CITI US equity strategy

As technical support breaks, investors scramble for cover. With the S&P 500 breaking below prior index support levels, chartists now seem to be in control of the tape with fundamentals falling to the wayside, especially given deep
economic and earnings uncertainty. Yet, such views were in place back in 2002 and equities were able to rally back as the outlook for the economy began to brighten following a massive inventory correction. Such conditions may be in place sometime in 2Q09.

Corporate cash levels argue for equities, but fear overwhelms everything. A quick review of corporate cash (excluding Financials) shows us reason for some optimism if one looks back to 2002 and the 1987 stock market crash. Furthermore, money market funds as a percent of equity market cap is quite bullish as are overall household deposits. While these data points do not provide a turning point, they do suggest that fear may be trumping common sense at this juncture.

Government programs appear to be adding to the confusion. The various banking and economic recovery plans being put in place have both their adherents and naysayers, but there is some reason to be concerned that more programs are being planned in the President’s budget, adding additional uncertainty at a time when stability is being demanded. For instance, health care stocks had been considered a safe haven in the current tumult and investors have been hurt there now as well due to planned budget cuts. The same might be said for energy stocks, as well as utilities facing higher dividend taxation.

History suggests that buying stocks makes sense at these moments. When equities are getting crushed and investors run to cash, gold and Treasuries, there is good precedent for bargain hunters with strong stomachs to step up and buy. In the past, awful 10-year returns for stocks have not been indicative of worse to come but rather led to better than random forward performance. The case for corporate bonds is also good, but, in our view, leaning into risk when the wind blows the other way appears reasonable after a more than 50% decline in stock prices.