Q4 | 10 Europe | North America | Japan | Asia Pacifc | Latin America Global market analysis from the Global Consumer Group GCG Outlook ........................................ 2 Regional Analyses ............................. 3 Guest Corner ....................................... 9 Asset Allocations ............................... 10 Opinions, forecasts, and weightings expressed by Citigroup Global Consumer Group Investments may not be attained or suitable for all investors. Past performance is no guarantee of future results. There are additional risks associated with international investments, including foreign, political, currency and economic factors to consider. Please contact your fnancial professional to determine what is suitable for your individual situation When bonds and equities decouple During the last decade, there has been an intuitive logic that has ruled the relationship between Equity performances and Bond yields which says in short that what is good for bonds is bad for equities and vice versa. Citi analysts observe indeed that over the period, bad news for bonds, such as higher economic growth or higher infation have usually been accompanied by higher bond yields and equity outperformance, while lower growth/ infation has been accompanied by falling yields and equity underperformance. During the third quarter, bond yields and equity performances have decoupled, sending diverging signals to investors. Pricing different realities Since early June, Global Equities, represented by the MSCI World index, have achieved positive performances with an increase of 6.7% while at the same time 10–year US Treasury yields fell by 77 basis points. Citi analysts think one reason why bond yields are diverging from equity prices is because the bond market is tracking weakening economic momentum while equity prices have been buoyed by strengthening earnings per share (EPS) expectations. During the second and the third quarter, economic indicators across the world have started to consistently slow down. This was particularly the case in the US where the end of economic incentives has largely weighed on the trend of indicators such as in the real estate sector. As a result, markets seemed to have been assuming that the US Federal Reserve (Fed) was about to re-open the monetary valve at its August meeting. Since the price of money was and is essentially nothing, the only way in which it could loosen policy was through quantitative easing (QE), i.e. by increasing the supply of money. The Fed was very likely to do this by buying government bonds. Since QE is expansionary, the Fed’s actions
Transcript
Q4 | 10 Europe | North America | Japan | Asia Pacific | Latin America�
Global market analysis from the Global Consumer Group
GCG Outlook ........................................2�
Opinions, forecasts, and weightings expressed by Citigroup Global Consumer Group Investments may not be attained or suitable for all investors. Past performance is no guarantee of future results. There are additional risks associated with international investments, including foreign, political, currency and economic factors to consider. Please contact your financial professional to determine what is suitable for your individual situation
When bonds and equities decouple�
During the last decade, there has
been an intuitive logic that has ruled
the relationship between Equity
performances and Bond yields which
says in short that what is good for
bonds is bad for equities and vice versa.
Citi analysts observe indeed that over
the period, bad news for bonds, such
as higher economic growth or higher
inflation have usually been accompanied
by higher bond yields and equity
outperformance, while lower growth/
inflation has been accompanied by falling
yields and equity underperformance.
During the third quarter, bond yields and
equity performances have decoupled,
sending diverging signals to investors.
Pricing different realities
Since early June, Global Equities,
represented by the MSCI World index,
have achieved positive performances
with an increase of 6.7% while at the
same time 10–year US Treasury yields
fell by 77 basis points. Citi analysts
think one reason why bond yields are
diverging from equity prices is because
the bond market is tracking weakening
economic momentum while equity prices
have been buoyed by strengthening
earnings per share (EPS) expectations.
During the second and the third quarter,
economic indicators across the world
have started to consistently slow down.
This was particularly the case in the US
where the end of economic incentives has
largely weighed on the trend of indicators
such as in the real estate sector. As a
result, markets seemed to have been
assuming that the US Federal Reserve
(Fed) was about to re-open the monetary
valve at its August meeting. Since the
price of money was and is essentially
nothing, the only way in which it could
loosen policy was through quantitative
easing (QE), i.e. by increasing the supply
of money. The Fed was very likely to do
this by buying government bonds. Since
QE is expansionary, the Fed’s actions
Citi outlook�A snapshot of Citi’s global market views across
a portfolio. Investors’ expectations of a new wave
of quantitative easing (QE) in the US after signs
of an economic slowdown continued to push
Treasury yields lower during the summer. Going
forward, Citi analysts expect US and core European
government bonds to sell off moderately as risk
aversion recedes and markets focus more on the
fiscal deficits of the “safe haven” countries, though
short term rates are likely to remain low as Federal
Reserve and European Central Bank interest rate
are likely to remain unchanged next year. Despite
the outlook for continued corporate earnings
growth over the coming year, Citi analysts believe
that longer-term global economic and corporate
earnings growth prospects are more subdued.
