Italian Banks: A Cause For Worry? What Investors …...middling US growth or a slight lift. The US...

September 2016

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MARKET PERSPECTIVES

Italian Banks: A Cause For Worry? What Investors Need to Know About the 2016 United States Presidential Election

Citigold Private Client September 2016

Perspectives

Paul Hodes Head of Traditional Managed

InvestmentsHead of Wealth Management

Asia PacificCitibank N.A.

Dear Clients,

In this month’s Perspectives, we focus on two events which Citi analysts believe can have important market implications for investors in the coming months.

In Europe, Italian bank losses threaten to derail the country’s reform agenda and potentially, longer term growth prospects. The banks’ bad loan b urden has weighed on the performance of Italian banking shares. The negative wealth effect and the heightened uncertainty surrounding the banking system are also starting to hurt consumer confidence and the economy. The Italian Prime Minister is facing a referendum on constitutional reform, likely in November. If voters express their dissatisfaction with Italy’s slow growth and banking weakness by rejecting the referendum, a period of heightened political uncertainty could lead to higher bond yields and credit downgrades in Italy.

As the Eurozone’s third largest economy, Italy’s problems matter. Citi analysts expect the Eurozone economy to moderate further in the second half of 2016. Despite cheap valuations, Citi has a neutral outlook on European banks with the sector expected to experience further earnings pressure going forward. However, selective opportunities can still be found.

In the US, investors are asking about the economic and market implications under a Clinton versus a Trump presidency. A Clinton win is likely to mean continued middling US growth or a slight lift. The US dollar is expected to remain range bound. This, together with a dovish Fed, is likely to remain supportive of emerging markets. A Trump win risks slower growth or recession if trade is restricted and fiscal expansion plans are curtailed. This can hurt earnings growth and the US equity market. An anti-trade policy will also be negative for the emerging markets.

I hope you find this report informative. Please contact your relationship manager for a more in-depth discussion on these and other events that can impact your portfolio.

Best regards,

Paul

MARKET PERSPEC TIVES

01

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.


Views

“…While the financial sectoraccounts for only 5.5% of

the Italian economy, thebanking sector can affect

the Italian economy throughseveral channels....”


02


Italian Banks – A Cause For Worry?

Italian bank troubles have weighed on Italian and European banking shares year to date (YTD). Since the UK referendum vote to exit Euro zone on June 23rd, European banking indices have declined 10% and are down 22% YTD end July. Italian banking shares have fared worse, declining 12% and 42% in the same period.

Italian banks are burdened with the highest bad loans in the Eurozone with Non Performing Loans (NPL) ratio at 11% of total loans (See chart). In late July, Prime Minister Renzi engineered a private sector rescue of Banca Monte dei Paschi di Siena, the country’s third largest bank which had been burdened with €50b of bad loans. The privately funded Atlante 2 raised €2.4b to invest in junior and mezzanine tranches of Italian banks’ NPLs. The fund aims to raise €2.5 -3bn by September 2016 and €3 -3.5bn by the deadline of July 2017. At that point, remaining resources from Atlante 1 (established earlier in April 2016 with €4.25bn capital, of which €1.7bn is still unused) can be transferred to Atlante 2. The fund is expected to be instrumental in helping to stabilize the Italian banking system by o�oading banks’ NPLs into vehicles and fostering liquidity in the Italian NPL market.

The private sector rescue was a political win for Renzi, as a state bailout would have imposed losses on thousands of junior bondholders and depositors of the troubled bank, as required under EU state aid rules.

While the financial sector accounts for only 5.5% of the Italian economy, the banking sector can affect the Italian economy through several channels:

� Tightening of credit standards � Negative wealth effects � Higher investor risk aversion towards bank bonds � Dampen consumer and domestic confidence (See chart)

Chart 1. Italy: Non Performing Loan Ratio Chart 2. Italy: Confidence and Stock Prices

Source: Citi Research. As of 6 July 2016. Source: Citi Research. As of 4 August 2016.


“…As the Eurozone’s 3rdlargest economy, Italy’s

problems should matter tothe Eurozone…”

“…. Europe has seen the strongest net equity

in�ows…..”


03


Banking sector weakness has already had an impact to the Italian economy with a 2Q16 slowdown in car registrations and retail spending. Overall growth was flat in 2Q16, below market expectations of a 0.2% gain. Citi analysts expect growth to stall in 2H16.

Weak economic growth will make it harder for lenders to reduce their non-performing loans. It may also make it tough for Italy to meet its fiscal commitments under EU rules. Similarly, it will be challenging for Atlante 2 to attract further capital under the rescue plan.

