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Global Strategy Quadrant February 1, 2019

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Global Strategy Quadrant February 1, 2019 Global Strategy Quadrant February 1, 2019 Steven Wieting Chief Investment More Early 2016 than Early 2018 Strategist and Chief Economist Financial markets have roared higher in early 2019 but we still see strong pockets of long-term +1-212-559-0499 opportunity. Sentiment and positioning are very different from early 2018 when investors were [email protected] overconfident. Early 2018 followed an unusually strong and smooth year of investment returns. We added Asian and US equity exposure. Equities in emerging Asia remain nearly 19% below year- Malcolm Spittler Maya Issa ago levels. We took the opportunity to add about 1% of our total world asset allocation to these equity Joseph Fiorica markets and a portion of developed Asia. We closed an underweight position in US equities that we held Investment Strategy during the fourth quarter 2018 and shifted certain European equity markets down to neutral. Ken Peng EM breadth points to gains. The share of emerging market equities in a rising trend recently turned Head – Asia Investment the corner, showing improving breadth. The last time the “breadth” trend changed from weakening to Strategy improving was early 2016, before further sustained gains. Catherine Cheung The monetary outlook has eased. The Federal Reserve signaled a more cautious approach to Asia Investment tightening US monetary policy this week, which historically has been positive for equities and fixed Strategy income. After nine rate hikes, US short-term rates still trounce most of the world’s fixed income yields. Jeffrey Sacks We see opportunity in US fixed income. Short-term investment grade opportunities exist at higher Head – EMEA yields than long-term US Treasuries and at roughly 100 basis points above cash. We allocated a full Investment Strategy further percentage point to short- and intermediate-term investment grade US bonds. Shan Gnanendran We put our remaining tactical cash position to work. Our increased allocations to equities and fixed EMEA Investment income has eliminated our overweight cash position. Our overall global fixed income position is neutral for Strategy the first time since late 2012, heavily weighted to the US and EM. Jorge Amato We believe asset allocation will provide a more suitable mix of safety and opportunity. This Head - Latin America follows the rare conditions in 2018, when nearly all global asset classes fell. While our global equity Investment Strategy tactical weighting is now higher at +2%, we don’t expect to increase this sharply as we would at the start of a new economic recovery cycle. (Our peak equity overweight in the current cycle was about +8%). Charles Reinhard Head - North America Trade friction remains a key market risk. Hopes have risen for a US-China agreement that will at Investment Strategy least defer a rise in tariffs on $200 billion of Chinese exports. While we expect Europe’s sluggish recovery Kris Xippolitos to endure and perhaps benefit from a US-China accord, the regional economic expansion has slowed Head – Fixed Income despite ECB stimulus having peaked. Brexit risks are priced in, but still sizeable and unpredictable. Strategy Cyclical sectors are key to the ongoing rebound. Having driven the decade-long equity bull market, Joseph Kaplan cyclicals have also powered global equities’ rally since late December, outperforming defensives once Fixed Income Strategy again. The nascent equity recovery’s continuation will depend heavily on cyclical sectors. Wietse Nijenhuis US investment grade corporate bonds offer some of the best risk-adjusted value in fixed income. Head - Equity Strategy Short-dated yields above 3% remain compelling versus lower yielding non-US bonds. US high yield bonds had their best January since 2009, with spreads moving back below historical averages. While we remain comfortable with underlying credit fundamentals, relative value favors hard currency (USD) emerging market debt. INVESTMENT PRODUCTS: NOT FDIC INSURED • NOT CDIC INSURED • NOT GOVERNMENT INSURED • NO BANK GUARANTEE • MAY LOSE VALUE st GIC – January 31 Asset Classes – Global USD with Alternatives Level 3 The Citi Private Bank Global Investment Committee eliminated our 2% tactical cash weighting at our January 31 meeting, reallocating -2 -1 0 1 2 the proceeds equally between global equities and fixed income. This leaves our allocation to global equities 2% overweight and fixed income neutral. Following widespread Fixed Income declines across asset classes in 2018, we see selective Developed Sovereign → opportunities across both low-risk and higher-risk assets over the coming 12-18 months. As such, we expect an improved Developed Investment Grade Corporates → performance from well-diversified