02 2014 Opportunities amid market volatility In January, market volatility increased substantially as investors are wary that liquidity outflow from emerging markets may pose a threat on global growth. In the near term, investors may continue to be cautious on EMs. In the longer run, the prospects of EM growth could be boosted by its exports, which will benefit from recovery in the U.S. and Europe. As such, buy-on-dip opportunities may have emerged for European equities. Citi analysts expect Stoxx 600 Index to reach 370 by end- 2014 (it closed at 322 on Jan 31). Cover Story: Opportunities amid market volatility 02 Global Focus & HK/China Stocks: China to avoid systemic risk China developers could be a catch-up play 03 FX: Asian currencies likely to be more resilient 04 Bond Market & Commodities: European high-yield corporate bonds may outperform Gold recovery may be short-lived 05 Important Economic Events 06 1
COVER STORY Opportunities amid market volatility In January, market volatility increased substantially as investors are wary that liquidity outflow from emerging markets may pose a threat on global growth. Citi analysts believe that recent outflows in emerging markets, which saw their currencies and equities being sold off, is about concerns over EM economy on liquidity withdrawal by central banks, including the Federal Reserve and European Central Bank. As a result, equity markets across the board posed a loss in the first month of 2014. The S&P 500 Index fell 3.6%, while European equities dived 1.8%. Citi analysts believe that over the short-term, markets may remain volatile. But the mid-to-long term outlook for global equities remains positive as the global economy and corporate earnings are expected to grow. Therefore, shortterm volatility could be buying opportunities. Following the FOMC meeting by the end of January, the Fed announced that beginning in February, the pace of asset purchases will drop from $75 billion to $65 billion per month, in line with promises of further measured steps at future meetings. Citi analysts continue to see QE ending this fall, followed by an end to reinvestment early next year, and preparations for rate hikes closer to mid-2015. Emerging markets that recorded substantial current account deficits, including India, Indonesia, Brazil, Turkey and South Africa could be more affected by the Fed s QE tapering, in Citi analysts views. (Chart 1) Economies that recorded current account surplus are mainly North East Asian economies, including Taiwan, Korea and China. In the near term, investors may continue to be cautious on EMs. In the longer run, the prospects of EM growth could be boosted by its exports, which will benefit from recovery in the U.S. and Europe. Citi analysts expect reacceleration in global real GDP growth from 2.5% in 2013 to about 3.3% in 2014, the best since 2010. In the U.S., Citi analysts expect a modest firming in growth as fiscal drag declines sharply and already stronger cyclical forces take charge. The updated forecast shows a quarterly pattern of growth averaging 3% through 2015. On the other hand, the Euro Area is emerging from recession, Citi analysts anticipate GDP growth at 1.1% in 2014 and 1.3% in 2015. Against the backdrop of stronger economic growth, Citi analysts expect earnings-per-share of European equities to grow about 10% in 2014. As such, buy-on-dip opportunities may have emerged for European equities. Citi analysts expect Stoxx 600 Index to reach 370 by end-2014 (it closed at 322 on Jan 31). Chart 1: EM Current Account / GDP (Forecast) and Fiscal Balance / GDP (Forecast) 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% -8.0% Turkey 2014 Current Account / GDP (Forecast) 2014 Fiscal Balance / GDP (Forecast) South Africa Brazil Indonesia India Latin America Portland Source : Citi (forecast as of Dec 4, 2013) Mexico Emerging Europe Thailand Russia EM Emerging Asia China Philippines South Korea Malaysia Taiwan 2
