ISSUE 8 PERSPECTIVES 2Q 2018 VIEWS 2Q18: Stay Diversified Amidst Higher Volatility INSIGHT EM Asia Tech: More Growth Ahead
Perspectives Dear Clients, Global markets underwent a volatile first quarter in 2018, triggered by investor concerns on US inflation risks and global trade impact by tariffs. Global economic fundamentals remain strong. Citi analysts expect the global economy to grow 3.4% in 2018, up from 3.3% in 2017 while global inflation is expected to rise slowly to 2.5% in 2018 from 2.4% in 2017. Citi analysts forecast a single-digit gain in global equity return in 2018 with earnings per share (EPS) up 13%. Paul Hodes Head of Wealth Management Asia Pacific and EMEA Citibank N.A. While global trade tensions have risen, Citi analysts believe that only a severe breakdown in trading relations would threaten the current global economic expansion. Citi remains overweight on global equities and underweight on global bonds. Citi is also positive on the technology sector, especially within the Emerging Markets Asia region, driven particularly by Chinese technology companies. The largest Asian technology companies earnings grew 3.3 times more on an average percentage basis than US tech earnings-per-share growth. Citi advocates investing in technology s lasting industry disruptors as the longer-term prospects for EM Asian technology appear even stronger than in other regions We hope you find this issue of Perspectives insightful. Please approach your Citigold Private Client Relationship Manager to understand how these developments can affect your portfolio. Regards, Paul PERSPECTIVES 2
Views 2Q18: Stay Diversified Amidst Higher Volatility Emerging Markets (EM): Robust earnings and attractive valuations In February, equity markets fell given concerns that an increase in US inflation could drive the Fed to more aggressive rate hikes. Global equity markets rebounded swiftly and were then impacted when the US imposed trade tariffs on steel and aluminum imports on 9 March and then announced potential tariffs of $50B on Chinese imports on 3 April. US Technology stocks also experienced a selloff at March-end over concerns on data protection and increased regulatory oversight. Citi analysts expect EM earnings per share (EPS) to grow 12% in 2018 while Developed Markets earnings are expected to grow at 9% reflecting a more advanced stage of economic expansion. EM equities trade at a discount to DM: 15x vs. 20x trailing price-to-earnings (PE). Within EM, Latam is slightly more expensive at 23x trailing PE while CEEMEA and Asia look more attractive at 12x and 15x, respectively. Chart 1: MSCI Regional Trailing PEs In spite of Q1 2018 stock market volatility, global economic fundamentals remain strong. Citi analysts expect the global economy to grow 3.4% in 2018 up from 3.3% in 2017, with global inflation expected to rise slowly to 2.5% in 2018 from 2.4% in 2017. Citi analysts forecast positive global equity returns in 2018 with earnings-per-share (EPS) up 13%. Source: Citi Research. As of 4 April 2018. Risks to global trade remain elevated given that a rise in US protectionism may elicit retaliation by its trading partners. However, Citi's base case remains for moderate tightening of trade rules rather than a full blown trade war. Citi analysts continue to remain overweight Global Equities and underweight Global Bonds. A weak US dollar also remains positive for EM and Asia. Due to stronger local currencies, inflation remains subdued supporting economic growth. Chart 2: EM and US Dollar Within equities, Citi analysts favor Europe as well as Emerging Markets (EM). Despite Citi s preference for equities, there are still opportunities within developed high yield and emerging markets bonds. Source: Citi Research. As of 4 April 2018. PERSPECTIVES 3