They therefore hold a balanced performance
outlook for global bonds and global equities over
coming months. Within bonds, they most favour
the outlook for corporate investment-grade and
high-yield bonds, with the view that the yields
available in these sections of the bond market are
generally attractive. Within equities, they favour
the outlook for European equities, particularly
German and French stocks, over other regional
equity markets, particularly US stocks.
Global equities
Market Market outlook
Portfolio allocation
Neutral Neutral
US Negative Underweight
Europe Positive Overweight
Japan Neutral Neutral
Latin America Neutral Neutral
Asia Pacific Negative Underweight
Eastern Europe Neutral Neutral
Global fixed income
Market Market Portfolio outlook allocation
Neutral Neutral
US Treasuries Negative Underweight
US High Grade Corporate Positive Overweight
Euro Government Bonds Negative Underweight
Euro High Grade Corporate Positive Overweight
Japan Investment Grade Neutral Neutral
High Yield Positive Overweight
Emerging Market Debt Positive Overweight
Alternative investments
Hedge Funds
Global currencies
Market outlook
N/A
Neutral
Portfolio allocation
Neutral
Neutral
Currency
Euro
Yen
Sterling
US Dollar
Outlook vs USD
Neutral
Negative
Negative
Outlook vs EUR
Negative
Negative
Neutral
Data Source: Citigroup Global Markets Inc. Weightings provided by Citigroup Global Wealth Management and Citigroup Global Consumer Group Investments as of December 2005.
would have benefitted both government
bonds (driving yields down) and equity
prices (driving prices up). In addition,
while economic momentum has slowed,
corporate earnings have surprised to
the upside. The recent reporting seasons
in the US and Europe have indeed been
strong and have led analysts to upgrade
earnings expectations. Citi analysts
estimate that this divergence between
economic momentum and earnings
growth is the consequence of positive
operational leverage as when companies
contain costs, any growth in revenues
makes for big gains in profits. While the
reasons behind the decoupling appear
straightforward, Citi analysts believe that
it is not sustainable.
Who is right?
Citi analysts observe that a similar
situation occurred in 2004-06 when
bond yields fell while equity prices rose.
With the help of hindsight we know now
that the bond market had relatively new
and large buyers back then who didn’t
really care where short rates were or
which way economic momentum was
heading. They were the Asian central
banks. At the start of 2004 Asian
foreign exchange reserves totalled
US$1.65 trillion. Given that many Asian
economies needed to buy US dollars to
fix their exchange rates, much of this
money ended up in US government
securities. In comparison, Citi analysts
estimate current Asian FX reserves at
about US$4.7 trillion. Back then, the re-
coupling occurred via increases in bond
yields and equity outperformance.
5.0 1800
4.5 1600
4.0 1400
3.5 1200
3.0 1000
2.5 800
2.0 600
1.5 400
AU
G 2
00
7
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00
9
FEB
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10
MA
Y 2
010
AU
G 2
010
US 10-Years Yield (LHS) Bund 10-Years Yield (LHS) MSCI World (RHS)
Equities Prices and Bonds Yields Sources: Bloomberg, MSCI
Just as there was a new and large buyer
of government bonds back then, we have
another one now – US and European
central banks – and talk abound again
of further quantitative easing. Citi
economists think that at some point,
further policy loosening is highly likely
as the Fed, at least, is breaching one
of its mandates: keeping employment
as high as possible. And as inflationary
pressures evaporate, it is also likely to
breach the other: keeping prices stable.
