By Barbara Kollmeyer
Stocks are down with investors still reeling from unpleasant CPI surprise that took a fresh bite out of markets on Wednesday. The tech sector was hardest hit, with Apple /zigman2/quotes/202934861/composite AAPL +3.71% losing 5% and surrendering its world’s biggest company crown to Saudi Aramco.
Big techs “need to recover to lead the market,” said Markets.com’s chief analyst Neil Wilson, who sees bulls putting up a fight if the S&P 500 /zigman2/quotes/210599714/realtime SPX +1.47% drops to 3,800. That’s “when things start to look very oversold…risk is the slow grind lower of the bear market, the exact momentum we saw in the bull market but in reverse.”
Our call of the day comes from Citigroup strategists, who offered a global equity portfolio to hedge against another equity downturn.
“It is long Value and short Growth. It favors the UK and EM over the US and Continental Europe. It prefers cheap Financials and commodity stocks to more expensive Tech-related trades,” said a team led by chief global equity strategist Robet Buckland.
The macro equity portfolio “minimizes exposure to a further real-yield driven derating across global equity markets, shorting trades where valuations are most sensitive to U.S. 10-year TIPS yields, and long those that are least sensitive,” the team said. The portfolio is wary of growth sectors, notably in the U.S.
As the team explained, the global equity market still isn’t that cheap vs. history.
They note the MSCI AC World benchmark /zigman2/quotes/208607471/composite ACWI +0.81% is off 17% year to date, trading on its long-term median of 15 times 12-month forward price/earnings — down from last year’s 20 times peak. Dropping to a 10-times multiple seen during the 2011-12 eurozone crisis would imply another ~33% derating, they said.
The MSCI AC World Growth index, meanwhile, is off 25%, while energy and U.K. health care are the only sectors bucking a “developing bear market,” said the strategists.
The relationship with real yields and equity valuations is key to determining more equity weakness, Citi reminded us.
“Monetary easing in 2019-2020 helped to drive down real yields and rerate equities. Monetary tightening in 2022 is driving up real yields and derating equities,” they wrote, adding that valuations for more rate-sensitive growth stocks probably have further to fall.
How much? The MSCI AC World Growth index hit a PE of 29 times towards the end of 2021 and now trades on 22 times, consistent with the current real yield of +0.3%.
Should that real yield head back down to -0.5%, the derating of growth stocks should reverse, but Citi’s global strategist Matt King saw real yields at risk of heading to 1%, which is bearish for equities and thinks stocks remain vulnerable even if 10-year TIPs stop climbing.
Their hawkish outcome on real yields would send the MSCI AC World benchmark to trade at forward price/earnings of 14 times from the current 15, and the MSCI U.S. to 16 times from 18 times. We’re almost there, they said, but the World Growth Index stands to drop to 17 times, down from the current 22 times.
As for how this de-rating strategy has performed so far in 2022, here’s a chart:
“The long-only strategy is down this year, but much less than the overall market,” said Buckland and the team.
Disney stock /zigman2/quotes/203410047/composite DIS +3.48% is down after the entertainment giant said it added more streaming subscribers than expected in the wake of Netflix’ s /zigman2/quotes/202353025/composite NFLX +1.35% rout, but warned of weakness ahead.