Importantly, there are concerns that Italy’s banking weakness and poor economic growth could derail the country’s reform agenda and ultimately, longer term growth prospects.

On the political front, Prime Minister Renzi is facing a referendum, likely in November 2016. If the referendum is passed, it will strip the Senate of most of its powers and drastically cut its numbers. This is key to Renzi’s broader reform program. While the referendum is focused on constitutional reforms in Italy, there is a risk that the voters will use the ballot box to express their dissatisfaction with Italy’s slow growth, weak economic prospects and banking woes. A rejection of the referendum may likely cause a surge in political uncertainty in Italy. This could in turn lead to higher bond yields, credit downgrades and a further slowing of the economy.

Impact On Eurozone Growth As the Eurozone’s 3rd largest economy, Italy’s problems should matter to the Eurozone. Italy’s weak 2Q16 performance contributed to the slowing growth in the region. The region grew only 0.3% qoq, even with Germany and Greece beating expectations.

Citi analysts see Eurozone growth moderating further in 2H16, but largely due to the impact of the UK referendum. While the knock-on effects on confidence and increased political uncertainty appear more contained than expected, the sharp slowdown in the UK economy could still impact the rest of Europe, especially for those countries most exposed to trade with the UK.

European Banks: A Value Trap? Despite relatively cheap valuations, Citi analysts are neutral on European bank shares. The sector is likely to experience further earnings pressure in a low/negative interest rate environment as well as heightened political uncertainty. Selective opportunities can be found in Belgium, Netherlands, Luxembourg, France, Switzerland and UK international banks.



04

All forecasts are expressions of opinion, are not a guarantee of future results, are subject to change without noti ce 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.

Banks Sector Earnings Revisions Most Negative Since GFC Recent European bank sector earnings revisions were already at the most negative levels seen since the Global Financial Crisis (GFC). This reflects the deflationary/negative interest rate policy macro-environment. EU banks now face further risk of earnings cuts in a post-Brexit scenario (See chart). The UK Domestic and Challenger Banks (Relatively small retail banks set up with the intention of competing for business with large, long-established national banks) are most exposed to increased UK economic and political risks in the near term. Political risks are also elevated in the periphery – especially in Spain and Italy. European investment banks could also be vulnerable in a prolonged period of heightened market uncertainty.

Chart 3. European Banks – Weekly Earnings Revisions Index (Dec-99 to July-16)

Source: Citi Research. As of 8 July 2016

Falling Rates May Weigh On Banking Sector Performance Over the past decade, European Banks’ relative stock performance vs the market has been highly correlated with 10-year bund yields (See chart). Citi Economists expect 10-year German government bond yields to decrease to -0.2% in 2Q17 from -0.1% currently. This suggests that European banking shares may see further weakness should interest rates continue to fall.

Chart 4. European Banks Sector Performance vs Interest Rates (10Yr)

Source: Citi Research. As of 8 July 2016

“…EU banks now facefurther risk of earnings cutsin a post-Brexit scenario…”



“…As for European financialbonds, Citi analysts

continue to see value in 5-year senior and 10-year

subordinated bankingsector bonds…”


05

European Financial bonds: Focus on Dutch, French And Swiss banks Citi continues to see value in European 5-year senior and 10-year subordinated banking sector bonds. We prefer Dutch, French and Swiss banks with strong balance sheets that are less exposed to the UK and with lower earnings risk.

� Dutch Banks: Potential for margin expansion and comfortable capitalization levels

� French banks: Improving deposit mix and pickup in depressed loan volumes may help mitigate margin pressure

� Swiss banks: Positive trends in wealth management likely to mitigate the impact of lower investment banking activity, thereby reducing earnings volatility

In contrast, German banks have weak capital levels and face regulatory uncertainty. UK exit implications may continue to weigh on UK-centric banks, particularly those with Scottish operations. Finally, we remain relatively cautious on Italian banks given capitalization needs.

Key Takeaways � There are concerns that Italy’s banking woes and poor economic growth can derail

the country’s reform agenda and ultimately, longer term growth prospects.

� As the Eurozone’s 3rd largest economy, Italy’s problems should matt er to the Eurozone. Citi analysts see Eurozone growth moderating further in 2H16, but largely due to the impact of the UK referendum.

� Despite relatively cheap valuations, Citi analysts are neutral on European banks. The sector is likely to experience further earnings pressure in a low/negative interest rate environment and heightened political uncertainty.

� As for European financial bonds, Citi analysts continue to see value in 5-year senior and 10-year subordinated banking sector bonds. We prefer Dutch, French and Swiss banks with strong balance sheets that are less exposed to the UK and with lower earnings risk.