Europe: Earnings growth still has upward momentum US: Valuations appear stretched Despite recent market weakness, Citi analysts remain positive on Europe ex-uk equities. Citi analysts believe that the 2018 GDP growth forecast of 2.4% could support corporate earnings growth of 10% this year. Europe ex-uk equities also offer high average dividend yields of 3.5%. The combination of tax cuts, a decrease in regulations and repatriation of overseas cash has buoyed expectations for faster US business activity in 2018. Citi analysts expect earnings growth of 14% in 2018. Chart 4: S&P 500 EPS and US Industrial Production Y/Y% Chart 3: PMI &12m Forward Earnings Growth Source: Citi Research. As of March 2018. Source: Citi Research. As of 22 March 2018. While a stronger Euro may weigh on exporters earnings, currency strength has helped attract inflows from non-european investors. Citi analysts also expect political risk to be relatively contained. In contrast, Citi analysts are neutral on UK large-cap equities as Brexit uncertainty is likely to remain a headwind. Although dividend yields above 4% appear attractive, UK consumer confidence has continued to fall since the 2016 Brexit vote and real wage growth has remained slow. Given this backdrop, UK equities are likely to rangetrade with higher volatility. While the US economy remains strong, US stock market valuations appear stretched. The trailing price to earnings (PE) ratio of 23x is above its long run average of 18x. See chart 2. Furthermore, risks of rising inflation alongside interest rate hikes and trade tensions could limit this year s US stock market gains. Citi analysts remain neutral on US equities for 2018. Within US equities, the Financial sector is preferred as it typically outperforms in a rising rate environment. Easing regulations for banks is also supportive. Other sectors that Citi analysts favor include Energy, Consumer Discretionary, Materials and Industrials. PERSPECTIVES 4
Japan: Yen strength may cap gains Citi analysts believe that the Japanese fiscal stimulus program as well as preparations for the 2020 Olympic Games could support Japanese equities in 2018. Japanese equities are not expensive at 13x forward price to earnings (PE), which is a 13% discount to its 10 year average. Historically, a strong yen has been a headwind and this may temper the market s upside in 2018. Investors can seek selective opportunities in Robotics, Information Technology, and Telecoms sectors, in which Japanese firms are globally competitive. Fixed Income: Position for Higher Yields Citi analysts expect tighter monetary policy in developed markets to drive bond yields gradually higher. The US Federal Reserve (Fed) raised policy rates by 25bps in March and Citi expects an additional 2 hikes in 2018. As US interest rates rise, the higher yields from emerging market debt and high yield bonds can provide investors with greater buffer compared with other lower yielding fixed income options. Opportunities in Emerging Market bonds: Citi analysts view local currency Latin American debt as attractive given a strengthening growth outlook, favorable inflation trends and attractive absolute yield levels. Among Asian bonds, Citi analysts favor China, as its onshore markets become more open to foreign investors. As China s Bond Connect platform, which provides access to local China bond markets, becomes better known and utilized, flows to Chinese bonds are likely to increase. The full inclusion of China s bond index within global bond indices can also help attract passive inflows of an estimated $250 billion. Corporate Investment Grade (IG): Favor US over Euro. At 3.75%, US benchmark yields are at their highest levels since 2011. High quality bonds can offer a buffer against equity volatility. In contrast, Citi remains underweight Euro IG as valuations remain weak and these bonds have limited protection in the event core rates rise. Spreads may also widen from declining ECB purchases later this year. High Yield (HY): Prefer US over Euro: Despite global volatility, US HY performance has been relatively resilient in Q1. Looking ahead, fundamentals remain strong and default rates remain low at 3.3%, well below historical averages. Benchmark yields above 6.0% still offer relative value when compared with other global markets such as Euro HY with its average yields of 3.35%. PERSPECTIVES 5
