Citigold A TIME TO BE NIMBLE. Keeping balance in a slow growth environment Annual Outlook

Transcription

1 Citigold A TIME TO BE NIMBLE Keeping balance in a slow growth environment 2016 Annual Outlook

2 02 A Time to be Nimble: Keeping balance in a slow growth environment COMMODITIES CONTENTS EQUITIES Page 02 FIXED INCOME Page 07 COMMODITIES Page 09 FOREIGN EXCHANGE Page 11

3 2016 Annual Outlook 01 A TIME TO BE NIMBLE Keeping balance in a slow growth environment Overall in what was a volatile year, our views saw a mixed performance. In equities, European and Japanese equities outperformed and registered positive returns while as expected the US markets were relatively flat. In EM, the markets were very challenging and even in Asia, performance was disappointing given multiple headwinds. China which was an overweight for us, was especially turbulent as we saw an uptick in volatility. In currencies, the US dollar did strengthen, particularly against EM currencies. Commodities were weaker while in the bond markets, performance was relatively muted. HAREN SHAH Chief Investment Strategist Investment Strategy Group Wealth Management Asia Pacific / EMEA Citi Here we are again, start of another year and wondering what is in store for the global economy and financial markets. Last year was again another challenging one for investors as we experienced uncertainty and heighten volatility. The global economic recovery remained uneven and on the heels of this, monetary policy with the exception of the US remained very accommodative. In 2015, our base case view was that growth was going to be uneven. The US economy was expected to remain on a modest growth path with other major regions remaining tentative. In such an environment, we expected divergent monetary policies among major central banks. Our portfolio alignment as such was to overweight equities and to have a bias towards the US dollar. In equities, our call was overweight Europe and Japan and to be selective in the US. In EM, we were overweight Asia particularly North Asia. So as we head into 2016, the economic landscape continues to be challenging. The US economy is growing at a modest pace while the rest of the world is struggling to maintain momentum. Japan and Europe are growing at subpar rates while China is expected to continue slowing to around 6%. Most other EM countries are anticipated to experience slow growth and those with large commodity exposure may even fall into recession. Overall, Citi expects the global economy to grow at around 2.8%. Against this background, the divergent monetary policies of 2015 could continue into Indeed the central banks such as the BOJ, ECB and the PBOC will remain accommodative in 2016 and this should be supportive for a relatively stronger US dollar. As far as the Fed is concerned, while rate normalization has begun in December, we expect the trajectory to be shallow and believe that the second increase is unlikely to occur until mid Commodity markets in such an environment will remain subdued but pockets of opportunities may develop. As for asset allocation, equity markets continue to remain an overweight in 2016 but sector selection will be important. In Developed markets, Europe and Japan continue to be Citi s preferred markets as both regions are beneficiaries of QE, stronger earnings and a weaker currency. But here again right sector selection is likely to add to performance. One particular sector that stands out in both regions is Financials. Meanwhile, the US is looking relatively expensive but there are pockets of value and opportunity in sectors such as Financials, Technology and Industrials. In EM, we remain cautious and very selective. We still prefer Asia as it has the best risk/ reward parameters. Our view is that China is expected to continue the restructuring of its economy in 2016 and the government s longer term plan is to promote new drivers of growth. On valuations, H-shares look more attractive than their onshore A-shares but there will be a need to distinguish the New vs Old economy sectors to achieve performance. So while the outlook for financial markets will remain uncertain in 2016, there will still be opportunities. Expect volatility to remain heightened in a maturing bull market but being nimble and having proper asset allocation will be essential in achieving appropriate returns.

