Perspectives Q1 2019

ISSUE 11 PERSPECTIVES Q1 2019

VIEWS INSIGHT 1Q19: Building Resilient The Evolving Face of Portfolios for Volatile Asia Times QUARTERLY PERSPECTIVES

Perspectives

Dear Clients,

Global equities rebounded by 11.4% YTD as of 26 February 2019 after falling 13.3% in 4Q18. The S&P 500’s close at 2,793 on 26 February 2019 also represents a rebound of 19% from its low made on 24 December 2018, a sharp recovery achieved in less than 2 months.

Q4 2018 was a difficult quarter for equities, impacted by investors’ concerns on the US/China trade conflict, global political volatility and questions whether the global economic growth could continue in 2019.

Paul Hodes Citi analysts expect that both the economic expansion as well as the equity bull market have further to run albeit with higher Head of Wealth Management volatility. Citi remains overweight equities while underweight Asia Pacific and EMEA bonds. A more dovish US Federal Reserve, progress between Citibank N.A. the US and China on trade and Chinese policy stimulus could help in rebuilding further investor confidence.

Asia’s emerging economies continue to challenge the dominance of the US and Europe, as Asian middle class is projected to expand 84% by 2030, the population migrates into cities, and advances in its home-grown technology.

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.

Best regards,

Paul

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All forecasts are expressions of opinion, are not a guarantee of future results, are subject to change without notice and may not meet our expectations due to a variety of economic, market and other factors. Likewise, past performance is no guarantee of future results. QUARTERLY PERSPECTIVES

Views Emerging Markets (EM): Asia is preferred Building Resilient Portfolios for In 2019, Citi analysts expect the sharp EM Volatile Times equity underperformance in 2018 to reverse. Underpinning the view is the likelihood of Global equities rebounded by 11.4% YTD as ongoing Asian growth accompanied by of 26 February 2019 after falling 13.3% in contained inflation with moderating US 4Q18. The S&P 500’s close at 2,793 on 26 growth limiting the extent of both US rate February 2019 also represents a rebound of rises and dollar strength. A significant easing 19% from its low made on 24 December in China is likely to offset the drag from trade 2018, a sharp recovery achieved in less than tensions. 2 months. Chart 1: A-Share valuations at 2014 levels Q4 2018 was a difficult quarter for equities, impacted by investors’ concerns on the US/China trade conflict, global political volatility and questions whether the global economic growth could continue in 2019.

The global economy is still anticipated to grow at a healthy pace of 2.9% in 2019, with global Source: Citi Private Bank. As of December 2018. inflation likely to remain subdued at 2.3% in 2019. A more dovish Fed, progress between In China – one of Citi’s favored markets – the US and China on trade and Chinese valuations have fallen to 2014 levels (see policy stimulus would help towards rebuilding chart 1). Since 2014, China has opened its investor sentiment. Citi analysts expect that mainland markets to greater international both the economic expansion as well as the participation, Chinese assets have been equity bull market have further to run albeit included in broad benchmark indices, and with higher volatility. Citi remains overweight implemented important supply side reforms. equities while underweight bonds. Citi analysts expect 2019 to be another Within equities, Citi prefers Emerging Markets milestone of A-share globalization, with (EM), and particularly Asia. Despite Citi’s significant acceleration in global index preference for equities, there are still inclusion. Citi expects both MSCI and FTSE opportunities within US Investment Grade to include A-shares at a substantially faster bonds and Emerging Markets bonds. pace, which could bring up to US$100bn foreign inflows in the onshore equity market.

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Europe: Selective opportunities US: Tax cuts impact could fade

European growth has slowed partly on Historically since 1950, post-midterm external risks including China’s slowdown election years like 2019 have been positive and to some extent, Brexit uncertainty. Citi for US equities, rising by an average of analysts expect the sluggish Eurozone 16.8%. Citi’s expectations for 2019 are more economic recovery to persist with 1.2% modest given US equity markets have more expected 2019 GDP growth. than doubled to highs since 2013 and valuations appear rich. On a cyclically-adjusted price to earnings basis (CAPE) of 19.3, Europe ex-UK US equities trade on forward price/earnings equities are trading at a 25% discount and cyclically adjusted price/earnings ratios relative to US equities, at 28. That compares of 15.6 and 30.1, above their respective to a historic average discount of 12%. long-term averages of 15.9 and 17.8.

