Market Outlook February 2015
China equities: Prefer H over A-shares CSI300/ MXCN corrected 8%/ 5% on Jan 19 given liquidity concerns following China Securities Regulatory Commission s (CSRC) three-month suspension of opening new margin-trading accounts for selective brokers. We had previously highlighted the liquidity risks, downgraded CSI300 (A-shares) to Neutral, Brokers to Underweight and upgraded Health Care to Overweight. After the correction, we believe MSCI China (H-shares) offers a good entry point as the macro environment may stabilize given gradual reforms, while patience is still needed for CSI300 given 1) CSI300 still outperformed MSCI China by roughly 45% since March 2014 trough; 2) Time is needed for CSI300 to digest/monitor the liquidity situation change, which has been the most critical driver for CSI300; and 3) Still big CSI300/MXCN valuation gap at 31% vs historical average at 21%. Citi s end-2015 MXCN/ CSI300 index targets stands at 78/ 3,700 respectively. Macro Overview US: We raised our 2015 growth forecast to 3.6%; Expect policy normalization to begin late this year. Europe: ECB announced 1.1tn QE plan to stimulate eurozone economy; Bolsters our overweight stance on Eurozone equities and credit Japan: 2015 could be a year of solid growth; BoJ may implement additional easing measures in July. Asia: China may grow 6.9% in 2015; Two more rate cuts in 1H and 3-4 RRR cuts could boost growth. Equities: Overweight We believe the global equity market has moved into the next phase of the cycle: Maturing Bull. Expect the search for yield and strong US$ to be key themes for global equities. Within sectors we prefer cyclicals/financials to defensives. Bonds: Underweight High Yield: Expect further spread tightening; Retain preference for High Yield over Investment Grade in both Europe and US. Emerging Market Debt: Cautious on local debt given improving prospects for stronger USD. Commodities: Neutral Gold: Q1 levels now projected to average $1,250/oz. Oil: Brent prices could return to the $60-70/bbl range by year-end. Currencies: Volatility is back EUR: Much Further To Go. EM Asia: Lower Oil Should help. Summary 2
Equity Markets and Commodities Australia Earnings pressure could constrain market gains Chart 1 ASX 200 Index Expectations of interest rate cuts have propelled the S&P/ASX200 index towards the Citi end-2015 forecast level of 5850. The oneyear forward price-to-earnings ratio now sits at approximately 15.5x, significantly above the long-run average level of 14.5x. Despite the lofty multiple, the market may well remain supported in the short-term due to the higher yields that are available from dividends relative to cash and bond interest. But heading into the mid-year earnings season, Citi analysts are not expecting the market to move substantially higher. Citi analysts only expect 4.3% earnings-per-share growth this financial year. When the short-term hubris of lower interest rates dies down, the market is likely to adjust to reflect the earnings results more closely. 35% 30% 25% 20% 15% 10% 5% 0% 3.28% 3.28% *Denotes cumulative performance Performance data as of 31 January 2015 Source: Bloomberg 7.67% 31.10% 1-Mth YTD 1-Yr 3-Yr* United States Policy normalization may begin late this year We expect an extra lift to US growth from the decline in crude oil prices. As a significant net oil importer, the US economy may benefit by about $140 billion in net foreign transfers. Consequently, we recently raised our 2015 growth forecast to 3.6% from 3.0% previously, led by a pickup in consumer spending. We anticipate a return to a slower, albeit still above-potential, pace in 2016. The Dec FOMC meeting confirmed our view that the current "zero rate" setting is not appropriate for an economy growing above potential. The Fed may use the temporary boost to growth from lower oil prices to begin raising rates sooner than our Dec-15 call. From an equity perspective, we remain constructive and expect 7% EPS growth in 2015 to drive markets higher. Our end-2015 target for S&P 500 is 2,200. In terms of sectors, capital spending is expected to grow double digits in the tech space with related strong demand for both IT products and services. Chart 2 S&P 500 Index 60% 50% 40% 30% 20% 10% 0% -10% -3.10% -3.10% *Denotes cumulative performance Performance data as of 31 January 2015 Source: Bloomberg 11.92% 52.01% 1-Mth YTD 1-Yr 3-Yr* Equity Markets and Commodities 3
Euro - Area Sizeable stimulus bolsters our overweight stance Chart 3 Dow Jones Stoxx 600 Index The ECB announced a 60-billion-a-month program of bond purchases, including eurozone government bonds. The program will run from March until at least September 2016 implying total purchases of more than 1 trillion helping to lift the ECB s balance sheet back toward 3 trillion. We remain optimistic on European equities and believe that aggressive policy action from the ECB will be a key driver, trumping macro/earnings concerns. We expect 10% earnings growth in 2015E, supported by: 1) ECB QE, 2) higher nominal GDP, 3) modest operating leverage, 4) weaker euro, 5) improving bank earnings. That said, we note that political risks still remain, with 2015 elections in Greece, Portugal and Spain all offering the potential to rile the markets. 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 7.16% 7.16% *Denotes cumulative performance Performance data as of 31 January 2015 Source: Bloomberg 13.81% 44.27% 1-Mth YTD 1-Yr 3-Yr* Japan 2015 could be a year of solid growth Chart 4 Topix Index We expect 2015 to be a year of solid growth. Japanese companies and consumers may likely enjoy an improvement in the terms of trade, driven by sharply lower oil prices in 2015. Most notably, consumer spending, the main culprit behind the technical recession of 2014, is likely to recover at a relatively solid pace, with steady growth in employment. The halving of oil prices is a complete game changer for the inflation outlook. Core inflation may approach 0% and turn negative, albeit temporarily, depending upon oil prices and the yen/dollar rate in coming months. In this context, we continue to expect the Bank of Japan (BoJ) to implement additional easing measures in July 2015. In terms of themes, we believe that auto related and industrial sectors are likely to be supported by the yen depreciation. Financials are a big laggard and are likely to benefit from increases in asset prices caused by the policies to get Japan out of deflation. 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 0.54% 0.54% *Denotes cumulative performance Performance data as of 31 January 2015 Source: Bloomberg 15.93% 87.36% 1-Mth YTD 1-Yr 3-Yr* Equity Markets and Commodities 4
