2019 Market Outlook. Citibank Wealth Management Investment Strategy & Portfolio Management. January 2, 2019
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1 INVESTMENT PRODUCTS: NOT A BANK DEPOSIT. NOT GOVERNMENT INSURED. NO BANK GUARANTEE. MAY LOSE VALUE Market Outlook Citibank Wealth Management Investment Strategy & Portfolio Management January 2, 2019
2 The Expected Events of The US Federal Reserve continued to raise rate and reduced balanced sheet, and more central banks planned to tighten policies Economic growth of China is slowing Markets were influenced by various political factors (Brexit negotiations, Eurosceptic victory at Italian election and divided control of US Congress after midterm election, etc.)
3 Top 10 Unexpected Events for Unpreceden ted US- North Korea Summit Trump Withdrawed from Iran Nuclear Deal Brent Oil Price Rose to a Four- Year High, However, Fell 30% From The Peak Recently S&P 500 Hit Record High of 2940 Unanticipat ed USD Strength Since April 10-year Treasury Yields Surged to a Seven-Year High of 3.25% Turkey s Currency Crisis Triggered Global Worries Italy s Budget Battle with EU Extended Brexit Uncertainty Flare up of Trade Tensions
4 Others Bonds Equities Asset Performance S&P 500 Index -6.2% STOXX Europe 600 Nikkei % -12.1% Shanghai Comp % Hang Seng Index HSCEI -13.6% -13.5% US Gov't Bond Index ^ 0.8% World IG Corp Bond Index ^ US HY Bond Index ^ -1.9% -2.1% US Dollar Index 4.4% COMEX Gold Futures -2.1% WTI Crude Oil Futures -24.8% Source: Bloomberg L.P., as of Dec 31, 2018 ^Reference Indices: FTSE Fixed Income Indices
5 Asset Performance (%) 1Q17 2Q17 3Q17 4Q Q18 2Q18 3Q18 4Q Global Equities US Europe Asia Japan Hong Kong China A Emering Markets Global IG US HY EM Sovereigns Gold Oil (Brent) Dollar Index EURUSD GBPUSD AUDUSD Source: Bloomberg L.P., as of Dec 31, 2018; Returns are total returns
6 Equity Overweight in Europe ex-uk equities 6 European Dividend Bull Market We expect Europe (ex UK) earnings per share growth of around 10% for 2019 broadly spread across different sectors. Valuations are attractive: On a cyclically adjusted price to earnings basis (CAPE) of 19.3, Europe ex-uk equities are trading at a 25% discount relative to US equities. Dividend yields are still attractive: dividend yields (3.3%) > bond yields (1.3%) in the region. Source: DataStream, Citi, as of Dec 17, 2018
7 Equity Overweight in Europe ex-uk equities 7 UK House Prices & RICS House Price Balance Survey Headwinds in Europe: UK: Vote in parliament on PM May proposed EU deal by Jan 21 political uncertainty remains, weaker domestic demand and investment across the UK. Italy: Populist leadership propose a lower budget deficit target - Italy remains economically fragile but we do not expect imminent crisis. Source: RICS, Nationwide, Halifax, Citi, as of Dec 17, 2018
8 Equity Neutral in US equities 8 US Government Likely to Deploy More Stimulus to Boost GDP US GDP growth has likely peaked since the mid-terms, real GDP growth may slow to 2.8% in 2019, a still-above trend pace. We anticipate delay of the 2020 fiscal cliff and the $200 billion Federal infrastructure spending package may add fiscal stimulus to the economy. Source: Citi, as of Dec 11, 2018
9 Equity Neutral in US equities 9 Simulated Impact on GDP Growth from Trade Tensions Scenarios (%) We expect 2 further rate hikes of 25bps in 2019, implying a terminal policy range of 2.75% %. However the exact timing of these hikes remain uncertain. US-China tensions are likely to continue despite recent truce. Additional trade and investment restrictions on China are likely. Source: Oxford Economics and Citi, as of Dec 3, 2018
10 Asia ex-japan: Uncertainty Yes, But Much Bad News in the Price 10 Asia ex-japan: Price to Book We are not expecting a recession in Parts of Asia are pricing in a recession already. Based on current P/BV, Asia historically has given a 15% return over the next 12 months and with a 72% probability since Source: MSCI, Citi as at Nov 30, 2018 Trade and USD may determine returns in An ending of the Fed tightening cycle may help cap the strength of the USD, thus helping Asian liquidity. EPS growth expectations for 2019 have been revised down from 12-15% to 8%, which is already much more sensible. We expect a slight slowdown to 5.7% in emerging Asian economic growth over the coming year. The powerful economic transformation of EM Asian countries has much further to go. But investors generally remain underexposed to the region s attractive growth potential.