Within the region, Citi analysts are selective Chart 3: US earnings growth already revised lower and favour German and Swiss equities, with preferences in Technology and Healthcare sectors.

Chart 2: Europe vs US cyclically adjusted P/E

Source: Citi Private Bank. As of 18 December 2018.

Citi analysts believe S&P 500 earnings are likely to grow 8% in 2019, after an estimated

Source: Citi Private Bank. As of 18 December 2018. 23% rise in 2018. The deceleration results from 2018’s corporate tax cut boost not Citi analysts are neutral on UK large-cap being repeated in 2019. Higher interest rates equities as Brexit uncertainty remains a and the US dollar’s strength in 2018 provide headwind and may increase volatility, other headwinds. Given this backdrop, Citi adding further downside pressure. analysts remain neutral on US equities.

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Japan: Opportunities in technology Among Asian bonds, despite trade tensions with the US, China remains a Japanese valuations are low among high conviction market. Chinese policy developed markets impacted by easing measures designed to support conservative earnings expectations. With a liquidity targeted at private enterprise are lack of robust long-term growth prospects likely to help stabilize defaults in 2019. and the central bank’s diminishing asset Better quality US dollar denominated purchase program, Japanese equities are at Chinese Corporate Bonds are attractive, risk. especially given their cheaper valuations.

Japan’s technology and consumer sectors • Corporate Investment Grade (IG) – offer value as many leading companies are Favor US over Euro: In late December, drivers of disruptive technologies. US IG corporate spreads widened to their highest levels since June 2016. Markets have since adjusted as IG corporate Fixed Income: Seek shelter with income benchmark spreads have moved back in- line with their long-term average of Citi analysts expect tighter monetary policy 130bp. Index yields remain elevated at in developed markets to drive bond yields 4.1%, near their highest levels in eight gradually higher. As US interest rates rise, years. higher yields from Investment Grade Bonds and Emerging Market Debt provide investors • High Yield (HY) – Neutral: After strong with a buffer. performance of 4.7% in January, HY spreads have fallen back below historical Opportunities in Emerging Market bonds: averages and now look relatively In Citi’s view, the 2018 sell-off in EM bonds expensive. While further improvements in was overdone and has created opportunities equity markets can have a continued in Latin America and EM Asia in both local positive impact on HY returns, volatility is currency and hard currency. likely to remain elevated.

Higher relative yields of 6% and a better fundamental backdrop in EM economies continue to be supportive for EM bonds. Nevertheless, Citi analysts expect continued elevated levels of volatility.

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Maintaining overweight in Equities and underweight in Fixed Income

While the strength of the financial market rebound in early 2019 is unlikely to be sustained, diminished investor sentiment suggests greater room for positive surprises in the coming year than at this time last year

Citi’s modest equity overweight reflects the view that while the economic expansion remains intact, global economic growth is unlikely to accelerate significantly, and asset prices are not deeply depressed overall.

Asset Class WEIGHT

NEUTRAL OVERWEIGHT Fixed Income Equity

UNDERWEIGHT NEUTRAL Global Investment Grade US

UNDERWEIGHT NEUTRAL • Global Sovereign Europe

OVERWEIGHT NEUTRAL • Corporate Investment Grade Japan

NEUTRAL OVERWEIGHT Global High-Yield Asia ex Japan

OVERWEIGHT NEUTRAL APAC ex Japan / EM Emerging ex Asia

UNDERWEIGHT • Emerging EMEA

OVERWEIGHT • Emerging Latin America

Key Takeaways

• The global economy is expected to grow 2.9% in 2019, with global inflation anticipated to remain subdued at 2.3% in 2019.

• Citi analysts forecast a late cycle bull market and remain overweight equities and underweight bonds. Within equities, Citi prefers Emerging Markets (EM), particularly Asia.

• Among bonds, Citi favors US Investment Grades and EM bonds as they provide a greater buffer compared to other lower yielding fixed income options.