4 02 A Time to be Nimble: Keeping balance in a slow growth environment EQUITIES While this bull market is maturing and volatility is rising, Citi analysts believe it is too early to call its end given where we are in the profit cycle. At 17x, global trailing PE is back to its long-run median. From here, we think that equity gains may be driven more by EPS growth rather than re-rating. Though there may be some short term post-hike volatility as there has been in the past, Citi analysts remain confident that the global equity market should shrug off this rate hike. Indeed, we set an end-2016 MSCI AC World of 535 and favour Europe and Japan where central banks are supportive and EPS momentum are reasonable. Citi s global sector strategy has a mild cyclical tilt, with Financials being the stand-out favourite across the regions. Citi analysts expect 2.8% global real GDP growth in Region wise, developed countries real GDP growth rate is forecasted at 2.0% in However, there is a wide divergence in expectations. For the US, Euro Area and UK, the EM crisis is more likely to produce a mid-cycle slowdown than a major downturn. In the US, Citi s economists have cut their 2016 growth projection to 2.5%. The US economy is expanding at a healthy pace, but the risk of an EM-led global recession and the attendant deterioration in financial conditions may dampen domestic growth. In Japan, our economists forecast real GDP to grow by 0.7% in Japan s main trading partners continue to slow, whilst on the domestic front, consumer spending remains lackluster. In the Euro Area, Citi economists expect 1.8% GDP growth in 2016, while in the UK, GDP forecasts were cut to 2.3% for 2016, reflecting softness in data and worries about the global growth outlook. The greatest downgrades are in Emerging Markets. Our economists now predict 4.0% EM real GDP growth in 2016 as China continues to be the biggest concern. The old economy is largely in recession, but the new economy seems relatively resilient. We keep their forecast of 6.3% for official GDP growth in 2016, but argue that the actual growth rate may remain at 4-5%. In terms of central bank action, despite the Fed hiking rates in Real GDP Forecasts vs. Historical Averages* DM US EA JP EM CH IN BR Historic Average Source: Citi Research and IMF, * Historical averages using IMF data: 1990 to 2014 for DM, 1996 to 2014 for EM. As of 2 December December, Citi analysts believe the second rate increase is unlikely to occur until mid-2016, and we have also deferred our forecast for the first BoE hike from 1Q16 to 4Q16. On the other hand, we expect further easing in coming months from the ECB, BoJ, PBOC, plus various other central banks. Indeed, the ECB may undertake two more deposit rate cuts (taking it to -75bp in the course of 2016), a further six-month extension of purchases, and probably with a step-up [+ 15bn] in monthly purchases at some stage. In Japan, we expect the BoJ to increase purchases of JGBs and ETFs, most likely in January

5 2016 Annual Outlook 03 EQUITIES EARNINGS CYCLE: MORE DOWNGRADES TO COME For 2016, bottom-up analysts consensus expects 10% global EPS growth. Top-down, expectation is for 8% EPS growth in 2016 which is consistent with Citi economists 2.8% global real GDP growth projection. In our view, analyst forecast still look too high but the good news is that analyst downgrades are not necessarily fatal for equity markets. When we look back at history, the annual median EPS miss since 1988 has been 7ppt, but the median annual stock market gain has still been 13%. VALUATIONS: BACK TO MEDIAN PE MSCI AC World trailing PE is back to its long-run median of 17x. While global equities do not look especially cheap (they hit just 12x in the Eurozone crisis), they are not especially expensive either. Within the region, the US trades on the highest trailing PE and LatAm is not far behind. In contrast, Japan and EMs look more attractive on this measure. MSCI Regional Trailing PEs EM Asia CEEMEA EM Japan Australia UK Eur x Uk DM LATAM DM Trailing PE Long Run Median Source: Citi Research and Datastream. As of 5 October GLOBAL SECTORS: MILDLY PRO-CYCLICAL Given that we think current fears of a global recession and accompanying bear market are overdone, it makes sense for our global sector strategy to have a mildly pro-cyclical tilt. We are Overweight Technology and Financials sectors. We are Underweight more defensive Consumer Staples and Utilities. Our preferred defensive is the more growth-oriented Healthcare sector. Indeed, Citi s model reflects a preference for sectors with decent earnings momentum and/or reasonable valuations. Financials look most attractive on this measure as they offer earnings momentum above the rest of the market, but valuations are below. Technology also shows well on our global free cashflow measures and balance sheets remain strong. We anticipate secular growth opportunities generated by continued product innovation.