11 China: Macro Headwinds Remain but Valuation Getting Attractive 11 Valuation at Historical Lower Bound We expect GDP growth to slow to 6.2%YoY in 2019E, the government may still announce a growth target around 6%-6.5% to anchor the expectations. Source: DataCentral, Citi as at Nov 30, 2018 We see another consensus earnings downgrade for 2019E from 15% currently forecasted to around 10-12% for MSCI China. Policy stance has turned more accommodative since last July, with moderated pace in deleveraging and stronger fiscal support. We expect more fiscal stimulus in the coming months to stabilize the economy. Valuation is already at distressed levels. Both onshore and offshore equities are trading at ~10x fwd PE, which is at the lower-end of the historical range. Pause in trade escalation, stabilizing domestic growth and a less hawkish Fed are potential positive catalysts with the US-China trade dispute being a major swing factor.
12 Hong Kong: Limited by Concerns Surrounding the China Macro 12 HSI PE Valuation HSI is currently trading at ~10.9x FY19E P/E, vs. the historical average of 12.5x. A lower multiple is justified given the concerns surrounding the China macro. HK Sectors (Overweight) Chinese Sectors (Overweight) Source: Citi, as at Nov 30, 2018 Macau Gaming, Select Office and Retail Property and Select Tech Staples, Insurance and Infra-related Capital goods We expect HK banks NIM to peak in Weaker credit demand resulting in lower loan growth. We see possibility of touching 2015 trough valuation. Asset quality should remain stable for the larger players. We remain positive on the outlook for the internet sector. Consumer internet competition will further intensify and industrial internet have become the new focus for leading giants. The gaming sector has experienced several regulatory clean-ups in various ways, which we view as a positive development for the industry in the long run. When overall market rebounds and macro slowdown concerns ease off, the larger cap Chinese Internet names will likely rebound stronger than smaller cap names.
13 Fixed Income Investment Factors 13 Coupons Coupons on new issues are now 100bp higher than they were a year ago Yields We do not expect an inverted yield curve until 2Q 2019; 10-year UST yields will likely be well contained under 3.75% Tenor Interest rate risk of shortdated bonds is lower Credit Spread Corporate bond spreads have been below longer term averages for the last two years. Robust economic growth may support prolonged periods of tight corporate bond spreads Fixed Income Investment Default Rate US speculative-grade default rates have dropped from 5.1% in December 2016 to 2.6% and may fall further
14 US Short-dated Investment Grade Corporate Bonds 14 US Short-dated IG Corporate Bonds Outperformed Flatter US yield curves have created an attractive value US Investment Grade Corporate Bonds US Short-dated Investment Grade Corporate Bonds proposition for short-dated 102 bonds /2018 4/2018 7/ /2018 Source: Bloomberg L.P., as of Dec 21, Short-dated IG credit has shorter duration (less sensitivity to rising US rates) as the US may continue rate hikes. US short-dated IG corporate bonds outperformed overall IG corporate bonds in 2018.
15 US High Yield Bonds & US Variable Rate Bank Loans 15 US Bank Loans: Attractive Yields, Less Volatility US HY bonds and US bank loans US Variable Rate Bank Loans Source: Bloomberg L.P., as of Dec 21, 2018 US High Yield Bonds 1/2017 4/2017 7/ /2017 1/2018 4/2018 7/ / diversify investment portfolios HY has historically been less correlated with IG fixed income assets, such as US Treasuries. HY has instead moved more in line with equities, where we expect positive returns in US bank loans have been negatively correlated with US Treasury debt. Default rate (2.6%) remains low and may fall further in Bank loans coupon payments rise and fall with US LIBOR rates. LIBOR has hit its highest levels in a decade. The appeal of earning higher rates has led to strong positive net inflows into US bank loans.
16 Bearish on USD in Medium and Long Term 16 The Dollar Smile Theory USD Appreciation Weak Global Economy Low Risk Appetite USD Safe Haven Status USD Depreciation Source: Citi, as of Dec 11, 2018 US Cyclical Outperformance Hawkish Fed RoW on hold / easing US Growth Slowing Dovish Fed Scepticism About Global Recession USD may more than reverse this year s rally over the medium term. We expect over two years USD trend to reverse with approximately 12% downside vs major currencies, and around 2-3% weaker over 6-12m. A flatter or inverted yield curve may be a precursor of weaker economic growth, which may undermine the USD. The Fed may end the rate hike cycle in 2019, while other major central banks may tighten the policy gradually.
17 FX Forecasts 17 Source: Citi, as of Dec 11, M 6-12M LT Comments Dollar Index USD may be undermined as the Fed may end the rate hike cycle in EUR/USD EUR may be supported as the ECB may hike rates in 3Q19. GBP/USD A resolution of Brexit may trigger faster BoE normalization, which may underpin GBP. USD/JPY Weak USD and rising market volatility may underpin JPY. USD/CHF CHF may be restrained as the SNB still sees it highly valued. AUD/USD NZD/USD USD/CAD USD/CNY AUD may stay neutral as the RBA may not hike rates until 2H NZD may stay neutral as the RBNZ may not hike rates until 1Q CAD may be underpinned as the BoC may still have three more hikes. If US-China agreement cannot be reached in 90 days, RMB depreciation pressure will likely resume afterwards.