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Insights

The Evolving Face of Asia With the largest population of any continent, the United Nations forecasts that the Asia’s population could swell from 4.5bn to 5.1bn In the midst of slow and steady global by 2040. Importantly, EM Asia’s middle class economic growth, Emerging Market (EM) looks to be on the verge of unprecedented Asian economies are ascending. growth.

EM Asia remains the only region to Currently 1.9bn people in the region are consistently grown its share of world output defined as middle class with households (quantity of goods or services produced) annual incomes of between US$14,600 and during the past four decades. In 1980, EM US$146,000. By 2030, the region’s middle Asia contributing less than a tenth of global class population is set to rise to 3.5bn. output, represents nearly one third today. This would represent nearly 90% of the Citi analysts believe this trend could growth among the world’s middle class (see continue. By 2023, EM Asia could account chart 2). for nearly 40% of world output (see chart 1).

Chart 1: EM Asia’s Rising Output Share

Source: Citi Private Bank. As of December 2018.

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EM Asia Urbanization EM Asia Innovation

With just under half of EM Asia’s inhabitants As the global digital revolution continues, currently urban dwellers, compared to more Citi analysts believe that parts of EM Asia’s than four-fifths of North Americans, Asia’s technology industry may have key urbanization is on the move. By 2030, five of advantages over rivals in the US and the six world cities with more than 20 million elsewhere. population are projected to be in EM Asia. By 2050, an additional 1.2bn people may By global standards, Chinese tech giants in live in cities across the region. particular are highly innovative and diverse. Heavy Chinese investment in artificial EM Asian urbanization could create intelligence, virtual reality, autonomous numerous economic benefits. The driving, and biotech is likely to create necessary upgrades to infrastructure – industry leading companies. China was the housing, utilities, and warehousing – to world’s largest buyer of industrial robots in accommodate the urban population could 2017, accounting for one in every three itself be an important driver of growth. installations.

The transition of people from rural areas to Citi analysts favour tech disruptors in China cities could also drive productivity increases and across EM Asia, where longer-term as well as real wage growth, boosting prospects are stronger than those in other consumer spending. Citi analysts believe regions. India and Indonesia could be key beneficiaries of urbanization.

Chart 2: EM Asia’s Rising Middle Class

Source: Citi Private Bank. As of December 2018.

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The combination of demographic change, China – the region’s largest exporter – has urbanization, and technological progress become less reliant on exports to grow e- could create opportunities for consumer commerce. Chinese exports as a businesses as Asia’s middle class consumer percentage of GDP have halved to 18% spending is likely to more than double from during the last decade. EM Asia’s exports to US$12 trillion by 2030. the US are 15% of GDP today, down from 22% of GDP in 1999. Chinese trade within Likely beneficiaries of rising regional Asia, by contrast, has expanded to 32% of incomes include the makers of branded GDP (see chart 3). goods, personal electronics, alcoholic beverages, sportswear, cosmetics, EM Asia Underrepresented in homewares, and automobiles. Demand for Benchmarks healthcare treatment and for financial products – including insurance and pensions EM Asia assets are currently – are also projected to rise. underrepresented in global benchmarks. While 24% of equities and 16% of fixed EM Asia Underappreciated Development income globally were issued in the region, they represent only 11% and 5% of global Investor concerns have been focused on the benchmarks. Citi analysts expect EM Asian effects of rising trade tensions between the assets to be given greater weightings within US and China. EM Asia has been a such benchmarks (see chart 4). beneficiary of freer global trade over the last few decades with a falling dependency on export driven growth.

Chart 3: EM Asian Intra-Regional Trade

Source: Citi Private Bank. As of December 2018.

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Conclusion Chart 4: Share of total % of index benchmark

The strength of the US dollar and concerns over trade caused EM Asian asset prices to struggle in 2018. Citi analysts believe that this may have created an attractive entry- point for positioning portfolios to benefit from ongoing Asian development.

While EM Asian investments have a higher risk profile than Developed Markets (DM), adding them to a diversified portfolio could help enhance risk-adjusted returns.

Source: Citi Private Bank. As of December 2018.

Key Takeaways

• The powerful economic transformation of EM Asian economies is not over and many investors remain underexposed to the region’s attractive growth potential.