6 04 A Time to be Nimble: Keeping balance in a slow growth environment EQUITIES US We estimate that the drag on GDP growth from the dollar s sharp appreciation since last summer would amount to a bit more than 0.5 percentage point per year, which peaks after two years, and slowly dissipates in another two years. Nevertheless, domestic final sales growth is expected to be bolstered by robust consumption growth for the next two years (close to 3% in 2016, roughly 2.5% in 2017). Indeed, given that the US economy is expanding at a healthy pace, the Fed recently embarked on rate normalization in December. Going forward however, Citi analysts believe that the second rate increase is unlikely to occur until mid The very shallow projected trajectory leaves the policy rate at 1% by end-2016, 1.5% by end-2017, and 2.25% by end Credit conditions remain favourable in the US but disappointment in EM could hold back the earnings story. Having said that, weak commodity price effects should fade due to easier comparisons and we expect 8% EPS growth in Nevertheless, the Fed has embarked on its tightening cycle and this could mark the end of six consecutive years of US outperformance, leading Citi to set an end-2016 S&P 500 target of 2,200. Thus we prefer to be selective and favour cyclical sectors such as Financials, Technology and Industrials. In contrast, we are underweight Consumer Discretionary as we find that it has historically been a consistent underperformer after previous rate hikes. EUROPE On 3 December 2015, the ECB cut the deposit rate by 10bp to -0.3%, while duration and scope of the bond buying program was extended from September 2016 to March Citi analysts believe the modest extra policy stimulus may probably be enough for the 2018 midpoint inflation target to be around %, broadly in line with the ECB s target. However, we maintain the view that headline inflation may probably undershoot the ECB s baseline again in coming quarters/ years. We therefore still see further easing, most likely through two more deposit rate cuts (taking it to -75bp in the course of 2016), a further six-month extension of purchases, and probably with a stepup [+ 15bn] in monthly purchases at some stage. This may support the annual GDP expansion to a slightly above-consensus % average in Over in the UK, growth appears to be slowing to an average pace of 2.5% in We suspect this is a mid-cycle slowdown rather than a sign that the expansion is nearing its end. In the meantime, CPI may likely be around 1% YoY in , as the economy faces sizeable disinflationary effects from the global slowdown plus sterling s sharp appreciation since early In this current environment, we continue to expect that the MPC is unlikely to hike rates in the next 12 months and pencil in the first hike for late There is modest positive momentum in Europe ex-uk EPS. Support for further growth comes from: 1) resilient/reasonable GDP growth, 2) weaker oil prices, 3) weaker euro, 4) improvements in Europe s financials/banks. Consensus estimates suggest 8-10% EPS growth for E. We back growth and re-rating to drive the Stoxx to 440 at end Meanwhile, decent economic performance has not prevented further cuts to market EPS expectations in the UK. This should not be surprising given that 70% of UK listed company revenues come from overseas. Lower commodity prices have been a particular drag given the high weightings in the Energy and Materials sectors. Sterling strength has also been unhelpful either and thus Citi analysts set an end-2016 FTSE 100 target of JAPAN The economy is facing significant challenges on two fronts, on external front Asian economic slowdown and on domestic front lacklustre consumption. Our economist expects GDP growth of 0.7% in And with inflation expected at 0.5% in 2016, concerns for deflationary pressure may force the BoJ to implement another QE in the coming months. In Citi s view, this could provide the catalyst for an improvement in sentiment towards the equity markets. We now put the chances of additional easing at 55% in January 2016, 25% in April, and at 20% for indefinite postponement.

7 2016 Annual Outlook 05 EQUITIES Though we should continue to see EPS growth of around 6.9% in 2016, the pace of growth in earnings is likely slower than the double digit growth we saw in 2015 as there will be limited room for weaker currency and/or lower crude. Based on this, Citi analysts set their TOPIX target for mid-2016 and end at 1,750 and 1,800 respectively. In terms of sector strategy, given concerns about downside risks, we overweight the defensive sectors such as Healthcare and Consumer Staples, as well as Financials, where additional monetary easing may work positively. We underweight Energy, where falls in crude prices have a negative impact, and are neutral elsewhere. ASIA PACIFIC EX JAPAN Growth will remain challenging in 2016 because of subdued external demand and the drag from relatively high household debt in places like Korea, Singapore, Malaysia and Thailand. With persistent low-flation, most countries may probably keep monetary policy accommodative (and a few have room to ease further) but we sense that pressure for fiscal stimulus could grow, especially among those who can afford it without threatening their credit ratings. The risk in light of the weak growth is further earnings downgrades. Asia is more topline sensitive than other EM regions. The saving grace is that input costs have fallen quite rapidly, which should provide relief for the bottom line. In terms of valuations, Asia is the only region within EM that continues to trade below its mean (Current P/E of 12.6x vs Avg P/E of 15.9x). Given current account surpluses, Asian markets are less exposed to further US$ strength than the other EM regions. The Asian economies are generally commodity importers so should eventually benefit from oil price weakness. Citi analysts thus set our end-2016 MSCI Asia ex Japan target of 610 and within the region, we are overweight on China, Taiwan and Singapore. Financials, Consumer Discretionary, Utilities and Technology are the preferred sectors. CHINA China continues to struggle with the restructuring of the economy. A large part of the old economy is in or near recession. Key traditional sectors - investment growth in property and upstream industries of the manufacturing sector, or roughly 26.9% of China s GDP activities, are suffering from negative growth. On the other hand, the new economy seems more resilient in relative terms. Retail sales probably bottomed out in April and edged up in recent months. Consumption, government and households included, has risen to 51.2% of Chinese GDP in 2014, up from the trough of 49.1% in This is in line with rising service sector share in GDP, up from 46.7% in 1H10 to 52.5% in 1H15. Overall, we expect the period of slow growth to be prolonged; lasting three years or more. China s authorities may lower its growth target to 6.5% in the 13th Five Year Plan and in our view the lower the better. Going forward, Citi economists expect three more 50-bp RRR cuts until mid We view such easing as helpful though not sufficient, and believe ongoing SOE reforms & overcapacity cuts are more effective to reduce cost of capital and drive sustainable equity valuation normalization. China is in a conjunction of cycles between the late stage of policy easing and the early stage of economic stabilization (not a V-shaped rebound), which should be incrementally more supportive to H-share equities given global investors fundamental focus, compared to A-share equities given domestic investors policy-easing focus. The potential Shenzhen-Hong Kong Connect, QDII2 scheme and the Mutual Recognition of Funds could also trigger more southbound inflows and favour H-shares. Indeed, we retain our positive stance on MSCI China and set an end-2016 target at 69, 0.5x st dev below 10-year average P/E, given lower earnings growth (3% in 2016E vs. 10-year average 11%). We stay Neutral on CSI300 given its 35% valuation premium and stick to our end-2016 target of 3,300. Sector wise, we continue to overweight Consumer Discretionary, Technology, Healthcare, Property, Insurance, Transportation and Utilities. INDIA India s economy has been resilient despite headwinds such as the deficient monsoon and weak external demand. The RBI s frontloading of monetary easing with a 50bps cut just before the busy credit/festival season is likely to support, if not spur, domestic demand. We continue to expect a modest pick-up in GDP growth to 7.5% in FY16 and 7.8% in FY17. On the monetary side, given our view of CPI inflation averaging at 4.8%-5% in FY16/17, we see space for an additional 25-50bps cut in Lastly on the fiscal front, the August fiscal data showed a surplus for the first time in 8 years, reflecting buoyant growth in tax and non-tax revenues. The equity market, with significant earnings cuts, has reset lower. That said, with its drivers well into transition, and coming together: we see a recovering growth cycle, improving earnings and a well-valued market ahead. We revise our Sensex target to 29,300 for mid-16 (35,000 previously), and introduce an end- 16 target of 32,000, benchmarked off a P/E of 16x 1yr Fwd. Our preferred sectors are Financials, Energy, Pharma, Autos, Cement and Utilities.

