Name: Investing in a Slowing Economy
Uploaded: 2023-09-25T12:00:00Z
Duration: 10 min 2 s
Description: David Bailin of Citi Global Wealth and Saira Malik of Nuveen debate the probability of a recession and discuss where they’re finding opportunities in equities and fixed income.

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David Bailin of Citi Global Wealth and Saira Malik of Nuveen debate the probability of a recession and discuss where they’re finding opportunities in equities and fixed income.

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Investing in a Slowing Economy 

Welcome to your "MarketBrief." Let's get you ready for the week ahead. We're coming off a losing week after a wake-up call from the Fed. The central bank's dot plot pointed to another rate hike this year and only two rate cuts next year, two fewer than expected, that sent bond yields surging and stocks tumbling. The NASDAQ saw the steepest weekly decline, falling 3.5%. Investors are coming to terms with rates staying above 5% through the end of next year, but my first guest is doubtful that will be the case. He's calling for upwards of four cuts in 2024. David Bailin is chief investment officer of Citi Global Wealth. Here's why.

I think that the yield curve has shifted, to actually believe that the Fed is gonna keep the rates higher for longer. I'm a little bit more skeptical about that now because the Fed typically keeps peak rates for about seven months on average, and we think at Citi Global Wealth that they're actually going to have to reduce rates more quickly than they think once unemployment actually starts to rise, which could happen in 2024.

So how many rate cuts do you have on your radar for next year?

Somewhere between three and four rate cuts in total, or really between 75 and a hundred basis points, because we would expect that once they cut, they're not just gonna cut by a, they'll cut by a small amount initially, and then they may have to cut a little bit more quickly in the event that we see, you know, labor markets weakening.

And if they're cutting because the labor market is weakening, does that mean you also have a recession in your forecast?

No, we actually don't. We already have this concept of a rolling recession taking place right now, which is that there are parts of the economy in manufacturing where you're actually seeing, you know, inventory declines, you're seeing, you know, production declines, and then other areas and services that are going extremely well. So that is the rolling recession. Next year we actually see modest growth across the actual spectrum of the market, and that's one of the reasons why, uncharacteristically, we added an equal weight index to our portfolios because we're gonna look for, you know, the tide to rise, for earnings to rise for the whole market. And then, ultimately, we'll be good for a much broader group of stocks than we're seeing this year.

And what makes you confident that earnings will rise for the whole market?

Well, if you think about it, as we go into next year, we're gonna see inventories again at a very low point, which means that once they start to rise, you know, I think you'll be able to maintain margin. Second of all, input costs are going to moderate, labor costs are gonna moderate, and consumer demand, we think, is gonna stay at about its current level. That combination would indicate, you know, reasonably good prospects for the 70% of the market that is consumer-oriented. And then, of course, when we talk about capital replacement cycles and things like that, AI, and other, you know, trends in the market, including some underinvestment that's taken place more recently, I think you're gonna bolster the corporate side of the market. So the combination of the two is what leads us to the sort of broader, better grow growth rate of earnings across the board.

So in the nearer term, it sounds like you're expecting this normalization of the market. So tell me what that could look like, and ultimately, you're bullish that this is a market that can move higher in the longer term?

Let's take a look at what makes this really an unusual market. Only in 1931 and in 1969 did we see the stock and bond markets go down at the same time until 2022. The last two times that occurred, right, two years later, a 60/40 portfolio, your regular boring portfolio, was up more than 20% in those two years. And I believe when we look from January 1 of '23 to December 31 of '24, portfolios, these boring portfolios will have done extremely well. And one of the ways we know that's true is if we look at the beginning of '22, short interest in equities was very high. And right now, short interest in treasuries, expecting yields to go higher, is very high. Those are snapback moments, right? They tell you that the market has yet to actually move ahead. So if you combine market positioning with earnings, I think we're gonna see, you know, that clients and investors who actually maintain their portfolios for the next 18 months are gonna be very well rewarded when we get to the end of '24.

So what does an ideal portfolio look like to you right now? Is it 60/40?