What Investors Need to Know About the 2016 United States Presidential Election

The 58th United States (US) presidential election is scheduled for Tuesday, 8 November 2016.

Democratic Party nominee Hillary Clinton and Republican Party nominee Donald Trump have strong, yet opposing views on the direction of the US economy, and priorities in their social/political agenda.

The heightened risks stemming from the different views of these candidates have consequences for trade, fiscal spending, tax reforms, geopolitical/military alliances, Federal Reserve (Fed) policy and global financial markets.

In this article, we provide investors with a deeper understanding of the election by:

� Correcting common misperceptions about presidential politics

� Summarising the respective policy platforms of the two candidates

� Analysing potential impact of the election outcome on the economy

� Analysing implications for different asset classes

The US Presidential election: Myth versus reality Myth #1: US citizens elect their president directly

The election of the US President and Vice-President is an indirect election with a process in which voters do not directly choose who will sit in the Oval Office. US citizens vote in the general election to determine a set of members of the US Electoral College, known as electors. Each state gets a number of electors equal to its number of members in the U.S. House of Representatives plus one for each of its two U.S Senators. ‘Electoral College’ votes are allocated to the presidential candidate who receives the most votes in that State. A candidate must receive a minimum of 270 of the 538 electoral votes to win.

Myth #2: The US election is a US specific political event. It does not concern non-US citizens

It is often mentioned that ‘when the US sneezes, the rest of the world ca tches a cold’. The US presidential election has significant implications for the global economy and the world’s �nancial markets. The US accounts for 25% of the world economy and represents more than half of total global equity market capitalisation.


06

Insights



Chart 1. Global economy breakdown (% of global GDP)

Chart 2. Global equity market breakdown (% free market capitalisation)

Source: IMF. 2016 estimates as of 22 August 2016 Source: Citi Research, Bloomberg as of 22 August 2016

History indicates that global economic growth is highly correlated with the US long term business cycle. A downturn in the US may worsen existing weakness in emerging economies. The correlation between the US equity market and global financial markets is high given the global financial transmission channel. Movements in the US dollar as well as the timing and pace of the Fed’s interest rates normalisation are key drivers for commodity prices, currencies, bonds and equity markets.

Chart 3. US economy vs. Global economy Chart 4. US market vs. Global equities

Source: Bureau of Economic Analysis, International

Monetary Fund as of 21 August 2016 Source: Bloomberg as of 21 August 2016

Myth #3: The state of the economy determines the president

Democratic strategist James Carville’s famous informal slogan during Bill Clinton’s 1992 presidential campaign – “It's the economy, stupid” – reinforces that economic performance plays a pivotal role in US presidential elections.

History shows that a strong US economy with declining unemployment and inflation rates (described as a lower ‘ Misery Index’ ) tends to lead to a win for the incumbent party candidate. If the economy is ailing and the ‘ Misery Index’ rises, people tend to vote for the candidate from the opposition party (see Table 1).

The utility of previous presidential elections forecasting models appears less valid these days. The aggregate economic growth may no longer guarantee political stability with the rise in ‘ Vox Populi’ risk. This recent global political trend is based on economic populism and greater support for non-mainstream political alternatives.

-6

-4

-2

0

2

4

6

8

1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011

US GDP Growth yoy(%) Global GDP Growth yoy(%)

0

50

100

150

200

250

300

350

400

450

500

0

500

1000

1500

2000

2500

1995 1999 2003 2007 2011 2015

S&P500 MSCI World


07



‘Vox Populi’ refers to shifting and more volatile public opinion that poses risks to both the business and investment environment. Citi global political analysts believe that the new Vox Populi risk is being fuelled by growing perceptions of income inequality and anxiety about globalisation, particularly among the middle classes. Donald Trump becoming the Republican Party nominee, together with the popularity of Bernie Sanders – the Democratic Party rival to Hilary Clinton in the Democratic primaries – can be seen as an expression of Vox Populi to upend the political status quo.

Table 1. The state of the economy vs. election outcomes

Source: Bloomberg and Wikipedia as of 22 August 2016

Myth #4: The US President is all-powerful

Although the US President can have a major impact to both the US and the rest of the world, the ability of the new president to make drastic changes is comparatively limited. The US Federal government system is divided into three branches: the Executive, Legislative and Judicial. This system places checks and balances that limit ‘overreach ’ by any one branch. See Table 2.

Congressional and judicial limits are designed to moderate more extreme policy proposals, relative to what the individual candidates hope to achieve. The economic and market scenarios presented in this article represent more constrained scenarios, which Citi analysts believe are more likely to occur.