8 06 A Time to be Nimble: Keeping balance in a slow growth environment EQUITIES CENTRAL & EASTERN EUROPE, THE MIDDLE EAST AND AFRICA (CEEMEA) Citi analysts believe that EMEA growth prospects are structurally weaker than in the past decade, and that the market has not fully re-priced to reflect this. In South Africa, we have significantly downgraded our growth outlook, and now expect the economy to expand by just 1.2% in Citi s growth numbers for Russia have also been noticeably slashed to 0.5% growth forecast for Turkey was reduced to 2.3%, while we also saw with similar cuts in Poland s GDP to 3.3%. As a region, CEEMEA screens poorly in terms of its heavy reliance on global capital flows, and its exposure to commodities. The downgrades to macro mean that earnings pressures should continue. At this stage, consensus analysts are expecting local currency earnings growth of more than 10%. Although we are expecting earnings downgrades to broaden out, we are not foreseeing a capitulation given earnings are not entering this slowdown at peak levels. Within CEEMEA, Poland sits as our overweight market given its defensive characteristics, whilst South Africa is our key underweight due to its expensive valuation and vulnerability to Fed tightening. By contrast, Russia and Turkey look to be nearer trough cycle valuations, though political environments still look uncertain. Our target for the MSCI EM EMEA at end-2016 is 250. Given these challenges, we maintain our preference for quality companies that have stable dividend growth. RUSSIA Russia was affected by a myriad of structural problems well before the Ukraine crisis and the current sanctionsbased backdrop is likely to exacerbate the weakness in the economy, in our view. Indeed, we expect the economy to continue heading down in 4Q15, contracting by another 0.3% QoQ. This is when we estimate that the economy may bottom, with the first positive QoQ growth of 0.4% expected in 1Q16 and positive YoY growth resuming in 2Q16. Meanwhile, should oil prices remain in the current range of US$45-50bbl and geopolitics do not offer any unpleasant surprises, we see a good case for the central bank to resume decreasing rates in the near future, bringing the end-2016 key REPO rate to 7.50%. This view is critically based on headline inflation decelerating significantly from its level of 12.4% YoY in December 2015 to 6.6% YoY in December Russia is cheap and has performed year-to-date, yet few investors desire to own the market given the politically driven nature of events. Furthermore, approximately 50% of Russian government revenues come from taxes directly linked to oil prices. Citi s base view is that a significant rally in oil prices is unlikely near-term, with Brent probably remaining in the low-$50s through Therefore, unless we see Russian risk comes down, either via a rally in oil or the Ukrainian crisis receding, we prefer to remain neutral. LATIN AMERICA Growth forecasts continue to be revised lower in LatAM. Current account deficit economies are still seeing their currencies being dragged lower. Looking at real effective exchange rates, we see more downside risk for the commodity producers. Recession may probably continue during 2016 in Brazil, exacerbated by additional fiscal tightening, which could likely hurt the government s approval ratings. In Mexico, we expect growth to pick up in 2016 and 2017, and look for Banxico to follow the Fed in hiking rates. In Argentina, while the market-friendly candidate won the elections, we believe the next administration may face several challenges, and we therefore remain cautious. In Venezuela, the government may be forced to undertake a series of measures in 2016, including devaluation, gasoline prices increases and cuts to subsidies. Even so, we expect the situation to continue to worsen. It is worth noting that LatAm s sentiment reading is now slightly higher than that of EMEA s and is thus no longer the lowest in the EM region. This comes at a time where our LatAM strategist believes there are some oversold stocks worth revisiting in big markets such as Brazil. However, our outlook for LatAm as a whole remains bearish given the weakness in commodity prices and the vulnerability to Fed rate hikes on CA deficit countries, namely Mexico and Brazil which Citi is neutral and underweight on respectively. BRAZIL In Brazil, we expect 2.2% GDP contraction in 2016 on the back of high interest rates, slow credit growth, fiscal contraction and a softening labour market. Indeed, it may likely take a while before rates come off. With the weak BRL feeding through to prices, the Brazilian Central Bank has removed the language from its statements that suggested convergence of inflation to the 4.5% target by the end of 2016, replacing it with the relevant horizon, i.e Citi expects short-term rates to stay flat and high at 14.25% all through Expected consensus 2016 EPS growth in Brazil is 17%. Citi analysts see downside risk to this number as the economy is headed for the worst recession in more than 20 years. We forecast Brazil stocks at 54,000 Ibovespa points at mid-2016 though achieving this target assumes some fiscal tightening in the next quarters and consequently lower country risk. We prefer Brazilian exporters, multinationals, and defensives protected from the domestic slowdown, tight policy, and the FX slide.