Global Focus China to avoid systemic risk In China, 2014 began with fears of a crisis, triggered by the risk of default by a trust product linked to a Chinese bank and high capital costs. Citi analysts believe that there are policy tools to avert a crisis, including government-led restructuring and liquidity injections by the People s Bank of China. Last month, China Credit Trust Co. said it reached an agreement to restructure a high-yield product that sparked concern over the health of the nation s financial stability. Citi analysts are of the view that while other trust products have the risk of default in future, mainland authorities may regulate shadow banking activities through market mechanism. This could be positive for Chinese economy in the long run. This is necessary to shake off incompetent assets and institutions in order to avoid any systemic risk. Bankruptcies and defaults would impose hard budget constraints on local governments and state-owned enterprises, and price risk premiums more fairly. Policy tools to avert a crisis However, Citi analysts believe that the Chinese government would only be willing to take a measured crisis. Any defaults or bankruptcies are unlikely to jeopardize economic growth, estimated at around 7.5% this year. There are policy tools to avert a crisis, including governmentled restructuring, establishing provincial-level asset management companies, securitization, PBOC relending, liquidity injections and debt nationalization. On capital cost, the People s Bank of China pumped more than 375 billion yuan into the banking system (through conducted reverse-repurchase agreements) in January to meet increased cash demand before the Lunar New Year holiday. Following the injection, the seven-day repurchase rate, a gauge of interbank funding availability, dropped 134 basis points to 4.98% by the end of January. HK/China Stocks China developers could be a catch-up play Shares in Chinese property developer underperformed the broader index local governments in China have stepped up tightening after the peak sales season in Sep Oct last year. However, latest industry data continue to point to healthy sales growth, and major developers beat sales target in 2013. Citi analysts are of the view that shares in developers may grind higher in 1H 2014 as the prospects of property sales remain positive and valuations remain attractive. Government tightening likely to ease in 2014 China s commodity property sales in 2013 reached Rmb8.1trn, up 26.3% year-on-year, latest statistics showed. Citi analysts anticipate that government tightening may ease in 2014. The government s prime focus is likely to be on supply and social housing, explicit price targets on property are unlikely this year. Sales of residential units may grow 18% in 2014, with price expected to go up 9%, while sales volume may rise 9%, according to Citi analysts estimates. While liquidity concerns and tighter controls on credit have been sector overhangs since 4Q 2013, the impact on earnings should not be exaggerated. Key listed names balance sheets are manageable while sales as key inflows are also robust. Pain should mostly come to small or unlisted developers with their hefty reliance on high-cost borrowings, which would likely eventually crowd them out of a competitive market. Leading developers are likely to widen their market share. Attractive valuation Shares in property developers are trading at 45% discount to net asset values, while the estimated 2014 price-toearnings is only 6.9x. Such valuation is attractive, in Citi analysts views. China property names could catch up on an anticipated healthy sales numbers in 2014, easing property tightening and liquidity condition may improve after the Chinese Lunar New Year. 3
FX Asian currencies likely to be more resilient Stepping into 2014, the EM currencies depreciated sharply on worries about the slowdown of economic growth and the growing default risk of trust products in China. Another trigger is that, as the Argentine government loosened capital controls of foreign currencies, investors were concerned that the authority may remove the supportive measures to the Argentine Peso in an attempt to slow the decline of its reserve. In Turkey, to prevent further capital outflows, the government announced to raise the benchmark repo rate from 4.5% to 10% last month, and also sharply increased the overnight rates and lending rates. These measures may avoid further panic in the EM market in short term, leading to a rebound in EM currencies. However, in medium term, central banks are unlikely to be able to reverse the recent downtrend of EM currencies by raising interest rates only. Turkey is a case in point. Since Turkey is now facing severe inflation and massive current account deficit, there is no doubt that the Turkish Lira may depreciate