Table 2. The US federal government’ s checks and balances Action President Congress

Initiate new taxes � Cannot legislate � Sole providence of Congress

Appointments to high cabinet and policy making positions

� Propose � Approves or Disapproves

Foreign Policy � Responses to foreign events � Resolutions and policy statements

Exit Trade Agreements � Initiates � Approves or disapproves

Hike Trade Tariffs � Initiates but limited to WTO rules � Can over-turn tariff hike

War � Can wage war as Commander-in- Chief

� Power to declare and end war

Military action � Can order troops to fight when nation is under imminent threat of attacked

� Di�cult to overrule President’s call for military action

Source: Citi Research as of 19 August 2016

Misery Index Up or Down

Incombent Party Candidate

Opposition Party Candidate







1960Richard M. Nixon

(Republican) < John F. Kennedy(Democratic)

1964 UnchangedLyndon B. Johnson

(Democratic) > Barry M. Goldwater(Republican)

1976Gerald R. Ford(Republican) < Jimmy Carter

(Democratic)

1968Hubert H. Humphrey

(Democratic) < Richard M. Nixon(Republican)

1972Richard M. Nixon

(Republican) > George McGovern(Democratic)

1992George H. Bush

(Republican) < William J. Clinton (Democratic)

1980Jimmy Carter(Democratic) < Ronald Reagan

(Republican)1984

Ronald Reagan (Republican) > Walter F. Mondale

(Democratic)

2000Albert A. Gore(Democratic) < George W. Bush

(Republican)1988

George H. Bush(Republican) > Michael S. Dukakis

(Democratic)

2008John McCain(Republican) < Barack Obama

(Democratic) 1996

William J. Clinton (Democratic) > Robert J. Dole

(Republican)

2004George W. Bush

(Republican) > John F. Kerry(Democratic)

Misery Index (Unemployment+Inflation)

Up in the the Last Year of TermOpposition Wins


Down in the the Last Year of TermIncumbent Wins Exceptions


Down in the the Last Year of Term


08



Clinton versus Trump: Di�erent policy platforms The two candidates have opposite approaches to almost all areas that drive the global economy and asset prices. These include trade, fiscal spending, tax reforms and the Federal Reserve policy. With the policy distance between the two candidates arguably the widest of any two presidential candidates in decades, Citi believes that markets could be in for a bumpy ride leading up to the November 2016 election. It is important for investors to understand the main characteristics of the two candidates and their approaches to major policies (see Table 3).

Clinton, the ‘Internationalist’ candidate

� Clinton’s economic policies focus on increasing spending to support US consumers and job creation, financed by higher taxes on wealthier households and businesses.

� She views higher wages for the struggling lower and middle class, family leave benefits and further immigration liberalisation as vital to expanding and strengthening the US labour force.

� Clinton is in favour of increasing regulatory oversight and accountability of large banks.

� She advocates revisions to existing and prospective trade agreements (though less than Trump) to ensure ‘fair’ trade.

Trump and his ‘“America First” campaign

� Trump’s stated economic policies centre on tax cuts for households and �rms, expanded infrastructure spending and unspecified offsets in other public spending.

� He advocates reduced regulation but more Congressional accountability and oversight of the Fed.

� Trump wants to further restrict immigration and deport undocumented persons which he believes will boost the labour market.

� He wants to aggressively renegotiate many existing trade agreements and in particular challenge China on trade as well as currency policies.

Table 3. Who are Hillary Clinton and Donald Trump Clinton: Establishment candidate Trump: Anti-establishment candidate � Democrat � Republican � Liberal Leaning � Conservative leaning � Monikers: stability, order, status quo � Monikers: change, upend status quo � Pragmatist � Idealist � Internationalist (strengthen alliances) � Nationalist (“Ameri ca First”) � Foreign policy: Interventionist � Foreign policy: Isolationist � Extensive political career � No political experience � Pro-globalisation and ‘fair’ trade deals � Critical of globalisation and trade deals � Pro-US labour (exp. manufacturers) � Friend of “the working man” � Pro-financial sector regulation (Dodd-Frank) � Pro-business (anti-Dodd-Frank regulation) � Pro-‘Obamacare’ (greater access to public healthcare) � Anti-‘Obamacare’ (prefers greater State and Private

control over health care) � Pro-social security (public retirement benefits for all) � Pro-social security but displays openness to some

modest changes � Pro-Immigration expansion � Anti-Immigration expansion

Source: Clinton and Trump election platforms, and Citi Research as of 29 July 2016

“…With the policy distance arguably the widest of any

two presidential candidatesin decades, markets could

be in for a bumpy ride...”


