WEEKLY MARKET UPDATE. Are Rising Bond Yields Bad For Risk Assets? Performance. Asset Allocation. 24 October US economic growth likely to improve

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1 WEEKLY MARKET UPDATE 24 October 2016 Are Rising Bond Yields Bad For Risk Assets? As investor attention has recently been focused on global central bank actions, developed market bonds yields have been on the rise in the past few months. Some worry if rising yields could be a threat to risk assets or may reduce the attractiveness of high yielding emerging market debts (EMD) as well as global equities. Citi analysts believe that EMD may experience some volatility from potential Fed rate hikes in December this year and beyond. However, the hikes are unlikely to be highly disruptive given the improved oil price backdrop and expectations of a gradual rate hike cycle. In Citi s view, modestly rising yields may not lead to equity outflows given the early signs of green shoots in the current Q3 US earnings season. Of the 106 S&P 500 companies that had reported 3Q earnings through 10/20/16, 83 had beaten estimates and 18 had missed. This week, US 3Q GDP growth is in focus. Citi expects that US real GDP grew by 2.5% in the third quarter and GDP growth returning to an above- 2% pace may be viewed positively. Performance Global equities finished slightly up last week with the MSCI World Index higher 0.57%. In the US, the Dow Jones Industrial Average gained nearly 0.1%, the S&P 500 Index increased 0.38% and the Nasdaq Composite was 0.83% higher. European equities measured by the Stoxx Europe 600 Index gained 1.28%, while Japanese equities finished higher with the Nikkei 225 and the Topix up 1.95% and 1.34% respectively. EM equities outperformed their DM counterparts with the MSCI EM index rising 1.58% led by MSCI Latin America (+4.15%). Meanwhile, the MSCI Emerging Europe finished higher 0.50% and the MSCI Asia ex Japan rose 0.97%. Within Asia, the Philippine Stock Exchange Index was the outperformer, rising 3.53% to Asset Allocation Equities Citi analysts believe that this 7 year global bull market is ageing, but not finished, and forecast double digit gains to end Credit Citi continues to prefer EM bonds given their high yielding nature and how immune EM yields have been to the rising core G10 markets in recent weeks. Rates Rising volatility in rates and underpriced expectations for US rate hikes suggest a neutral approach on duration over short-term. Commodities For copper prices to outperform, improvements in Chinese economic fundamentals are needed, something which Citi analysts are still wary of. US economic growth likely to improve Citi Economic Surprise Index CESIUSD Index CESIEUR Index CESICNY Index 60 High yield outperforms amid rising oil prices Accumulated 3-month Bond Index Returns World Govt Bonds Index Global EMD Index HY Index Equities rebounded on the week Accumulated 3-month Equity Index Returns MSCI World MSCI EM MSCI Asia Week Ahead Key Data and Event % 3.0% 2.0% 0.0% % 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% -2% Date Country Data & Event Period Survey Prior Citi Fct 24-Oct JN Exports YoY Sep -10.8% -9.6% -9.6% 24-Oct TA Industrial Production YoY Sep 5.4% 7.7% 6.6% 24-Oct EC Markit Eurozone Composite PMI Oct Oct SK GDP YoY 3Q 2.6% 3.3% 2.5% 26-Oct US New Home Sales Sep 600K 609K 608K 27-Oct CH Industrial Profits YoY Sep % Oct US Initial Jobless Claims 22 Oct 255K 260K 260K 28-Oct JN National CPI YoY Sep -0.5% -0.5% -0.4% 28-Oct US GDP Annualized QoQ 3Q 2.5% 1.4% 2.5% 28-Oct JN Jobless Rate Sep 3.1% 3.1% 3.0% 28-Oct EC Economic Confidence Oct Oct US U. of Mich. Sentiment Oct INVESTMENT PRODUCTS: NOT A BANK DEPOSIT. NOT GOVERNMENT INSURED. NO BANK GUARANTEE. MAY LOSE VALUE.