But there is no consensus within the
US central bank or outside it for more
monetary easing yet. The Fed and other
central banks will wait, Citi economists
think, until markets or economic growth
expectations or both fall. In parallel,
they maintain their view that the global
economy is likely to enjoy a sustained
but uneven recovery, led by strength
in emerging markets. Therefore, our
rates strategists believe that bond yields
are likely to rise although short yields
may remain at record low levels for an
extended period of time. They believe
the sustained global economic recovery,
the historically low level of bond yields
and the challenging fiscal outlook could
all contribute to eventually drive bond
yields higher. They forecast US bond
yields to rise by a further 96 basis points
by the end of 2011. German 10-year yields
are expected to rise by a further 65
basis points over the course of 2011.
Forecasts may not be attained. Past performance is no guarantee of future results. Standpoint Q4 | 10 There are additional risks associated with foreign investments. 2
Citi Euro Big
DJ Stoxx 600
Europe
Growth stocks preferred
Citi analysts observe that macro forces
have been the key driver across financial
markets over the past couple of years.
Although they think “de-equitisation” (the
reduction of shares supply) progressively
threatens to throw its weight behind an
ongoing shift back towards bottom-up
factors, they still estimate that macro
trends could continue to set the overall
Lacklustre growth limits the potential
for yield increases
With stronger-than-expected 2Q10
GDP and further gains in economic
confidence in 3Q10, Citi analysts have
revised up their 2010 GDP forecast, from
1.1% to 1.5%, and their 2011 GDP forecast,
from 1.0% to 1.3%. However, less
dynamic export growth and broad-based
fiscal tightening are likely to cap GDP
growth next year. Although Citi analysts
note that many arguments plead in
favour of higher government bonds
yields in the Euro Area, such as the
historical absolute low level of Triple-A
yields, the broad based necessary
fiscal and debt adjustments and risk of
mutualisation of the European sovereign
credit crisis through the implementation
of the European Financial Stability
Facility, they continue to believe that
interest rates are likely to remain low.
They estimate that the below par GDP
Citi analysts now expect 40% earnings
growth in 2010 and close to 15% in
2011 as cost control remains stoic and
revenues are likely to be dragged higher
by rising nominal GDP growth. However,
the path to economic recovery remains
an uncertain one and given recent
mixed data out of the US, there could
still be some downside risks, which, they
think, are embedded in the current low
growth expectations is likely to
maintain deflation fears and prompt
the European Central Bank to keep
interest rates their record low levels
for longer. They also expect increasing
economic and fiscal divergences among
core countries and periphery in the
Euro Area. Consequently, lower yields
for longer and greater divergences may
support investor’s robust appetite
for high quality Triple-A yields in the
bond market.
They also reiterate their view that
credit markets could potentially post
the best returns relative to risk-free
securities this year. Although absolute
yields in high-quality corporate
debt are near record lows, spreads
relative to risk-free benchmarks are
still attractive and already discount
slowing growth scenarios.
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Data source: Bloomberg as of September 30, 2010
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Citi Euro BIG (EUR)
wake of positive macro surprises during is experiencing below-par growth. Companies that see a large share of their the summer. This presents an excellent revenues stream exposed to the faster foundation for European companies to growing emerging markets are also much deliver decent earnings growth over better positioned to achieve significant the coming 12-18 months. In aggregate, earnings growth than those exposed to
Forecasts may not be attained. Past performance is no guarantee of future results.�There are additional risks associated with foreign investments. Standpoint Q4 | 10�
the domestic European economy which than in general during the last 25 years.
Global nominal GDP growth in 2010 and just over 10 times earnings, European 2011 while they upgraded their prospects equities have rarely been much cheaper for the European economic growth in the
agenda for equity investors over the next valuations of European equities.
12-18 months. Despite downgrades to US Among European equities, Citi analysts and Chinese GDP Growth expectations, continue to prefer Growth stocks versus Citi economists continue to back 6% Value stocks. They observe that, at prices
Fixed income�
Equities�
DJ Stoxx 600�Data source: Bloomberg as of September 30, 2010
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3
S&P 500 Index
Citi US Big
North America
economy to pick up steam in the second
half of 2011.