9 2016 Annual Outlook 07 FIXED INCOME Fixed income has had a challenging year in 2015 with subdued returns in investment-grade credit and downside risks developing in Emerging Markets. The US interest rate outlook fluctuated significantly but was ultimately more dovish than initially expected as growth expectations went through a long stretch of downward adjustments and inflation expectations remained anchored at very low levels. This left US Treasuries in positive territory for the year at 0.9% in total return (year-to-date as of November 27th). Outside of the government sector, US investment-grade was lacklustre as spreads widened amid a lack of positive catalysts and a generally shareholder-friendly environment that saw leverage increase through the year. US high-yield saw a notable underperformance of -2.9% at first driven by energy, but eventually spreading across other sectors as leverage continued to rise. European indices were in positive territory (2.1% in investment-grade and 4.0% in high-yield), albeit the gains were largely offset by currency movements from a US investor standpoint. Comparison of year-to-date performance across Citi Fixed Income Indices YTD Return% (2.0) (4.0) (6.0) (8.0) (10.0) Overall Treasury Credit: Corp US Broad Investment-Grade US High-Yield Euro Broad Investment- Grade* European High-Yield* All Asia CEEMEA Latam EM Hard Currency Source: Citi Research; *Euro BIG and Euro HY Index returns are shown in Euro-terms. As of 27 November In Emerging Markets, Russia was the star while Brazil came under significant pressure. Market volatility was centred in the Emerging Markets, which returned a negative 1.3% overall. Developing concerns about the pace and extent of China s slowdown have had far-ranging implications across commodity and foreign exchange markets. Latin America struggled, returning a loss of 8.9% amid a sovereign downgrade caused by a contractionary economic backdrop driven by sharply lower commodity prices and major policy execution challenges. Political risk has also escalated amid a spiralling corruption probe that threatens key political figures. The CEEMEA sector outperformed as the market collapse of Russia credit in Dec-14 set the year up for dramatic spread tightening despite major sovereign downgrades, geo-political risks and lower oil prices. Refinancing risks in Russia were not as significant as expected, helped by funding from China, and bond technical were supportive with assistance from the onshore account base. Russian credit returned 15.4%, outperforming the broader CEEMEA region which was up 4.5%. Asia meanwhile remained the most defensive sector and overcame early volatility from a restructuring in the China property sector to return 0.6% with Chinese property turning out to be the star.

10 08 A Time to be Nimble: Keeping balance in a slow growth environment FIXED INCOME We continue to favour opportunities in US and European credit markets. The Fed has already commenced lift-off in December, however we do not see this as a major constraint to bond performance since the trajectory of US rates is expected to be extremely shallow given that despite improvements in US housing and unemployment data, inflation pressures are expected to remain benign amid a modest growth backdrop. As such, we continue to favour valuations in US investment-grade, which have widened and offer better relative value, and are constructive on high yield (ex-energy). We also continue to expect hybrid financials and US municipals to outperform. In European credit, we expect positive performance (in local currency terms) as the ECB recently cut deposit rate by 10bp to -0.3%. Given that the expansion of quantitative easing may likely deepen net negative sovereign bond supply, this may provide strong technical support for Eurozone periphery markets, and we are also overweight Euro investment-grade and high-yield sectors. Selective in Emerging Market sovereign and corporate debt. With a continuation of EM-centric structural growth concerns likely to dominate in the year ahead, we are cautious on Emerging Market sectors. We expect EM weakness may persist with Russia and Brazil remaining in economic contraction and the balance of EM also facing structural challenges due to major uncertainties surrounding China and by extension continued depression in commodity markets. In addition, we expect a lack of alternate growth engines either of an export-led variety or through greater economic and institutional integration with the EU or the US. We do see selected sectors such as strategic Chinese state-owned corporates and the India sector (which is a major beneficiary of lower commodity prices) as among the more defensively positioned, and see Russia as well supported in the immediate term. However, Citi analysts expect to see limited additional upside in these sectors and see potential for further volatility in the Brazil and Indonesia sectors which may be vulnerable to further downside in commodity prices and could present better buying opportunities in the year ahead.