09



Who will be the next US president? The post-convention national polling and Electoral College projections from leading US pollsters underline strengthening support for Clinton: approximately 7 points in national polls and with Electoral College projections of 347/538 compared to Trump's 191/538. See Chart 5.

While the current polls are pointing to Hillary Clinton as the next US president, the recent Brexit result reminds investors to be prepared for unexpected outcomes.

Chart 5. Clinton leads in the polls with a post-convention bounce

Source: Citi Research; RealClearPolitics as of 15 August 2016

Growth implications Markets participants appear to believe that Hillary Clinton is more mainstream of the two candidates and likely to maintain policy continuity. Nonetheless, there are uncertain transition costs and policy issues for each candidate as well as a new Congress. A Trump victory is likely to result in greater uncertainty. With the Republicans also likely to have control of Congress, this potentially allows for ambitious legislative changes.

Economics: The effects of the election on the US economy will depend on the path of US policies as well as on who is the next president. The most important policy issues are likely to be proposals relating to business taxation and spending on infrastructure. Both candidates claim to offer economically stimulative policies including infrastructure spending and tax cuts although their approaches are quite different. Both have promised a tougher stance on trade (although Clinton has given mixed signals about trade compared with Trump who clearly wants to renegotiate trade deals broadly).

“…Current polls arepointing to Hillary Clinton as

the next US president...”


10



� Clinton: Under a Clinton administration, Citi analysts do not expect much change in current US policies that will drastically impact US and global growth. Citi analysts expect a modest rebound in US and global growth after the election, as uncertainty recedes. Citi analysts expect global growth of 2.5% (annualised, at market exchange rates) in the second half of 2017 (2H17), following a 2.3% expansion in the first half.

� Trump: Trump’s proposals could be stimulative for the economy in the near term as he may cut taxes and spend aggressively on infrastructure. However, there are major downside risks for US and global growth in the medium term if a Trump victory is followed by a major rise in (US-led) protectionism. In Citi’s view, the risk under a Trump administration would be a US recession.

Table 4. The 2016 US elections: Economic impact Trump wins Clinton wins

US GDP growth -

May rise in the short term due to stimulus measures but slowdown in the medium term given increased uncertainty and trade disruptions.

+

Continue to expand at moderate pace. Materially faster growth is an upside risk if Clinton is able to execute her stimulative agenda.

Trade - Moderate trade-related friction and damage to global trade +/- TPP fails to be implemented. Little/no change to

existing trade deals.

Inflation + Firmer given slightly higher import prices + Muted increase

Consumption - Hurt by higher prices and reduced confidence -

Higher precautionary savings due to aging population. Multiplier effect of stimulus reduced as economy already close to full employment.

Business Investment - Uncertainty may likely dampen investment

and hiring - Higher corporate taxes may dampen investment.

Labour Market +/-

Stay close to full-employment range. Increased nationalism vs lobbying from industries that currently benefit from cheaper immigrant labour.

+/-

Congress support needed to open the doors to more legal immigration. New policies (expanded paid family leave and childcare support) likely to require lengthy negotiations.

Wages + Upward pressures to build on the back of current momentum; close to full employment +

Federal minimum wage increases may be implemented but smaller in magnitude and over an extended period

Source: Citi Research as of 19 August 2016

Market implications If Clinton wins, the market e�ect is likely to be muted in Citi’s view as it is currently the most expected outcome.

US Dollar (USD): With a Clinton win, the USD is likely to trade sideways or lower. A Trump victory could be positive for the USD over the short to medium term.

� Clinton: Long-term dollar appreciation cycles tend to end after 5-6 years. This suggests that the broad dollar index has likely peaked at the end of last year and is turning lower. Under a Clinton win, we expect this trend to continue and the US dollar to trade sideways or lower.

� Trump: Trump’s more expansionary �scal plans may likely send in flation higher and accelerate the Fed’s interest rate normalization. This could potentially lead to higher bond yields and a stronger dollar. In fact, Trump has criticised the Fed for an overly accommodative monetary policy and for considering global factors when setting rates. He might appoint more hawkish members to the FOMC in 2018.

“…Under a Clintonadministration, Citi analystsdo not expect much change

in current US policies...”

“…If Clinton wins, themarket effect is likely to bemuted as it is currently the

most expected outcome....”


11



Interest rates: A Clinton win could imply a continuation of low interest rates. A Trump presidency may result in higher inflation and possibly a steeper yield curve.