Stay diversified While trade tensions and central bank tightening may cause market volatility to rise, Citi views market pullbacks as opportunities to the degree that geopolitical events do not cause a global recession. Staying diversified across regions and asset classes can help mitigate the risks ahead. Key Takeaways While volatility in Q1 2018 was driven by concerns over rising inflation alongside interest rate hikes and trade tensions, Citi analysts believe that equity markets can deliver positive gains in 2018 as strong global growth is expected to drive corporate earnings growth. Citi analysts expect the global economy to grow 3.4% in 2018 up from 3.3% in 2017. Global earnings are forecast to grow 13% in 2018. Within equities, Citi analysts prefer Emerging Markets (EM) and Europe excluding the UK. Among bonds, Citi favors US Investment Grades and High Yield Bonds as well as EM bonds as they can provide a better buffer against rising yields. PERSPECTIVES 6
Insights EM Asia Technology: More Growth Ahead economy sectors such as Technology (see Chart 1). US Technology stocks have had a volatile start to the year due to ongoing trade war threats, rising user privacy concerns on social media and tech bubble fears. But Citi analysts believe that comparisons to 1999 s tech bubble burst are wide off the mark. Unlike 1999/2000, the Technology sector s current valuation of 22.6x price-to-earnings (PE) is lower than the 65.7x PE in 1999 a far milder valuation risk. In 2008, Energy and Materials made up 34% of the EM index. In 2018, these two sectors represent less than 15% of the index. Technology has become the largest sector, representing 28% of the EM index, up from 10% in 2008. Chart 1: The changing index composition in EM The changing face of EM Emerging Market (EM) equities have historically underperformed compared with developed markets (DM) during market corrections. In the last eight DM corrections, MSCI EM equities, on average, underperformed global equities by 4% in US dollars. However, EM equities held up relatively well in the Q1 2018 equity sell-off, outperforming global equities by 1%. Citi analysts believe that EM s current resilience is largely attributed to the changing composition of EM equity indices, moving away from old economy sectors including Energy and Materials towards new Source: Citi Research. As of March 2018. Chinese technology in focus The largest EM Asia technology companies are from China, Korea and Taiwan. Asian technology companies operate in a supportive regulatory environment. In China, for example, domestic firms have imposed self-censorship adhering to government requirements. PERSPECTIVES 7
In exchange, the firms are allowed significantly less regulatory controls than tech firms in other markets to operate in areas including financial transactions, foreign acquisitions and intellectual property. China has also shown potential leadership in the Fourth Industrial Revolution (FIR), which is the fourth major industrial era combining mobile connectivity and artificial intelligence to change the way people live and work. EM Asia Technology performance EM Technology represents about 18% of the global Technology sector. Citi maintains an overweight view on global Technology as it recorded the best performance in 2017 and yet remains the cheapest among regions. Supported by favorable regulations and innovative players, EM Asian tech valuations are at a 32% discount to DM. China s position as a frontrunner in the FIR is supported by an abundant supply of talent, a supportive government and ample financing. Chart 3: EM IT valuations appear more attractive than DM on PE basis Chinese tech giants such as Tencent and Alibaba are also highly innovative and diverse by global standards as they have moved on from merely being apps or marketplaces to developing vast ecosystems differing from platforms in Western markets. Chart 2: 12-month performance (in local currency) Source: Citi Research. As of March 2018. While EM Technology returned an impressive 65% since 2017, valuation multiples have only increased from 17.5x earnings in January 2017 to current levels of 18.1x. Source: Citi Research, MSCI, Factset. As of 4 January 2018. Developed market technology share prices, by contrast, have outpaced their earnings by almost 17% over the same time period. PERSPECTIVES 8