2 Drivers and Risks By Market United States Driver: Despite the recent slowdown in housing investment, continued strength in new home sales this week may give confidence that the consensus forecast for an increase in housing activity remains on track. This would add only percentage points to real GDP growth, but it is a necessary contribution toward attaining Citi s 2% GDP forecast trajectory. Risk: Data to date have failed to support even modest expectations for near 2% real GDP growth in Indeed, above 2% growth has not been achieved since the second quarter of End-2016 Target: 2150 S&P 500 Implication: With awful sentiment, supportive valuation and the likelihood of a better EPS pace in the quarters ahead, Citi analysts find the balance to be tilted in favour of higher stock prices next year. Citi s mid-2017 and 2017 year-end targets stand at 2,250 and 2,325 respectively. Europe Driver: Last week, the ECB left all its monetary policy tools unchanged. It also left unchanged its forward guidance on rates to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases and on asset purchases intended to run until the end of March 2017, or beyond, if necessary, in any case until it sees a sustained adjustment in the path of inflation consistent with its inflation aim End-2016 Target: 310 Risk: Inflation may continue to undershoot the ECB projections in coming quarters and hence continues to warrant additional monetary stimulus DJ Stoxx TMI Implication: Citi analysts maintain our view that the ECB may likely extend its asset purchase programme by a minimum of six months on 8 Dec, although that decision might be reached with a compromise on the size of the monthly purchases. Citi also sees a small reduction in the pace of monthly QE to 60bn as likely from Apr-17 onwards and expects QE to last for another 18 months after Mar-17, adding an extra 700bn (5.5% of GDP). Japan Driver: In September, the BoJ changed its policy framework in a way that is more consistent with a long drawn-out process toward the 2% inflation target. The BoJ now seems much less likely to ease policy simply because it may revise down its inflation forecasts. Risk: Media reports suggest the BoJ is likely to revise down its core inflation forecast for fiscal 2017 from +1.7% in July to the low- or mid-1% range. But Citi analysts think that the BoJ s forecast is unlikely to be met even assuming a further modest rebound in oil prices. Implication: Citi analysts now expect the BoJ s next easing may be in July More concretely, the BoJ may cut the short-term policy rate from -0.1% currently to - 0.2%, while also reducing the target for 10-year JGB yields from around 0% currently to around -0.1%. Asia Driver: China s 3Q16 real GDP at 6.7% came in line with consensus, but the 1.8ppt acceleration of nominal GDP growth (3Q16 vs. 3Q15) with 3ppt higher Tertiary Industry contribution matters more, implying EPS stabilization. Risk: The USDCNY strength since October 1st generated pressure on China equities, but Citi analysts note the dollar index appreciated 2.7% against G10 currencies during the same period. Implication: Citi analysts believe that China s internal resilience (lower corporate credit growth and little GDP downside) is more than enough to offset external turbulence (F/X uncertainties given global politics). Citi favours MSCI China and HSCEI over CSI End-2016 Target: 1375 Japan Topix End-2016 Target: 530 MSCI Asia ex JP Page 2