� Clinton: A Clinton presidency would imply marginally higher inflation and a continuation of the status quo with low rates.

� Trump: A Trump presidency could imply higher inflation and possibly a steeper yield curve. Trump may slash taxes which have Treasury market implications as budget deficits widen. Moreover, greater globalisation, immigration and central bank independence have helped keep inflation in check over the past few decades. If these trends are at risk of reversing, it could likely raise inflation risk and steepen the yield curve.

US Equities: Historically, the economy and the health of the corporate sector have been much bigger drivers of S&P 500 returns than politics. Since the stock market tends to reflect earnings patterns, policy differences may impact more on the sectorial level rather than the broad index. For example, a Trump win may lead to pressure on Health Care stocks while Financials may do better with potentially higher interest rates. Sector investments, rather than directional strategies, may be a better investment strategy in Citi’s view.

� Clinton: US equities may experience a relief rally if Clinton wins, but the upside may be limited in the medium term.

� Trump: The market is likely to experience significant volatility if Trump wins. Citi analysts expect that a Trump victory could spark a 3-5% setback in the S&P 500 potentially. Trade restrictions could impact growth and thus earnings but less than in previous recessions. The correction could deepen if fears on global trade begin to emerge given Trump’s threats of tari�s and rhetoric about the World Trade Organisation (WTO) and China. We believe the US government’s checks and balances may mitigate such risks.

Credit: Under a Clinton Presidency, slight spread tightening is likely and credit continues to offer decent volatility adjusted returns. A Trump win, however, may be negative for credit. Fiscal expansion may boost the economy however higher Treasury yields may lower total returns to credit. If Trump’s trade policies push the economy into recession, Treasury yields may fall but spreads would widen sharply.

Commodities (Energy): While who wins the Presidency matters, existing low prices have made the energy agenda a reduced priority for voters. A Clinton administration should continue policies established during the Obama administration and a Trump administration could reverse a number of executive actions, potentially changing the domestic energy landscape. Nevertheless, the Constitutional separation of powers could moderate major policy changes.

Commodities (Precious Metals): Gold is likely to range trade with a Clinton win. Citi analysts’ current 2017 year -end forecast for gold stands at US$1250/oz. The increased uncertainty resulting from a Trump presidency could cause gold prices to reach US$1400/oz.


12



Emerging Markets: There is limited upside for Emerging Markets (EMs) from a Clinton victory while a Trump win would lead to a negative macro environment for EM assets. It is difficult to see many EM countries benefitting from a Trump presidency, with Russia the possible exception. With US sanctions on Russia up for review in March 2017, Russian assets may benefit if sanctions are lifted.

� Clinton: A Clinton victory is largely seen as continuation of the status quo with a range-bound US dollar and a dovish Fed. The probable hike by the Fed at the December FOMC meeting may offer a relief rally in EM assets but overall, the potential move should be modest in our view.

� Trump: In a Trump victory, the combination of weaker US equities, a stronger US dollar and higher long term rates could likely lead to weaker EM currencies, credit and equities.

� In terms of trade pressures, Mexico may be most exposed and the Mexican Peso (MXN) is likely to experience significant downside.

� EM equities are vulnerable as many EM economies are highly dependent on world trade. Any protectionist policy emanating from the US can affect large Asian exporters including China, South Korea and Taiwan.

� The impact on EM rates might be more contained, but is also likely to be negative. If US Treasury yields were to rise, EM rates would also be dragged higher.

Table 5. The 2016 US elections: Market implications Trump wins Clinton wins

USD ++ Strong USD. Encourage repatriation of overseas profits. Inflows may be larger than during the 2004 Homeland Investment Act.

+ Modest USD strength.

US Equities -

Negatives from stronger USD, greater uncertainty and higher risk aversion. Defence and Infrastructure sectors likely to benefit from increased spending. Healthcare may suffer +/-

Financial markets likely to respond more favourably given greater certainty and more moderate views. But exuberance may be short lived depending on outlook on taxes and prospects of additional restrictions on the financial services industry. Defence and Infrastructure sectors likely to benefit from increased spending. Healthcare may suffer

Rates - Fed may hike rates if growth rises in the short term. However, expect sustained or lower rates given slower growth eventually.

+ Status quo. Fed likely to continue gradual unwind of loose monetary policy.

Credit spreads - Greater uncertainty, slower growth + Greater certainty, firmer growth

Commodities -

Hurt by strong USD and potentially unfriendly EM policies. Gold could be an exception and benefit from increased uncertainty

+

Relatively dovish Fed, modest USD strength and gradual improvement in EM fundamentals

EM growth, assets and currencies

-

Hurt by strong USD, higher bond yields, rising protectionist measures and risk aversion. Mexico and China are likely to be most affected on the trade front. Russian assets and RUB may benefit if US sanctions are lifted (March 2017 review).