global portfolios in 2019. As highlighted recently (New Year Opportunities Amid Old Business High Yield ← Cycle Risks) the periods following 20% declines in equity markets have → most often been followed by strong one- and two-year Emerging Market Sovereigns returns. Negative returns in US equities after such periods have occurred only in three out of nine occasions in the past six decades, all during economic crises. Equities While the strength of the financial market snapback in early 2019 is unlikely to be sustained, bearish investor, sentiment and positioning Developed Equities suggest greater room for positive surprises in the coming year than at this time last year. US → The still-modest scope of our equity overweight reflects our view that US Large Cap → while the economic expansion remains intact, global economic growth is unlikely to accelerate significantly, and asset prices are not deeply US SMID Cap depressed overall. The market correction of 2018 was not in any way indicative of a new economic recovery cycle. Non-US ← After a year of widespread fears of trade disruption and a weakening Europe ← global economy, the twelve-month trailing return on emerging Asian equities stands at -16%. Ongoing trade disputes between the US, Asia ex-Japan → China, and others remain a significant risk. However, we see the valuation decline as an opportunity to invest in this dynamic region Japan where global investors are generally very underexposed. We expect Chinese policy stimulus to offset trade disruptions in time. Meanwhile, Emerging Market Equity → the US Federal Reserve’s newfound caution with policy tightening should help most global markets, emerging markets in particular. However, the Fed may eventually resume modest additional monetary policy tightening if trade disputes are resolved and US growth proves Cash ← enduring (our base case). Commodities On a net basis, we increased our overweight in emerging Asia by nearly one percentage point across six countries. We expect to continue building this allocation over time. Allocations as of January 31, 2019 Meanwhile, European growth has slowed partly on external risks -2 = very underweight; -1 = underweight; 0 = neutral including China’s slowdown and to some extent, Brexit uncertainty. We 1 = overweight; 2 = very overweight expect the sluggish Eurozone economic recovery to persist. Certain Arrows indicate changes from previous GIC meeting securities and industry sectors offer attractive valuation and income. However, both the pace of regional growth and political instabilities at a time of peak European monetary stimulus drove our shift in allocation in favor of Asia. Overweights were retained in Germany and Switzerland. We reduced overweights to select European markets that are less sensitive to any improvements on the trade front. The GIC also closed a small underweight position in US equities held over the course of 4Q 2018, returning to neutral. We continue to favor larger- cap securities with stronger balance sheets. The GIC added further to our overweight position in short- and intermediate-term investment grade US fixed income. This already represents our largest single overweight allocation across all global asset classes. This includes consumer asset backed securities. Within our fixed-income allocation, this generally improved bond quality and diversification from corporate sector risks. Similarly, after a very strong rebound, we shifted our small overweight position in US high yield to add further to our emerging markets fixed-income overweight. After nine Federal Reserve interest rate hikes, short-term US yields significantly exceed long-term sovereign bond yields in other developed markets, where we remain underweight. Meanwhile, the extra return on certain short-term US investment grade instruments exceeds cash yields by 100 basis points, creating a stable and positive real return opportunity. While we invest across the maturity spectrum and particularly in certain segments of fixed income where yield curves are steep, long-term US Treasury yields offer little premium over short-term yields. We retain a neutral - or fully invested - allocation to long-term US Treasuries given their role in dampening portfolio volatility, but believe US recession fears are premature. In both fixed income and equities, we continue to favor higher quality income-generating assets even amid market recovery - see Outlook 2019 for more). Global Strategy: Quadrant February 1, 2019 2 More Early 2016 than Early 2018 Over the past year, investors “fell out of love with risk.” As our colleagues in Citi From “love” to “panic”, Research might put it, the “euphoria” investors felt at the start of 2018 has turned to emotional markets have “panic”. We see a limited opportunity in this after US and global equities fell about created some
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