3 Currency Forecast Last price Forecasts Currency 21-Oct-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 G10-US Dollar Euro EURUSD Japanese yen USDJPY British Pound GBPUSD Swiss Franc USDCHF Australian Dollar AUDUSD New Zealand NZDUSD Canadian Dollar USDCAD EM Asia Chinese Renminbi USDCNY Hong Kong USDHKD Indonesian Rupiah USDIDR 13,042 13,213 13,399 13,509 13,529 13,549 13,569 Indian Rupee USDINR Korean Won USDKRW 1,135 1,097 1,086 1,082 1,086 1,090 1,094 Malaysian Ringgit USDMYR Philippine Peso USDPHP Singapore Dollar USDSGD Thai Baht USDTHB Taiwan Dollar USDTWD EM Europe Russian Ruble USDRUB South African Rand USDZAR EM Latam Brazilian Real USDBRL Mexican Peso USDMXN Weekly Market Performance (17 21 October 2016) 0.4% 0.3% 0.2% 0.1% 0.5% 0.5% 1.3% 1.3% 1.2% 0.9% 0.9% 1.5% 4.1% 0% 2% 4% 6% Gold Oil China HSCEI Korea KOSPI US S&P 500 UK FTSE 100 MSCI Latin America Taiwan TAIEX Japan TPX Index Europe Stoxx Europe 600 MSCI AsiaXJapan China Shanghai Composite HK Hang Seng Citi High Yield MSCI AC World MSCI Emerging Europe Citi World Broad Inv Grade Citi Global Emerging Mkt Sovereigns Source: Citi Research and Bloomberg as of 21 October 2016 Market Performance (Year-To-Date) (As of 21 October 2016) Short Rates and 10-Year Yield Forecasts Last price 21-Oct-16 4Q16F 1Q17F 2Q17F 3Q17F 4Q17F Short Rates (End of Period) US Japan Euro Area Year Yield (Period Average) US Japan Euro Area Source: Citi Research and Bloomberg as of 21 October % -11.8% -12.7% 42.1% 37.3% 19.3% 17.7% 17.0% 14.3% 12.5% 11.6% 9.9% 6.7% 5.6% 4.8% 3.7% 3.6% 0.3% MSCI Latin America Oil Gold MSCI Emerging Europe Citi High Yield Citi Global Emerging Mkt Sovereigns UK FTSE 100 Taiwan TAIEX MSCI AsiaXJapan HK Hang Seng Citi World Broad Inv Grade US S&P 500 Korea KOSPI MSCI AC World China HSCEI Europe Stoxx Europe 600 Japan TPX Index China Shanghai Composite -40% -20% 0% 20% 40% Page 3

4 World Market At Glance US / Global Last price 52-Week 52-Week 21-Oct-16 High Low 1 week 1 month 1 year Year-to-date Year-to-date (USD) MSCI World % -0.99% 2.21% 3.55% 3.55% Dow Jones Industrial Average % -0.81% 5.69% 4.14% 4.14% S&P % -1.02% 6.05% 4.76% 4.76% NASDAQ % -0.71% 8.62% 4.99% 4.99% Europe MSCI Europe % -1.51% -8.76% -4.80% -4.80% Stoxx Europe % 0.53% -5.06% -5.88% -5.81% FTSE % 2.72% 10.59% 12.47% -6.59% CAC % 2.87% -3.39% -2.18% -2.11% DAX % 2.63% 4.62% -0.30% -0.64% Japan NIKKEI % 2.24% -7.38% -9.71% 4.78% Topix % 0.93% % % 2.40% Emerging Markets MSCI Emerging Market % 0.62% 6.07% 14.75% 14.75% MSCI Latin America % 9.81% 29.99% 42.07% 42.07% MSCI Emerging Europe % 0.77% 3.06% 17.66% 17.66% Brazil Bovespa % 9.79% 36.33% 47.88% 85.05% Russia RTS % 0.70% 15.11% 30.29% 30.29% Asia MSCI Asia ex-japan % -0.80% 4.00% 9.85% 9.85% Australia S&P/ASX % 1.70% 3.47% 2.54% 6.88% China HSCEI (H-shares) % -1.65% -9.04% 0.26% 0.16% China Shanghai Composite % 2.15% -6.92% % % Hong Kong Hang Seng % -1.25% 1.68% 6.66% 6.55% India Sensex % -1.51% 2.89% 7.50% 6.37% Indonesia JCI % 1.25% 17.46% 17.77% 25.06% Malaysia KLCI % 0.68% -2.18% -1.33% 1.47% Korea KOSPI % -0.15% -0.49% 3.66% 7.31% Philippines PSE % -0.33% 7.86% 10.04% 7.02% Singapore STI % -0.69% -6.43% -1.79% -0.24% Taiwan TAIEX % 0.85% 8.10% 11.62% 15.41% Thailand SET % 0.89% 5.97% 16.49% 19.56% Commodity Historical Returns (%) Oil % 12.15% 12.50% 37.28% 37.28% Gold spot % -5.05% 8.49% 19.30% 19.30% Page 4

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