• As the global digital revolution continues, Citi analysts believe that the EM Asia’s technology industry may have key advantages over rivals in the US and elsewhere, and thus potentially offer attractive opportunities. Citi analysts favour tech disruptors in China.

• The combination of demographic change, urbanization, and technological progress could create opportunities for a wide variety of businesses. Likely beneficiaries of rising incomes include branded goods, personal electronics, alcoholic beverages, sportswear, cosmetics, homewares, and automobiles. Demand for healthcare treatment and for financial products – such as insurance and pensions – could likely grow.

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World Market at a Glance

Last price 52-Week 52-Week Historical Returns (%) 27-Feb-19 High Low 1 week 1 month 1 year Year-to-date US / Global Dow Jones Industrial Average 25985.16 26951.81 21712.53 0.12% 5.04% 2.26% 11.39% S&P 500 2792.38 2940.91 2346.58 0.28% 4.79% 1.75% 11.39% NASDAQ 7554.51 8133.30 6190.17 0.87% 5.44% 3.06% 13.85% Europe MSCI Europe 443.02 493.46 390.84 0.53% 3.92% -9.47% 9.69% Stoxx Europe 600 372.58 397.86 327.34 0.30% 4.12% -2.56% 10.35% FTSE100 7107.20 7903.50 6536.53 -1.68% 4.38% -2.41% 5.63% CAC40 5225.35 5657.44 4555.99 0.57% 6.08% -2.22% 10.46% DAX 11487.33 13204.31 10279.20 0.75% 1.82% -8.03% 8.79% Japan NIKKEI225 21556.51 24448.07 18948.58 0.58% 3.77% -3.72% 7.70% Topix 1620.42 1838.30 1408.89 0.43% 3.47% -9.49% 8.46% Emerging Markets MSCI Emerging Market 1061.26 1228.48 929.90 1.14% 2.80% -12.46% 9.89% MSCI Latin America 2875.78 3156.32 2366.54 -0.24% -0.09% -7.95% 12.08% MSCI Emerging Europe 165.03 182.60 147.18 -0.16% -0.59% -9.93% 8.48% MSCI EM Middle East & Africa 258.28 312.24 229.47 0.64% -1.11% -17.73% 7.42% Brazil Bovespa 97307.31 98588.63 69068.77 0.79% -0.38% 11.93% 10.72% Russia RTS 1191.01 1308.81 1033.31 -0.28% -0.08% -9.14% 11.44% Asia MSCI Asia ex-Japan 658.53 749.36 568.61 1.34% 4.35% -10.63% 10.38% Australia S&P/ASX 200 6150.27 6373.50 5410.20 0.88% 4.14% 1.54% 8.92% China HSCEI (H-shares) 11457.27 12850.26 9761.60 2.03% 5.37% -9.40% 13.16% China Shanghai Composite 2953.82 3333.88 2440.91 6.98% 13.53% -10.27% 18.44% Hong Kong Hang Seng 28757.44 31978.14 24540.63 0.85% 4.31% -8.03% 11.27% India Sensex30 35905.43 38989.65 32483.84 0.42% -0.33% 4.54% -0.45% Indonesia JCI 6525.68 6630.13 5557.56 0.20% 0.66% -1.11% 5.35% Malaysia KLCI 1713.45 1896.03 1626.93 -0.74% 0.73% -8.44% 1.35% Korea KOSPI 2234.79 2516.57 1984.53 0.23% 2.62% -9.01% 9.49% Philippines PSE 7889.12 8575.44 6790.58 -0.63% -2.04% -8.18% 5.67% Singapore STI 3250.02 3641.65 2955.68 -0.87% 1.49% -8.20% 5.91% Taiwan TAIEX 10389.17 11261.68 9319.28 1.14% 4.21% -3.94% 6.80% Thailand SET 1665.27 1840.06 1546.62 1.21% 2.57% -9.02% 6.48% Commodity Oil 56.94 76.90 42.36 0.04% 6.05% -9.63% 25.39% Gold spot 1319.85 1365.40 1160.27 -1.39% 1.28% 0.12% 2.92%

Source: Bloomberg, as of 27 February 2019.

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