18 18 INVESTMENT PRODUCTS: NOT A BANK DEPOSIT. NOT GOVERNMENT INSURED. NO BANK GUARANTEE. MAY LOSE VALUE Appendix
19 Appendix:Economic Forecasts 19 GDP Growth (%) CPI Inflation (%) Current Balance Fiscal Balance (% of GDP) (% of GDP) 2018F 2019F 2020F 2018F 2019F 2020F 2018F 2019F 2020F 2018F 2019F 2020F Global U.S Japan Euro Area U.K Canada Australia New Zealand EM Asia Latin America EM Europe China Hong Kong South Korea India Indonesia Brazil Russia Source: Citi, as of Dec 11, 2018
20 Appendix:Interest Rate and Commodity Forecasts 20 Citi analysts forecasts Unit 1Q19F 2Q19F 3Q19F 4Q19F 1Q20F 2Q20F U.S. % Japan % Euro Area % U.K. % Canada % Australia % New Zealand % China (1-year deposit rate) % Hong Kong (3-month Hibor) % NYMEX WTI Crude USD/bbl ICE Brent Crude USD/bbl NYMEX Natural Gas USD/MMBtu Aluminum (LME) USD/MT 2,000 2,100 2,100 2,100 2,200 2,200 Gold (Comex) USD/oz 1,240 1,250 1,300 1,300 1,325 1,325 Soybean (CBT) USD/bu ,000 1,025 Source: Citi, as of Dec 11, 2018
21 Appendix:Equity Indices Forecasts 21 Region Dec 29, 2017 Close Dec 31, 2018 Close End-2019 Forecast Level 2019 Potential Return (%) Global Global MSCI AC World Index % EM MSCI Emerging Market 1, , % Developed Countries U.S. S&P 500 Index 2,674 2,507 2, % Europe STOXX Europe % FTSE 100 7,688 6,728 8, % Japan TOPIX Index 1,818 1,494 1, % Asia Asia ex Japan MSCI Asia ex Japan % China Shanghai Stock Exchange Composite Index 3,307 2, CSI 300 Index 4,031 3,011 3, % MSCI China Index % Hong Kong Hang Seng Index 29,919 25,846 30, % Hang Seng China Enterprise Index 11,709 10,125 11, % Source: Citi and Bloomberg L.P., as of Dec 31, 2018
22 Important Disclosure 22
23 Important Disclosure 23
24 Important Disclosure on High Yield Bonds 24 Unrated or non investment grade Debt Securities typically offer a higher yield than investment grade Debt Securities, but also present greater risks with respect to liquidity, volatility, and non-payment of principal and interest. As a result of being classified as non investment grade Debt Securities, these Debt Securities present a greater degree of credit risk relative to many other fixed income Debt Securities. Higher Credit Risk Unrated or non investment grade Debt Securities generally have predominantly speculative characteristics with respect to the issuer s capacity to pay interest and repay principal. There is greater risk of non-payment of interest and loss of principal. Many issuers of these Debt Securities have experienced substantial difficulties in servicing their debt obligations, which has led to default and restructurings. The issuers of these Debt Securities generally have to pay a higher rate of interest than investment grade Debt Securities. Higher Liquidity and Secondary Market Risk The markets in which unrated or non investment grade Debt Securities are traded are generally more limited than those in which investment grade Debt Securities are traded. This lack of liquidity may make it more difficult to resell these Debt Securities and obtain market quotations. Downgrade Risk Downgrades in the credit rating of unrated or non investment grade Debt Securities by rating agencies are generally accompanied by declines in the market value of these Debt Securities. In some circumstances, investors in the unrated or non investment grade Debt Securities market may anticipate such downgrades as a result of these credits being placed on credit watch by rating agencies, causing volatility and speculation of further credit deterioration. Higher Vulnerability to economic cycles - During economic downturns, unrated or non investment grade Debt Securities are typically more susceptible to price volatility and fall more in value than investment grade Debt Securities as i) investors may reevaluate holdings in lower-quality bonds in favor of investment-grade corporate Debt Securities; ii) investors become more risk averse; and iii) default risk rises. This is often referred to a flight to quality. Event Risk This includes any of a variety of events that can adversely affect the issuer of unrated or non investment grade Debt Securities, and therefore the issuer s ability to meet debt service obligations to repay principal and interest to Debt Securities holders. Event risk may pertain to the issuer specifically, the industry or business sector of the issuer, or generally upon the overall economy. It could have a direct or indirect impact on the issuer and their outstanding debts.
25 Important Disclosure on RMB 25 Risk relating to RMB If you choose RMB as the base currency or the alternate currency, you should also note the following: RMB is currently not freely convertible through banks in Hong Kong. Due to exchange controls and/or restrictions imposed on the convertibility, utilisation or transferability of RMB (if any) which in turn is affected by, amongst other things, the PRC government's control, there is no guarantee that disruption in the transferability, convertibility or liquidity of RMB will not occur. There is thus a likelihood that you may not be able to convert RMB received into other freely convertible currencies. CNH exchange rates and CNY exchange rates are currently quoted in different markets with different exchange rates, whereby their exchange rate movements may not be in the same direction or magnitude. Therefore, the CNH exchange rate may be different from the CNY exchange rate.
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