Citigroup strategist singles out Britain and China as outperformers in a deteriorating global climate

Robert Buckland tips country-level recessions but favours UK-listed pharmaceutical and consumer staples companies, while China’s sharemarket is another key overweight recommendation.

Paradice Investment Management’s David Paradice. Picture: John Feder.

Robert Buckland sees the British and Chinese sharemarkets outperforming amid a deteriorating global economic outlook that could result in corporate earnings forecasts downgraded further.

While a series of severe supply shocks continue to weigh on global growth forecasts, most central banks have had few options but to aggressively tighten policy because of soaring inflation.

Citigroup’s chief global equity strategist sees a “series of rolling country-level recessions”.

In his base case, that makes bottom-up consensus earnings per share forecasts of 11 per cent too high.

In his “hard landing” scenario, consensus earnings forecasts are 24 per cent too high.

“The risks of a hard landing have been growing, while a soft landing looks to be moving increasingly out of reach,” Mr Buckland said.

“In our hard landing, inflation proves more persistent – and more aggressive central bank tightening is required, resulting in a full-blown global downturn.”

Citigroup chief global equity strategist Robert Buckland. Picture: Hollie Adams

But at a country level, economic outlooks don’t necessarily drive sharemarket outlooks.

He notes that about 70 per cent of UK corporate earnings are derived from overseas operations.

That compares to about 40 per cent for US corporate earnings.

And unlike the US sharemarket, where the surging greenback is likely to result in earnings forecasts being downgraded in the current quarterly earnings ­period, UK shares have a huge currency tailwind.

“We’re overweight UK equities … it doesn’t mean we like the economy, but the UK stockmarket and the UK economy are not the same thing,” Mr Buckland said.

Investors have more buying power after the pound hit a record low last month, and the exchange rate weakness will translate to bigger earnings from UK companies with offshore earnings.

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“Getting the US economy right and getting the US stockmarket right are pretty similar, but it’s not quite the same in the UK,” Mr Buckland told The Australian at the Citi Investment Conference in Sydney.

“I hear people saying the UK looks like an emerging market, but it’s already priced like one.”

Emerging markets benchmarks trade on a PE ratio of 11 times, but the UK trades on a PE of nine times.

The UK gilt market sell-off that followed the UK government’s fiscal plans last month has forced pension funds to exit leveraged long positions tied to so-called liability driven investment strategies.

That has caused sustained pressure on UK gilts despite emergency buying from the Bank of England.

But the British sharemarket hasn’t suffered the same kind of sell-off because the very same UK pension funds only have about 2 per cent of their assets in the UK stockmarket.

“They sold their big equities positions down over the past 20 years to build liability matching positions in gilts,” Mr Buckland said. “If the general mix of fiscal and monetary policy in the UK comes under continued pressure (to ease), which is clearly what’s going on at the moment, you get a weaker sterling, and actually that leads to upgrades in the stockmarket.”

Paradice Investment Management’s David Paradice. Picture: John Feder

While the S&P 500 has fallen 25 per cent in the year to date, the FTSE 100 is only down about 7 per cent, as the consensus 12-month aggregate earnings per share forecast for UK companies has risen to 45 per cent, from only 3 per cent at the start of the year.

The UK now faces a severe ­recession as soaring interest rates look set to crush the property market.

But Mr Buckland favours big UK-listed pharmaceutical and consumer staples companies.

China’s sharemarket is another key overweight recommendation for Citi. China doesn’t have the inflation constraint of other nations, its policymakers are tentatively going in the opposite ­direction to Western policymakers, and it has scope to ease its “Covid zero” policy.

China “can cut interest rates, and they can see some reopening effects when Covid restrictions ease. It is the one major economy where we have growth accelerating next year,” Mr Buckland said.

In Australia, Paradice Investment Management has focused on commodity exposures – particularly in uranium companies and the energy sector more broadly – after years of underinvestment in increasing capacity to meet global demand.

But the fund manager’s founder and managing director, David Paradice, said his funds were preparing to broaden their exposure to Australian companies after the S&P/ASX 200 index had fallen as much as 16 per cent in the past five months amid rising interest rates.

Speaking after a Future Generations Investor Webinar, Mr Paradice noted Australian sharemarket trading value had been unusually low as investors were “lacking conviction”.

“I do think inflation increases are starting to reduce and that starts creating opportunities,” he said. “It’s much better to buy shares on a contrarian basis, and it just seems people are too bearish.”