Despite signs that the pace of recession is moderating, financial conditions remain an obstacle to renewed economic growth. Although imminent fiscal measures and stepped up financial and monetary policy actions promise to buoy demand, Citi analysts believe that risks of deflation in the US remain elevated.

Pronounced weakness in economic activity has recently been dominated by firms' attempts to re-align inventories in preparation for slow demand ahead. Declines in household wealth and rising joblessness are also likely to put the brakes on any rebound though on the plus side, the free fall in consumer spending appears to have ended.

Margins are likely to remain weak in 2009 and Citi analysts believe that this could limit share prices, however given the sharp retreat of stocks from their 2007 highs, much of this weakness appears to be already factored in to share prices. Citi's own Leading Profits Indicator and analysis on input costs and pricing power suggest company earnings may recover in 2010.

The latest moves by the US Federal Reserve (the Fed) to buy Treasuries and further expand its balance sheet are primarily directed at bolstering credit markets, and while financial stocks have rallied in recent weeks, the sustainability of the recent bounce is uncertain.

In Citi's view, the Financials sector is unlikely to provide new equity market leadership, though the potential for the sector to post a sharp rebound remains. Citi analysts continue to remain overweight in Energy, Industrials and Technology, while being underweight in Utilities and Consumer Staples.