11 2016 Annual Outlook 09 COMMODITIES 2016 is shaping up to be a critical transitional year for commodities a year of volatile and ongoing W-shaped price adjustments, as the market grapples with conflicting signals of whether and how rapidly supply/demand fundamentals are shifting to balance for many commodities. This transition predicates a more persistent price recovery by 2017 for oil and base metals, and possibly agriculture. The rising US dollar should be an ongoing headwind for commodities priced in nominal USD, though the pace of dollar strengthening should be slower, easing pressure on commodities. ENERGY Oil The oil market remains significantly oversupplied, to the tune of m b/d, and the return of Iranian barrels in early 2016 materially adds to the overhang. Citi expects 2H16 to be materially better, with non-opec declines and Saudi Arabia s production expected to roughly flat-line and Iraq slowing growth from current levels. Forecast demand growth of 1-m b/d points to a balanced market with higher prices by end Citi s average 2016 forecast for Brent and WTI stand at $51/ bbl and WTI at $48/bbl. Gas Oversupply remains the theme for global natural gas. We see prices progressing through several stages first before a possible recovery in late Firstly, over the coming months, conflicting outlooks for winter weather should increase price volatility. By early 2016, prices could stay low and range-bound post-winter due to the perceived resilience in production and the market s belief that it knows how coal-to-gas switching should balance the market. If production falls despite sharply stronger need for gas supply in 2017, prices could rise in late Thus Citi expects Henry Hub Natural Gas prices to average $3.00/MMBtu in PRECIOUS METALS Gold Given weak price performance in 2015 and strong USD sentiment, investors may continue to reduce gold exposure and look for returns in equities and bond markets. However, as has been the case in 2015, we expect continued macro risk concerns, plus a supportive physical market to prevent outright price capitulation. Gold prices may average $995/oz. in Silver Despite growth within the renewables sector, demand from the traditional electronics sector has been falling since This decrease has been precipitated by a weaker economy in China, where silver electronics demand is expected to fall, as well as in other developing countries such as India. Hence, in light of these developments, we expect prices may decline further to average $14.30/oz in BASE METALS Copper Much debate surrounds the extent of Chinese copper demand growth. However, Citi analysts believe apparent consumption points to Chinese absorption rates of copper growing at 3.8%, suggesting demand remains stronger than expected. Furthermore, from Chile to Zambia, supply disruptions have significantly dented production momentum globally. Indeed, the price rally seen in last April and September have been a direct cause of supply impingement and Citi analysts see this trend continuing into the coming months, forecasting prices to average $5,240/t during Aluminium Further USD strength and associated RMB devaluations may put further downward pressure on smelter costs outside of the US. In addition, we also believe further RMB devaluations, combined with higher VAT rebates could spur a rebound in Chinese aluminium exports. Citi analysts therefore forecast aluminium prices to average $1,510/t in 2016 with new lows expected in 1Q. Nickel Despite only a modest improvement in nickel demand projected for 2016, we still expect the market to move into deficit, on supply cuts and continued declines in Chinese NPI output. However, deficits in a high inventory environment point to only modest price support. Citi analysts have therefore downgraded our 2016 average price expectation by $1,175/t to average $10,875/t. Zinc After being the favoured base metal due to deepening concerns over future mine supply, investor interest in zinc has waned on weak global demand growth, and continued robust Chinese refined output growth. Hence we have downgraded our 2016 average price forecast to $1,760/t.