Among the largest technology names, EM Asian companies are growing faster while trading at lower valuations than their US counterparts. The largest Asian technology companies earnings grew 3.3x more on an average percentage basis than US tech earningsper-share growth. The largest DM Technology companies trade at an average valuation of 36x 2017 s earnings compared with 30x for EM Asia s largest firms. Citi advocates investing in technology s lasting industry disruptors as the longer-term prospects for EM Asian technology appear even stronger than in other regions. Key Takeaways Citi analysts believe that EM s current resilience is largely attributed to the changing composition of EM equity indices, moving away from old economy sectors including Energy and Materials towards new economy sectors such as Technology. EM technology represents about 18% of the global Technology sector. Citi maintains an overweight view on global Technology as it recorded the best performance in 2017 and yet remains the cheapest among regions. The largest Asian technology companies earnings grew 3.3x more on an average percentage basis than US tech earnings-per-share growth. Citi advocates investing in technology s lasting industry disruptors as the longer-term prospects for EM Asian technology appear even stronger than in other regions. PERSPECTIVES 9
World Market at a Glance Last price 52-Week 52-Week Historical Returns (%) 29-Apr-18 High Low 1 week 1 month 1 year Year-to-date US / Global Dow Jones Industrial Average 24311.19 26616.71 20553.45-0.62% 1.90% 16.10% -1.65% S&P 500 2669.91 2872.87 2352.72-0.01% 2.19% 11.98% -0.14% NASDAQ 7119.80 7637.27 5996.82-0.37% 1.58% 17.73% 3.13% Europe MSCI Europe 485.24 523.74 439.22-0.65% 2.04% 10.37% -0.52% Stoxx Europe 600 384.64 403.72 362.04 0.73% 4.64% -0.63% -1.17% FTSE100 7502.21 7792.56 6866.94 1.82% 7.17% 4.14% -2.41% CAC40 5483.19 5567.03 4995.07 1.30% 7.18% 4.10% 3.21% DAX 12580.87 13596.89 11726.62 0.32% 5.10% 1.15% -2.61% Japan NIKKEI225 22467.87 24129.34 19144.62 1.38% 5.40% 17.04% -1.30% Topix 1777.23 1911.31 1528.71 1.49% 3.50% 16.02% -2.22% Emerging Markets MSCI Emerging Market 1156.30 1278.53 972.95-1.02% -2.44% 18.24% -0.19% MSCI Latin America 3011.67 3243.07 2423.52-0.63% 0.51% 15.80% 6.49% MSCI Emerging Europe 165.04 187.38 136.46 0.44% -4.53% 9.54% -0.33% Brazil Bovespa 86444.66 88317.83 60314.70 1.05% 3.15% 32.17% 13.14% Russia RTS 1164.09 1339.41 958.83 1.60% -6.42% 4.46% 0.84% Asia MSCI Asia ex-japan 712.15 780.56 593.48-0.84% -1.97% 19.85% -0.18% Australia S&P/ASX 200 5953.65 6150.00 5629.80 1.45% 2.08% 0.50% -1.84% China HSCEI (H-shares) 12066.58 13962.53 9882.17 0.10% -1.91% 18.07% 3.05% China Shanghai Composite 3082.23 3587.03 3016.53 0.35% -2.67% -2.30% -6.80% Hong Kong Hang Seng 30280.67 33484.08 24358.72-0.45% -1.66% 23.02% 1.21% India Sensex30 34969.70 36443.98 29804.12 1.61% 5.41% 16.88% 2.68% Indonesia JCI 5919.24 6693.47 5577.52-6.60% -4.67% 4.11% -6.87% Malaysia KLCI 1863.47 1896.03 1708.48-1.29% 0.05% 5.40% 3.71% Korea KOSPI 2492.40 2607.10 2202.20 0.65% 1.65% 13.01% 1.01% Philippines PSE 7721.02 9078.37 7526.30-0.07% -4.05% 0.78% -9.78% Singapore STI 3577.21 3625.95 3170.14 0.11% 4.01% 12.65% 5.12% Taiwan TAIEX 10553.43 11270.18 9845.84-2.10% -3.94% 6.90% -0.84% Thailand SET 1778.02 1852.51 1531.68-1.29% -1.36% 13.52% 1.39% Commodity Oil 68.10 69.56 42.05-0.41% 4.37% 38.05% 12.71% Gold spot 1323.35 1366.18 1204.68-0.92% -1.62% 4.34% 1.56% Source: Bloomberg, as of 30 April 2018. PERSPECTIVES 10
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