+

Relatively dovish Fed, modest USD strength and gradual improvement in EM fundamentals

Source: Citi Research as of August 2016


13

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, marke t and other factors. Likewise, past performance is no guarantee of future results.


Stay diversi�ed The economy and business cycle are the main drivers of market returns over the longer term, however headline events including geopolitical shocks, the UK Referendum on EU membership and the forthcoming US Presidential Election can also have considerable and enduring effects if they cause risk premia to be re-priced or influence underlying trends. While unexpected events can cause strong short-term moves in markets, policy responses can moderate their impact and allow core themes to re-assert themselves.

Both betting markets and polls are pointing to a Clinton win, but they have recently had a mixed track record in predicting political outcomes. Investors also currently appear to be assigning a low probability to a Trump victory. If the likelihood of a Trump presidency increases, markets may experience heightened volatility as they reprice. Given expensive equity and bond markets, the current environment offers a narrower choice of investments that could potentially outperform in the coming months.

To position for heightened market volatility, investors with concentrated equity positions may want to become more diversified. Citi analysts favour higher quality bonds as well as emerging market assets.

Investors need to be aware of the elevated volatility that Emerging Market equities and bond may experience in a Trump win scenario. In that scenario, the USD and gold are likely to outperform.

“…To position for volatility,investors with concentrated

equity positions may wantto become more diversified.

We favour higher qualitybonds as well as Emerging

Market assets....”


14



Table 6. Clinton versus Trump on domestic policies

Source: Citi Research as of 29 July 2016


15

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 var iety of economic, market and other factors. Likewise, past performance is no guarantee of future results.



16


Table 7. Clinton versus Trump on foreign policy

Source: Citi Research as of 29 July 2016


World Markets At a Glance

Source: Bloomberg as of 24 August 2016

Last price 52-Week 52-Week

24-Aug-16 High Low 1 week 1 month 1 year Year-to-date

US / Global

Dow Jones Industrial Average 18481.48 18668.44 15450.56 -0.50% -0.48% 16.45% 6.06%