Well, it depends on the individual circumstances, but yes is my quick answer. The opportunities in fixed income have never been as rich as they are right now since probably 2006. So you actually can make good money in fixed income, you can make good money in emerging market debt, you can make good money in a whole variety of instruments, you know, across the marketplace. BDCs, MLPs, lots of that. On the equity side, if you choose the right parts of the market, you can also do well. And there are a couple of those, right? Mid-cap growth is selling at 16 times with a 9% expected growth rate. If you take a look at SMID stock, right, which are very good in the first year of recovery, same exact story. Non-US stocks are 45% less valued than US stocks are. So these are areas where, if you're selective in what you buy, you can create outsized returns. So I think there are very specific opportunities for investors now.

David, do you have a year-end S&P price target?

A few percentage points more than it is now would be where we would expect it to be up from here, but not a lot.

And then next year?

And the next year, we would sort of expect markets to be up between seven and 10%.

Many thanks to David Bailin. Meanwhile, the Fed may have revised up its economic growth expectations, but my next guest isn't as confident about a soft landing scenario. Saira Malik is chief investment officer at Nuveen. Here's why she thinks a recession is in the cards.

I think likely we eventually get to a mild recession. If you look at the consumer, which is one area that's been holding up the economy, we're seeing a significant increase in consumer credit, auto and credit card delinquencies, and then the employment markets are still very strong. I would call them Goldilocks right now, but we are starting to see some cracks there with slowing employment numbers. So eventually a mild recession. But if you look at history, markets tend to rally and go up when the Fed pauses. So it doesn't mean investors should get out of the market, they should just be thinking differently about how they position their portfolios.

So the US economy may be late cycle, but you say there are still opportunities for investors to find suitable returns in the market. Where are those opportunities?

In two areas. Areas of defensive and a cyclical segments of portfolios. So for example, defensive areas of US equities tend to be technology stocks, which have been, you know, kind of hit and in a downturn recently. But we think they can come back because they're less dependent on the economy. And then also dividend growers. These are companies that tend to raise their dividend payouts over time. They've underperformed quite handily this year. They tend to be quite defensive during market downturns and actually outperform during market downturns. Then, outside of equities and fixed income, I think it's time to start taking baby steps to adding duration and lock in some of these yields because when the Fed pauses, it'll be positive for fixed income. And then, outside of public markets, private credit tends to be less cyclical, especially those firms that are investing in areas that are like healthcare and software which are less reliant on the economy. That's another area of portfolios where you can get lower volatility.

And where are you comfortable buying in tech right now, given current valuations? We've seen a bit of a pullback in September, but some are still pretty highly priced.

Sure, we like semiconductors and software. Software companies tend to be less dependent on the economy, less dependent on pricing power, which may be hard for companies to hold onto as inflation moderates and semiconductors peaked, and they've been underperforming for a couple of months now. These were some of the key suppliers to artificial intelligence companies, so became a consensus-long trade. But companies such as Broadcom are really in the sweet spot for artificial intelligence. They're less cyclical. They also have a software business. They're closing the VMware deal, that'll be positive for them. And they have a lot of cash on the balance sheet to buy back shares. I think that's a company that is interesting from here.

When it comes to finding value in emerging markets, where specifically do you like? China?

We're looking at companies that have exposure to China more so than companies that are within China. So European luxury, good companies with exposure there. Companies like Starbucks, which has a large position in China and large exposure to China. I think Starbucks can continue to do well even if the consumer slows in the US, Starbucks is kind of a main piece of people's portfolio that they spend wallet on. So I think Starbucks is another way to play China without directly owning companies in China. I think eventually it can turn from a headwind to a tailwind as China bottoms. And you know, many investors have basically left China. Some people, you know, think that the narrative is that China's uninvestible. I think China is increasingly putting stimulus into their economy. If they focus more on the property market, China can start to show signs of turning around. And then, outside of China and emerging markets, areas that have been strong, Brazil, Mexico, Indonesia, these are all segments of the market that have continued to perform well. So emerging markets is not just all about China. And then another area we like is Japan in developed markets. You have strong economic growth there, looser monetary policy than we're seeing in the US. Japan is an area that continues to do well.

Thanks to Saira Malik. Before we go, let's take a quick look at what could move markets this week. Investors will have multiple economic reports to parse through, including readings on consumer confidence, new and pending home sales, second quarter GDP, as well as the Fed's preferred inflation gauge, the core PCE price index. And we'll wrap up earning season with reports from a few key names, including Costco, Micron, and Nike. That concludes this week's "MarketBrief." Thanks so much for watching. I'm Caroline Woods, have a great week.

Investing in a Slowing Economy

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