst of a “rolling recession”, with some parts cooling even as others heat up, according to Citi Global Wealth. But that’s not stopping the firm from striking more of a “glass-half-full” tone in its midyear outlook, “Investing Through A Slowing Economy”. It sees plenty of opportunities ahead – including in what might be the most-anticipated bear market ever – and is reminding its clients about the importance of staying invested. Here are my takeaways from what the firm had to say…

What’s the outlook, then?

Well, not surprisingly, the big picture is about inflation and the interest rate hikes the Federal Reserve (the Fed) is using to throttle it back. Citi believes that as inflation dwindles in the US, the Fed will shift from raising interest rates to cutting them, unlocking potential opportunities for investors. Now that transition may be turbulent and opportunities may be hard to come by. Citi says that with so many investors sitting on the sidelines now, hoping for a bear market, any decline in this market is likely to be short-lived and untradeable. In other words: you could easily miss that boat.

To calculate its strategic asset allocation, Citi uses a proprietary model that estimates future potential returns over a ten-year horizon for various assets. It’s based on the premise that today’s lower valuations will give way to higher potential returns over time – which seems sensible – and these assumptions are updated on an annual basis. The model also aims to diversify exposure across different asset classes to improve investment outcomes.

Citi’s present asset allocation prioritizes “quality income” stocks – in other words, companies with strong balance sheets and consistent dividends, the kind that do well even in times of economic uncertainty. It’s got expensive defensive consumer staples and healthcare stocks, and some quality fixed-income assets (think: high-grade corporate bonds and US Treasuries).

Citi Global Wealth’s Level 3 strategic return estimates, by asset, as of Oct. 31st, 2022. The percentages refer to the estimated annual returns over the next ten years. Source: Citi.

Where are the opportunities?

Global dividend growth. Citi’s had an overweight position in these kinds of stocks for a while, and it’s panned out: they’ve seen smaller drawdowns since the bear market began in 2022. While dividend growers tend to arrive late to an economic recovery, Citi still believes that with their record of long-term outperformance, they deserve a permanent place in a core portfolio. To achieve that, you could consider the SPDR S&P Global Dividend Aristocrats UCITS ETF (ticker: GLDV; expense ratio: 0.45%).

Small and mid-cap stocks. Citi says it plans to reduce its exposure to the S&P 500’s big-cap stocks: they’ve had a great run but now look expensive on a relative basis. The firm says value is starting to emerge in profitable small and mid-cap (SMID) stocks, which are currently trading at a 30% valuation discount to those big-cap peers. Plus, SMID stocks generally perform best in the first year of a recovery. The Invesco S&P MidCap Quality ETF (XMHQ; 0.25%) might help you take advantage of that.

Renewable energy. It’s one of the biggest long-term investing themes – Citi calls it an “unstoppable trend” – and renewable energy is becoming more attractive as prices slide and demand rises. The iShares Global Clean Energy ETF (ICLN; 0.42%) invests in offshore wind farms, hydrogen solution providers, semiconductor equipment makers, and more.

Generative AI. Face it, it’d be weird if this wasn’t on Citi’s radar. AI is widely forecast to be one of the biggest tech revolutions ever. The Invesco QQQ Trust Series (QQQ; 0.2%) provides broad-based exposure to the AI scene, but, alternatively, you could consider buying the iShares Semiconductor ETF (SOXX; 0.35%).

Nearshoring. US neighbors (especially Mexico) look set to continue to benefit as manufacturing moves closer to home in a trend called nearshoring. With its close ties to US industry and demand, Mexico has seen a flood of inbound capital that’s likely to continue flowing in. The iShares MSCI Mexico ETF (EWW; 0.5%) offers a mix of Mexican assets.

US dollar rivals. Unstoppable trends like global aging, electrification and decarbonization, and a rising Asian middle class may benefit more than just US firms. So investing with a US bias risks missing out on a key subset of potential winners. What’s more, Citi says that a decade of US dollar dominance – which the firm accurately predicted way back when – is now coming to an end. Citi says the US dollar has peaked, which makes the notion of owning assets priced in foreign currencies (i.e. unhedged) potentially all the more enticing.

Citi’s Global Investment Committee recently bought shares in Asia, Europe, and Latin America, which in aggregate trade at a 30% valuation discount to the S&P 500. And it says it’s planning to buy a lot more over the next 18 months.

Fixed income. Right now, staying invested in cash or very short-term bonds could be a risk. That’s because, at maturity, the money could be reinvested at lower yields if interest rates fall. Citi’s model likes emerging market bonds after a weak performance in 2022 made their valuations more attractive. And with the US dollar expected to decline, that could boost their potential returns. The Invesco Emerging Markets Sovereign Debt ETF (PCY; 0.5%), which has an 8.6% yield to maturity, could be an interesting addition to your portfolio.

Europe. Like American tourists in the summer, Citi loves Europe, which has seen improved corporate governance and companies continue to streamline and restructure operations. The iShares Core MSCI Europe ETF (IEUR; 0.09%) provides a broad-based sampling of its shares.

Emerging market stocks. Potential returns for emerging markets look highest, according to Citi’s model, with companies in Thailand, India, Indonesia, and the Philippines seeing strong earnings growth and a rally in stock prices. But because the rally has lagged earnings, valuations are still at the lower end of their historical multiyear range. Citi still likes China, too, particularly because with valuations of under 10x forward price-to-earnings ratio, they actually look too cheap. For broad-based exposure to these countries’ stocks, you could choose the iShares MSCI Emerging Markets ETF (EEM; 0.69%), or to focus more on India, one of Citi’s favored emerging countries, you could buy the iShares MSCI India ETF (INDA; 0.68%).