A guide to investing through a slowing economy

Alfonso Camacho
Global Head of Markets Distribution
Jeffrey Sacks
Client Portfolio Manager, Citi Investment Management

The choices investors make over the next six to nine months may have profound implications for their portfolio returns over the years to come. While we believe staying invested is always wise, the current environment requires investors to reconsider their portfolio composition and the timing for making allocation changes.

We are entering an economic slowdown or a mild recession, one that has been telegraphed. While we believe the Federal Reserve will inhibit a rapid rebound, there is a huge amount of surplus cash waiting to “buy the dip”. Investor sentiment is poor, the landscape for investing is improving. Long-term potential growth opportunities in areas such as artificial intelligence and Sustainable Energy are potent and unrelated to today’s economic challenges.

Investors should now reconsider their portfolio composition and the timing for making allocation changes, while invested. As the year progresses, more active asset allocation should include lengthening duration in intermediate duration corporate bonds, US municipal bonds, preferred securities, and increasing investments in both non-US debt and equities. Looking forward to the next US recovery, there is relative value in US small and mid-cap (SMID) stocks and potential opportunities in tech outside of the leaders as growth recovers.

Our Global Investment Committee has allocated to bonds to capture higher yield and to hold defensive income oriented equities. With this Mid-Year Outlook, we are preparing for a reallocation in our portfolios. Here are some strategies for investors to consider:

Fixed income allocations

In the short-term, staying invested in cash or ultra short-term fixed income securities represents a risk to medium-term returns as reinvestment may occur at lower future yields. The US yield curve is inverted, with the shortest term bonds yielding the most.

Investors should consider transitioning away from non-core cash and short duration fixed income investments. Higher yields may be achieved by prioritizing the selection of quality investment grade corporate credits. After a substantial yield rise a compelling case for adding to emerging market debt (US dollar denominated) is building.

We also see potential opportunities in private credit and other areas of illiquidity and dislocation in the fixed Income markets. For qualified investors, private credit and other alternative funds may bolster medium-term fixed income returns.

A coming reallocation within equities

Defensive positioning in equities should not mean staying out of the market. For now, dividend growing companies may help reduce portfolio volatility while also offering some growth and income.

We believe that small and mid-sized firms in the US, and select emerging markets, are becoming undervalued.

Our opportunistic overweights by industry include cybersecurity and semiconductor equipment, defense shares among others.

Diversification of currency exposure

After a decade of US dollar dominance, currency exposure diversification may be important for the potential to strengthen investment returns and long-term preservation of investors’ wealth. In addition, qualified investors may consider diversifying portfolio exposures into non-US dollar investments in applicable asset classes. In cases where investors have large holdings in less liquid US dollar assets, it is important to consider the use of these risk management strategies to possibly mitigate the impact of the bearish US dollar trend.

Unstoppables remain

Unstoppable trends continue as long-term multi-year trends that are likely to transform the world around us, including technological advances, demographic developments and new behaviours. Broad thematic funds seek to capture these potential opportunities. Based on each investor’s objectives they may use strategies to build the exposure gradually with a long-term view. Currently, some of the sub-trends such as cybersecurity and life sciences offer good entry points.

Signals to follow

We believe decision-making should be guided by holding asset allocation within diversified portfolios. In our multi-asset class strategies we seek to rotate to different types of equities and, ultimately, tilt portfolios toward a greater exposure to equities. We do not believe that cash yields will be as strong a year or more from now.

How can suitable investors raise equity allocations?

  • Selection of equity markets and sectors that have lower than typical valuations
  • Investments that may provide suitable investors with an entry point at the minimum price of a market over a pre-set period
  • Strategies that seek downside risk mitigation at the price of giving up potential returns
  • Markets that may benefit from foreign exchange movements into returns

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Private Credit is debt financing provided by non-bank lenders such as hedge funds, private debt funds, business development companies (BDCs) and specialty finance companies. Private credit can take on various forms, including direct loans, mezzanine financing or private debt funds. Small- and medium-sized companies most commonly take on private credit.

SMID is short for small- and mid-cap stocks.

Yield Curve is a graph that plots the yields of all bonds of the same quality with maturities ranging from shortest to longest. When short-term rates are lower, it is called a positive curve. When short-term rates are higher, it is called an inverted yield curve. When there is little difference between long- and short-term rates, it’s called a flat yield curve. The most common version of the yield curve plots US Treasury securities.