12 10 A Time to be Nimble: Keeping balance in a slow growth environment COMMODITIES BULK COMMODITIES Thermal Coal Citi analysts expect thermal coal prices to continue to decline in 2016 (averaging $48.00/t for the year) and 2017 as we believe demand from China and developed markets is in terminal decline while we see strong supply growth in India and Colombia. Metallurgical Coal Prices are expected to continue to decline in 2016, averaging $70.00/t due to cutbacks in Chinese steel production. Market balances are expected to tighten in the medium-term though as curtailments increase, Indian demand improves and Australian projects are postponed. Iron Ore Global iron ore demand has peaked and may remain under pressure from China s structural transition, rising scrap availability, and slowing global population growth. On the supply side, larger steel production cutbacks in 1H16 are then expected to drive prices down to average around $41.00/t in Risks to our forecast are thus skewed to the downside. AGRICULTURE Citi s outlook has been structurally bearish the agri sector and world food price CPI. But benchmark contracts are starting to stabilize and could rise into 2016/17. Since the 2012 drought, CBOT grain prices have plunged 45-55%, CME ethanol prices are down 40% and ICE coffee, cotton and sugar prices have dropped 20-30%. Cocoa is one of the lone crops trading higher today versus 2012/13. But ag supply cycles are short-lived and typically do not last more than 2-4 years as producers can reallocate acreage/inputs and since supply is weather dependent. Ongoing strong El Niňo conditions should provide an upside skew for prices and world food CPI. Soft commodities such as coffee are likely to rise in 2016 as FX impacts moderate and stock draws support markets. We are neutral cotton between cents while cocoa prices can continue trading at historically elevated levels but seem a bit rich north of $3,400/MT, given that high prices crimp demand growth.

13 2016 Annual Outlook 11 FOREIGN EXCHANGE The 2016 outlook for FX is likely to be characterized by overall USD strength as widening rate differentials between the US that commences rate normalization and the rest of the major economies that retain a neutral to easing bias, encourages further capital inflows into the US. However, we expect USD gains to be 5-6% at best from current levels and most probably less as the Fed would be only too aware of the consequences of widening policy divergence with the rest of the world risks strengthening USD to levels that could jeopardize the US economic recovery. Currency gains are typically driven by movements in yield differentials as the chart below shows and the Fed s task will be on how to proceed with rate normalization without causing an excessive blowout in yield differentials (and USD) given that other major central banks will retain an easing bias in USD G10 FX 2Yr Interest Rate Differentials Versus USD Index USD Index 2 Yr Rate Differentials /2/2008 1/2/2009 1/2/2010 1/2/2011 1/2/2012 1/2/2013 1/2/2014 1/2/ Methodology: US 2Yr Swap Yield Average Of The 2Yr Swap Yield Of EURUSD, USDJPY, GBPUSD, AUDUSD, NZDUSD & USDCAD. Source: Bloomberg. As of 17 November Currencies are driven by yield differentials and the latter are a function of the level of current rates plus expectations about future rate movements. The Fed has already commenced lift-off in December and so what is left for the Fed to help limit USD gains is to manage market expectations about the future path of rates. The Fed may likely do this by Signalling an extremely gradual pace of tightening at every occasion it can Lowering its own Fed Funds forecasts ( dot plots ) to help limit expectations about the peak in rates in the current tightening cycle to be a lot lower than in previous cycles And look to carefully calibrate its policy tightening with the easing bias of other central banks For the ECB, concerns about the increasingly weak euro zone inflation outlook has seen it signal its intention to add more stimulus to its current QE program via a further deposit rate cut, additional monthly asset purchases and/or a possible extension to its QE program beyond the current mandated September Such a move would undoubtedly weaken EUR aggressively.