further. USDCNY to grind lower to 6.00 In contrast, Asian currencies may be more resilient due to improvement in fundamentals. For example, the current account deficit as a percentage of GDP in Indonesia may drop to 2.7% in 2014, from 3.7% in 2013. The deficits of both current and capital accounts in India may narrow this year. In China, the yuan may benefit from the tightening of monetary policies by the People s Bank of China. For the coming 6-12 months, USDCNY may test lower to 6.00. Chart 2: EM currencies performances YTD -20.00% -16.00% -12.00% -8.00% -4.00% 0.00% -18.58% Argentine Peso -6.25% Russian Ruble -5.46% South African Rand -4.02% Turkish Lira -0.12% Chinese Renminbi Interest Rate Forecast Jan 24, 1Q 2014 2Q 2014 3Q 2014 2014 (Forecast) USD 0.25% 0.25% 0.25% 0.25% EUR 0.25% 0.25% 0.00% 0.00% GBP 0.50% 0.50% 0.50% 0.50% CHF 0.00% 0.00% 0.00% 0.00% JPY 0.10% 0.10% 0.10% 0.10% AUD 2.50% 2.50% 2.50% 2.50% NZD 2.50% 2.75% 3.00% 3.25% CAD 1.00% 1.00% 1.00% 1.00% Source: Citi, forecast as of Jan 24, 2014 Major Currencies Forecast 0-3 months 6-12 months (Forecast) USD Index 80.38 79.32 EUR 1.37 1.40 GBP 1.69 1.75 CHF 0.90 0.89 JPY 105 107 AUD 0.87 0.85 NZD 0.83 0.87 CAD 1.11 1.12 Source: Citi, forecast as of Jan 21, 2014 Other Currencies JPY to be pressured in medium term Citi analysts expect the Japanese yen may resume depreciation as the BoJ will likely expand the size of asset purchase program in mid-2014. The 20-year JGB yield recently dropped below 1.5%, which is a crucial watershed on whether Japanese long-term investors like lifers would increase foreign investments or not. Under this circumstance, money outflow from Japan may help stabilize global markets but send the JPY lower. Therefore, Citi analysts believe, for the coming months, USD/JPY may test higher to 105. In Jun - Jul this year, the pair may rise further towards 108-110. Source: Bloomberg L.P. (as of February 5, 2014) 4
Bond Market European high-yield corporate bonds may outperform With anticipation that the Federal Reserve will continue to taper bond buying this year, bond investors will have to be tactical amid an expected surge in U.S. treasury yields. A pick-up in U.S. treasury yields will generally exert pressure on USD bonds. On the other hand, a monetary policy in Europe is expected to loosen further, which could be good news for bond investors. As such, Citi analysts believe that European high-yield corporate bonds could benefit from European Central Bank s loose monetary policies and accelerating growth in the region. Default rate to drop in Europe The ECB may cut rate in 1H 2014. The yield of 5-year German Bunds may drop to 0.5%-0.6%. European corporate bonds may benefit from loosening policies. (Chart 3) Citigroup s Economic Surprise Index showed Eurozone economic data have been better than expected since July, hinting it is exiting from recession. The Eurozone economy may grow 1.1% and 1.3% respectively in 2014 and 2015. According to Moody s, in Europe, speculative-grade default rate declined to 3.4% in 4Q 2013 from 3.6% in 3Q 2013. Moody's expects default rate to drop to 2.1% in Europe by end-2014 (Expected U.S. default rate by end-2014: 2.3%). In the U.S., with risk free rates rising, and limited scope for further spread contraction, Citi analysts believe U.S. credit returns will be much lower than in stocks. Greater corporate sector leverage is a relative negative for credit compared with stocks. Citi analysts anticipate 2.0% total return (in US$) for U.S. High Yield and 4.6% total return (in ) for European High Yield to end-2014. Chart 3: 5-year government bond yields U.S. & Germany Commodities Gold recovery may be short-lived Spot gold has been underpinned recently on risk aversion, as the Chinese HSBC manufacturing PMI in January dropped below 50, the first time for 6 months, a Chinese trust product is facing risk of default and money flowed massively out of Latin America. In addition, the Indian Revenue Secretary said a review of curbs on gold demand would come by the end of March, fueling speculation that the government may remove the measures in the near future. These resulted the gold price jumping from the low at $1182 an ounce in early January to around $1270. Since India added the import tax to gold and gold jewelry by 10% and 15% respectively in order to stem money outflow, import of gold have tumbled to 515 tonnes in the current financial