S&P 500 2175.44 2193.81 1810.10 -0.31% 0.02% 14.91% 6.43%

NASDAQ 5217.70 5275.74 4209.76 -0.21% 2.30% 15.28% 4.20%

Europe

MSCI Europe 403.77 437.44 353.59 0.87% 3.55% -1.90% -1.75%

Stoxx Europe 600 344.93 387.43 302.59 1.31% 1.35% 0.85% -5.71%

FTSE100 6835.78 6955.34 5499.51 -0.34% 1.56% 15.88% 9.51%

CAC40 4435.47 5011.65 3892.46 0.40% 1.24% 1.19% -4.35%

DAX 10622.97 11430.87 8699.29 0.81% 4.69% 10.10% -1.12%

Japan

NIKKEI225 16597.30 20012.40 14864.01 -0.89% -0.18% -10.48% -12.80%

Topix 1306.71 1609.76 1192.80 -0.34% -1.57% -11.76% -15.55%

Emerging Markets

MSCI Emerging Market 896.75 919.43 686.74 -1.42% 3.16% 16.19% 12.92%

MSCI Latin America 2420.56 2540.39 1550.47 -2.95% 1.19% 23.70% 32.28%

MSCI Emerging Europe 127.73 133.76 91.09 -1.46% 1.92% 12.01% 15.75%

Brazil Bovespa 57717.88 59417.88 37046.07 -2.71% 1.26% 30.18% 33.14%

Russia RTS 958.04 987.07 607.14 -0.76% 2.36% 32.19% 26.55%

Asia

MSCI Asia ex-Japan 541.82 551.47 434.84 -0.71% 3.08% 15.73% 8.38%

Australia S&P/ASX 200 5561.67 5611.20 4706.70 0.48% 1.15% 11.21% 5.02%

China HSCEI (H-shares) 9507.09 10884.88 7498.81 -1.40% 5.26% -0.99% -1.59%

China Shanghai Composite 3085.88 3684.57 2638.30 -0.76% 2.43% -3.86% -12.81%

Hong Kong Hang Seng 22820.78 23423.64 18278.80 0.09% 3.90% 7.38% 4.14%

India Sensex30 28059.94 28289.96 22494.61 0.19% 0.92% 9.01% 7.44%

Indonesia JCI 5403.99 5476.22 4033.59 0.60% 3.98% 29.79% 17.66%

Malaysia KLCI 1682.06 1729.13 1503.68 -0.72% 1.49% 9.79% -0.62%

Korea KOSPI 2043.76 2064.72 1806.79 0.00% 1.66% 11.69% 4.20%

Philippines PSE 7866.13 8118.44 6084.28 -1.01% -1.98% 15.83% 13.15%

Singapore STI 2869.57 3104.72 2528.44 0.92% -2.57% 0.92% -0.46%

Taiwan TAIEX 9017.38 9200.42 7368.47 -1.10% 0.05% 21.69% 8.15%

Thailand SET 1547.55 1558.32 1220.96 1.04% 2.55% 18.95% 20.15%

Commodity

Oil 46.77 51.67 26.05 -0.04% 5.84% 22.31% 26.27%

Gold spot 1324.15 1375.45 1046.43 -1.82% 0.13% 14.64% 24.75%

Historical Returns (%)


17


Currencies Forecasts


Source: Citi Research, Bloomberg as of 24 August 2016; Forecasts as of 19 August 2016

Last price

Currency 24-Aug-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18

G10-US Dollar

Euro EURUSD 1.13 1.14 1.15 1.16 1.16 1.17 1.17 1.17

Japanese yen USDJPY 100 100 99 98 98 97 97 96

British Pound GBPUSD 1.32 1.30 1.30 1.29 1.29 1.30 1.30 1.30

Swiss Franc USDCHF 0.97 0.96 0.95 0.95 0.95 0.94 0.94 0.94

Australian Dollar AUDUSD 0.76 0.77 0.77 0.78 0.78 0.78 0.78 0.79

New Zealand NZDUSD 0.73 0.71 0.71 0.70 0.70 0.70 0.70 0.69

Canadian Dollar USDCAD 1.29 1.29 1.28 1.27 1.25 1.24 1.23 1.22

EM Asia

Chinese Renminbi USDCNY 6.66 6.73 6.76 6.79 6.82 6.86 6.90 6.94

Hong Kong USDHKD 7.75 7.76 7.77 7.78 7.78 7.78 7.78 7.79

Indonesian Rupiah USDIDR 13,248 13,023 13,213 13,399 13,509 13,529 13,549 13,569

Indian Rupee USDINR 67.10 67.5 67.7 67.9 68.2 68.6 69.0 69.4

Korean Won USDKRW 1,122 1,109 1,097 1,086 1,082 1,086 1,090 1,094

Malaysian Ringgit USDMYR 4.04 4.09 4.05 4.00 3.96 3.93 3.89 3.86

Philippine Peso USDPHP 46.54 46.5 46.3 46.2 46.2 46.5 46.8 47.1

Singapore Dollar USDSGD 1.35 1.38 1.37 1.36 1.36 1.37 1.38 1.39

Thai Baht USDTHB 34.62 34.9 34.7 34.6 34.5 34.6 34.7 34.8

Taiwan Dollar USDTWD 31.76 31.7 31.8 31.9 32.1 32.3 32.5 32.7

EM Europe

Czech Koruna USDCZK 23.99 23.67 23.51 23.36 23.16 22.91 22.66 22.41

Hungarian Forint USDHUF 274.80 273 272 272 272 273 273 274

Polish Zloty USDPLN 3.83 3.81 3.73 3.66 3.61 3.60 3.59 3.58

Israeli Shekel USDILS 3.77 3.81 3.79 3.77 3.78 3.83 3.88 3.93

Russian Ruble USDRUB 65.17 62.7 62.6 62.6 62.4 62.1 61.8 61.5

Turkish Lira USDTRY 2.95 2.99 3.03 3.08 3.11 3.14 3.17 3.20

South African Rand USDZAR 14.16 13.49 13.39 13.30 13.41 13.76 14.12 14.46

EM Latam

Brazilian Real USDBRL 3.23 3.11 3.23 3.34 3.42 3.46 3.50 3.54

Chilean Peso USDCLP 670.15 669.00 664 660 659 664 668 673

Mexican Peso USDMXN 18.46 18.5 18.3 18.1 18.0 18.1 18.2 18.3

Colombian Peso USDCOP 2943.00 2965 2923 2882 2850 2828 2806 2784

Forecasts


18


Singapore

: This report is distributed in Singapore by Citibank Singapore Limited (“CSL”). Investment products are not insured under the provisions of the Deposit Insurance and Policy Owners’ Protection Schemes Act 2011 of Singapore and are not elig ible for deposit insurance coverage under the Deposit Insurance Scheme.

Disclaimer



19


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