14 12 A Time to be Nimble: Keeping balance in a slow growth environment FOREIGN EXCHANGE But if limiting USD gains to sustain the US recovery becomes a shared objective of the ECB, then the clear risk here is the ECB delivers somewhat less stimulus than expected which may still likely retain the bearish sentiment in EUR but shift the floor somewhat higher on EURUSD than the parity target most analysts see in 2H16. It is a similar view for JPY with the BoJ s refusal to entertain further easing so far likely to be seen not only as a more cautious BoJ waiting for further Japanese data and in particular, the wage negotiations, but could also be part of a broader strategy designed to carefully calibrate its policy with the Fed to help minimize USD gains. If true then this may also limit the weakness in the Yen to something well short of the 130 level expected by many analysts in mid The rest of the G10 central banks seem to be caught lying somewhere between the Fed and the other G2 (ECB and BoJ). Case in point is GBP that remains caught between a weakening EUR and a strengthening USD and these trends are expected to continue as the BoE is unlikely to follow the ECB with additional easing, but neither is it likely to follow the Fed to hike any time soon. Whereas the CHF looks materially overvalued as SNB policy likely remains dovish with a resolve to intervene in the FX markets as required given that sluggish Swiss economic growth is still very much a concern and deflationary risks persist. The commodity bloc as a whole (AUD, NZD & CAD) also remains vulnerable to further weakness in key commodity prices amid a decline in the pace of world trade growth (particularly in EM). But within the bloc, AUD is expected to be more resilient given the RBA s relatively more upbeat outlook for the domestic economy and jobs and business spending in particular. And most analysts still pencil in one more 25bp rate cut from the RBA in January that is increasingly contingent on China deteriorating markedly. Failing that, a Fed more actively seeking to contain USD strength and a less pessimistic RBA may well instil a higher floor in AUDUSD than the area most analysts expect to see in In New Zealand though, the economic themes remain broadly unchanged, with the balance of concern for the RBNZ resting primarily between global growth concerns, weak dairy prices and an overheating Auckland housing market. And with the NZD Trade Weighted Index gaining some 8% since September, this increases the risk of the RBNZ lowering rates to weaken NZD and makes NZD relatively more vulnerable than AUD. Turning to CAD, whilst rate differentials suggest that the unit may be undervalued, its high sensitivity to oil prices continues to keep CAD vulnerable. Having been stuck in a USD43 - USD50 range for much of September and October, WTI prices have collapsed again and with near term supply imbalances prevailing, CAD is also seen as relatively more vulnerable than AUD within the commodity bloc until WTI prices rebound in 2H16. Finally, turning to Asia EM, given low commodity prices, a slower China that is willing to let its currency depreciate significantly, a stronger dollar vs. G10 albeit limited in its gains, and the generally weak EM growth outlook means that exchange rates in Asia EM may likely continue to depreciate. In particular, Chinese authorities could likely relax their exchange rate regime further now that the currency is included in the SDR basket and let the RMB depreciate further in the medium term to stimulate the economy that in turn may impact IDR, MYR, THB and KRW the most. Less impacted is likely to be INR, given the more resilient external accounts on the back of the recent compression in trade deficit and subdued crude prices as well as the positive impact from the gradual expansion of foreign investment limits on government bonds. For PHP and SGD, that have traditionally been more resilient to external shocks, the prospect for further MAS easing in Singapore as the economy experiences a negative output gap and the narrowing current account surplus and political election uncertainty in the Philippines are likely to see both currencies weaken in line with other SE Asian currencies this time round. In conclusion, 2016 could well be similar to 2015 in that the overarching theme of policy divergence is likely to drive USD higher. But the differences may arise from a more vigilant Fed sensitive to the impact of higher rates on USD strength and is likely to more pro-actively manage such gains via a very active communications strategy and a well coordinated and calibrated approach to rate normalization with the other central banks a two steps forward one step back for USD.

15 ECONOMIC GROWTH & INFLATION FORECASTS GDP Inflation 2015F 2016F 2017F 2015F 2016F 2017F Global 2.6% 2.8% 3.1% 2.2% 2.7% 3.0% US 2.5% 2.5% 2.5% 0.3% 1.6% 1.8% Europe 1.5% 1.8% 1.7% 0.1% 1.1% 1.5% Japan 0.6% 0.7% 0.3% 0.9% 0.6% 1.6% Latin America -0.5% 0.0% 2.4% 11.7% 12.9% 15.0% Emerging Europe -0.5% 1.7% 2.9% 9.9% 6.0% 5.1% Middle East & North Africa 2.8% 2.3% 3.2% 4.3% 4.6% 5.1% Asia 5.9% 5.7% 5.8% 2.0% 2.3% 2.5% China 6.9% 6.3% 6.2% 1.4% 1.7% 2.0% Hong Kong 2.5% 2.0% 2.3% 3.0% 2.0% 1.9% India 7.5% 7.8% 8.2% 5.0% 4.8% 5.0% Indonesia 4.7% 4.5% 4.9% 6.4% 5.3% 4.3% Malaysia 5.0% 4.6% 4.7% 2.1% 3.2% 3.0% Philippines 5.8% 5.1% 5.5% 1.4% 1.1% 1.7% Singapore 1.6% 1.5% 2.0% -0.5% 0.5% 1.5% South Korea 2.5% 2.4% 2.8% 0.7% 1.7% 2.4% Taiwan 0.6% 1.8% 2.5% -0.2% 1.4% 1.4% Thailand 2.9% 2.4% 2.8% -0.8% 0.4% 1.1% Source: Forecasts from Citi Research. As of 30 November EXCHANGE RATE FORECASTS (VS. USD) 1Q16 2Q16 3Q16 4Q16 Europe Japan UK Australia China Hong Kong India Indonesia Malaysia Philippines Singapore South Korea Taiwan Thailand Source: Forecasts from Citi Research. As of 30 November INTEREST RATE FORECASTS Current 1Q16 2Q16 3Q16 4Q16 US 0.50% 0.50% 0.75% 0.75% 1.00% Europe 0.05% 0.05% 0.05% 0.05% 0.05% Japan 0.10% 0.10% 0.10% 0.10% 0.10% Australia 2.00% 1.75% 1.75% 1.75% 1.75% UK 0.50% 0.50% 0.50% 0.75% 1.00% Source: Forecasts from Citi Research. As of 30 November Current rates as of 17 December 2015.

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