year, from 846 tonnes in the previous financial year. But now, money outflow from India has already slowed down and the expected current account deficit will likely drop from record high at $88 billion to below $50 billion this year, which may encourage the Indian government to relax some of the restrictions on gold demand. In the longer term, as the global economy is improving and that investors predict equities may go up in 2014, money outflow from commodity markets may resume. Even if the Indian government removes import tax on gold in future, the rebound in gold price is unlikely to be sustained. Technically, although the gold price recovered from $1182 an ounce, upside may be limited at around $1300 and price may later fall back toward $1200. Chart 4: Spot gold/usd - Daily Chart 1800 3 2.5 2 5-Year U.S. Treasury Yield (%) 5-Year German Bund Yield (%) 1700 1600 1500 1.5 1400 1 1300 0.5 1200 0 10 11 12 13 14 Source: Bloomberg L.P., as of January 17, 2014 1100 08/12 11/12 02/13 05/13 08/13 11/13 Source: Bloomberg L.P. (as of Jan 29, 2014) 5
Important Economic Events 1/2 China Manufacturing PMI 7/2 U.S. Unemployment Rate 12/2 China Trade Balance 14/2 China CPI 20/2 FOMC Minutes 21/2 G20 Finance Ministers Meeting 24/2 German IFO Business Climate Index 26/2 U.K. GDP 28/2 U.S. GDP Act now to stay abreast of the latest market information! Please visit for more details. Important Disclosure This document is based on information as of January 31, 2014 provided by Citigroup Investment Research, Citigroup Global Markets, Citigroup Global Wealth Management and Citigroup Alternative Investments. All information, views and estimates are based on the opinions on or before this date, and are subject to change without further notice. Past performance is not indicative of future performance. It is provided for your information only. It is not intended as an offer or solicitation for the purchase or sale of any security. Information in this document has been prepared without taking account of the objectives, financial situation or needs of any particular investor. Accordingly, investors should, before acting on the information, consider its appropriateness, having regard to their objectives, financial situation and needs. Any decision to purchase securities mentioned herein should be made based on a review of your particular circumstances with your financial adviser. Investments referred to in this document are not recommendations of Citibank (Hong Kong) Limited ( Citibank ) or its affiliates. Although information has been obtained from and is based upon sources that Citibank believes to be reliable, Citi analysts do not guarantee its accuracy and it may be incomplete and condensed. All opinions, projections and estimates constitute the judgment of the author as of the date of publication and are subject to change without notice. Prices and availability of financial instruments also are subject to change without notice. Past performance is no guarantee of future results. The document is not to be construed as a solicitation or recommendation of investment advice. Subject to the nature and contents of the document, the investments described herein are subject to fluctuations in price and/or value and investors may get back less than originally invested. Certain high-volatility investments can be subject to sudden and large falls in value that could equal the amount invested. Certain investments contained in the document may have tax implications for private customers whereby levels and basis of taxation may be subject to change. Citibank does not provide tax advice and investors should seek advice from a tax adviser. Investment products: (i) are not insured by the Federal Deposit Insurance Corporation; (ii) are not deposits or other obligations of any insured depository institution (including Citibank); and (iii) are subject to investment risks, including the possible loss of the principal amount invested. In the event of discrepancy between the English and Chinese versions of this document, the English version shall prevail. You may, at any time, choose not to receive our promotional materials. Please let us know in writing in case of such a request. Fax No.: (852) 2968 4127 or GPO Box 3463, Hong Kong. 2014 Citibank Citi and Citibank and Arc Design are registered service marks of Citibank, N.A. or Citigroup Inc. Citibank (Hong Kong) Limited 6