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Citigroup’s recommended investment strategy for this volatile market

The S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index is trying to claw its way back from a two-year low but don’t expect the volatility to subside anytime soon.

The top 200 stock index briefly slumped below the psychologically important 5,600 level in morning trade before recovering some of the deep losses to trade down 0.5% at 5,642.

That’s still below last month’s low of 5,664 points and chart readers will be tipping further downside risks for our market.

I had thought (or maybe hoped) that the market would stabilise above October’s trough and build a base ahead of the Santa Rally, which officially kicks off the week or two before Christmas.

I still think we will get the end-of-year free kick but we will probably have to endure more volatility for the next week or two.

If you are wondering how best to navigate the fog of war on our market, Citigroup has a couple of tips that you might find useful.

Buy the banks for their cost cutting upside

The first is to use the weakness to buy bank stocks after their circa 12% market rout over the last three months.

You can blame regulatory risks from the Hayne Royal Commission and the slump in the property market for their underperformance, although Citi doesn’t think these factors should put you off the sector as the bad news is largely reflected in the banks’ depressed share price.

Throw in the upside from their cost-cutting programs and Citi’s estimates that mortgage stress has hit a 10-year low, and you can see why the broker thinks there are opportunities in the sector.

Citi ranks National Australia Bank Ltd. (ASX: NAB) as its top pick among the banks, followed by Australia and New Zealand Banking Group (ASX: ANZ) and Westpac Banking Corp (ASX: WBC).

Retail sector on a slippery slope

The falling property market is a bigger threat to retailers than the banks, according to Citi.

Consumers are feeling poorer and more nervous as the value of their homes falls and that will deter discretionary spending.

“Savings rates are likely to stabilise with a 2-percentage point slowdown in sales possible across discretionary retail categories,” said the broker.

“We forecast LFL [like-for-like] sales growth to slow for Bunnings and turn negative in electronics.”

Wesfarmers Ltd (ASX: WES) owns Bunnings and Citi has slapped a “sell” on JB Hi-Fi Limited (ASX: JBH) and Harvey Norman Holdings Limited (ASX: HVN).

Property sector landmines

The property sector is a mixed bag. While some property trusts have a big exposure to the residential market, those that are leveraged to shopping centres and malls are the ones Citi fears the most.

The broker said that the bigger issue is for retail landlords where slowing sales is a risk for rents and multiples, while a lot of bad news is already in the share prices of residential property groups.

It has a “sell” on Scentre Group (ASX: SCG) and a “neutral” on Mirvac Group (ASX: MGR) and Stockland Corporation Ltd (ASX: SGP).

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