Bond Markets Favour high yield credit over longer duration exposures US Treasuries We expect the US rates curve to flatten in excess of forwards, with the long end outperforming in an environment of low inflation risk premium and lower term premiums. The front end of the curve is expected to sell off in excess of forwards. The selloff is likely to be tempered by expectations of a more gradual pace of hikes. US Corporates Potential total returns in high grade corporate bonds are likely to be modest. Indeed, low absolute yields and fully-valued spreads especially in the US are unlikely to sufficiently offset declines in principal value as interest rates rise. We prefer European investment grade debt over US corporate bonds, and financial over non-financial credits. US High-Yield Recent sell-off provides attractive entry point for new exposures. In particular, we favour Single-B credits in US and Europe as they appear poised to generate relatively impressive returns in 2015 as stable fundamentals, low default rates and the demand for higher yields support further gains. Emerging Market Debt Euro Bonds Favour hard currency sovereigns/corporates over local debt given improving prospects for stronger USD. Prefer manufacturing vs. commodity exporters, and surplus over deficit countries. We continue to see a very mild rise in Bund yields for 2015 (0.65% by Dec 15), reflecting both the negligible risk of a spike in inflation as well as the weak potential growth environment. Other factors such as demographics, productivity trends, real interest rates and political risks may likely contribute to our medium-term scenario ("low-for-longer"), despite a short-term expectation of a post- QE sell off in core EGBs. Japan Bonds Asia Bonds We remain bullish on JGBs for the near term, due to a lack of sellers. Domestic investors are likely to keep unrealized profits until the next fiscal year (starting in April) so that the BoJ s purchases may keep squeezing the market. In addition, the market is likely to price in additional easing by the BoJ if equities lose the gains since QE2 that was announced last October. Higher yielding local markets - especially those without external vulnerabilities linked to falling oil prices or a weaker EUR may outperform. We are now more constructive on duration in Indonesia, where we find a larger potential for inflows amidst a gradually improving macro backdrop. Finally, we think it is too early to add duration exposure in Malaysia, and expect seasonally tight liquidity to restrain rates in China from dipping lower. Bond Markets 5
Currency Volatility Is Back Broader policy divergence, with the Fed and BoE still expected by Citi economists to raise interest rates over the year while the ECB and BoJ likely to ease further via balance sheet expansion to continue the broad trend of USD gains through 2016 but more against G10 than EM with intermittent corrections quite likely. EUR: Much Further To Go Significantly more downside in EUR/USD seen medium term both because of generalized USD strength and due to EUR weakness as a result of ECB monetary easing via balance sheet expansion. Ultimately, the spot is seen heading below parity as Europe continues to suffer from weak real growth, slack labour markets and weak and falling inflation/ inflation expectations. GBP: Nothing Near term, mixed Bag Medium Term After an impressive acceleration, a variety of UK economic indicators now appear to have levelled off albeit from a high base and likelihood of negative readings on the Citi UK surprise indices have risen. Thereafter, UK political risk (General Election in May 2015), the EU referendum (currently tabled for 2017 if conservatives win) and sizeable current account/budget deficits to continue to cap cable. JPY: Consolidation After QE News Again USD/JPY seems to have entered another consolidation range, with the pull-back so far to just over 115 but recent moves in relative rates and the 2013 precedent suggest a pull-back as far as 109-111. Medium to long term, however, much further upside is seen, driven partly by expectations that further US economic outperformance will raise front end yields and promote generalized USD strength. Additional BoJ QE as core CPI hits close to zero and GPIF (and other related) asset allocation rebalancing are also expected to promote capital outflows to foreign bond and equity markets. AUD, NZD & CAD: Medium Term Weakness To Persist AUD: The Citi Terms of Trade has fallen 70% since the start of 2014 and is expected to decline further and AUD still remains overvalued, currently 20% above its historical mean. Continued jawboning from Governor Stevens echoes this, with the Governor offering 0.75 as a broad guide to end of year NZD: NZD weakness, less than AUD so far, was primarily led by the drop in milk prices and paring back of expectations on RBNZ hikes. Citi economists feel the RBNZ can maintain its on-hold policy stance until Q4 2015, with risks that this is pushed out to H1 2016 given subdued inflation. This is likely to see a lower trajectory on NZDUSD CAD: Citi economists attribute some weakness in the currency to Canadian economic weakness as well as the decline in oil prices that could cut as much as a half percentage point from 2015 GDP. With the BoC now also having cut interest rates and possibly signalling more to come, the 0-3m forecast is raised to 1.19 while the mediumterm forecast remains at 1.25. EM Asia: Lower Oil Should Help Slower global growth, divergent monetary policies, lower for longer oil and strengthening USD should see EM currencies as a whole weaken. EM Asia however should fare better due to the impact of lower oil on the current account and a more benign outlook for US rates. CNY still remains the outperformer within Asia. CNY s short to medium-term macro trends remain supportive due to improving trade balance even as the capital account faces pressure. However, low inflation and a highly levered corporate sector could see China regarding a weaker CNY as a potential policy tool. Currency 6
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