While Citi analysts believe the economic
recovery is ongoing, the reduced
pace of the cyclical recovery and the
relatively rich equity valuations could
limit stock price performance in the
short term. Moreover, a long list of
US stocks may underperform over the
coming year due to relative valuation
concerns
US equities were volatile in the third
quarter as the outlook for the US
economy darkened somewhat over the
summer months. September saw some
data suggesting that the economy
is unlikely to experience a “double
dip” second recession, helping equity
Less supportive conditions to keep the
Fed’s focus on accommodation
The US continues to face a challenging
economic landscape amid concerns
about slower global growth on the
back of Europe’s austerity measures
and China’s efforts to cool its economy.
Rather than policy normalization, the
Federal Reserve (Fed) now appears to
be readying a possible renewal of its
strategy of extraordinary intervention
in the securities markets. In short,
Citi analysts expect soft economic
conditions to keep the central bank’s
focus on monetary accommodation.
With inflation continuing to be subdued,
Citi analysts expect the Fed to leave the
current 0-0.25% policy interest rate
unchanged throughout 2011.
In addition, Citi analysts stress the
need for Fed officials to be prepared
in the months ahead to enhance
accommodation efforts if financial
Data source: Bloomberg as of September 30, 2010 Compared to other regional equity
markets around the world, Citi analysts
fear that US stocks may underperform
over the coming year due to relative
valuation concerns.
concerns including US financial
reform, the health of the European
banking sector, uncertainty over the
US mid-term elections, the prospect of
higher taxation and rising bond yields
are of concern.
A renewed rally in 2011 is however
forecasted by Citi analysts, and is
expected to be driven by solid
corporate earnings growth, some
duration in the sovereign sphere.
With corporate default rates expected
by Citi analysts to continue falling,
they favour the outlook for corporate
bonds. Furthermore, as yields on US
Treasury bonds recently fell sharply,
they believe that investors may now
be well compensated for holding lower-
rated corporate bonds.
1400
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1100
1000
900
800
700
1400conditions threaten to undermine
the recovery. While risk appetite has
returned, demand for “safe haven”
assets is still strong, leading both US 1300
government bonds and riskier fixed
income asset classes to perform well.
Reoccurring episodes of financial
uncertainty may favour US Treasuries 1200
during intermittent periods, but Citi
analysts’ general expectation for the 1100
year ahead is for healthier economic
momentum to be occurring in tandem
with the Fed’s intervention efforts,
leading to a preference for longer Citi US BIG�
Fixed income�
Equities�
markets regain their footing. Although improvements in the labour market and Citi analysts trimmed their US GDP domestic demand. Within the US equity forecast for this year to 2.6%, and 2.2% market, they continue to have no bias next year, they see potential for the for small-, mid- or large-cap stocks. S&P 500 Index
Sep
–09
Data source: Bloomberg as of September 30, 2010
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Forecasts may not be attained. Past performance is no guarantee of future results. 4 Standpoint Q4 | 10 There are additional risks associated with foreign investments.
Japan Nikkei 225 Index
MSCI F Asia Pacific Ex-Japan
Japan and Asia Pacific
Japan Equities�
Yen weakness could set the stage for
stocks to rally
Yen strength was likely the main
reason behind the recent falls in
Japanese equities, Citi analysts
believe, though they do not hold out
much hope on policy actions. They
note that although the Bank of Japan
has decided to supply approximately
¥10 trillion in new funds to the market
in August, this represents only 0.7% of
broadly defined liquidity. Additionally,
despite the Ministry of Finance’s
intervention in the foreign exchange
market in September, they are of the
view that this is unlikely to change the
recent trend of yen strength.
Over the longer term, Citi analysts
see potential for Japanese equities
to rebound in the event US interest
rates rise and the yen weakens. With
valuations having fallen markedly, they
believe that a turn around in US long-
Vulnerable to a potential slowdown
in China
Asian equity markets are likely to remain
volatile as concerns about the global
growth slowdown and double-dip risks
persist. Moreover, the region remains
vulnerable to a material slowdown in
Chinese growth. But, Asia’s relatively
stronger growth profile versus the
industrialised countries, coupled with
term interest rates could see the yen
weakening significantly and set the stage
for stocks to rally. That said, they caution
that investors still need to be mindful
of the risk scenario, in which markets
overshoot on the downside and the yen
gets locked in the range of ¥70-80/USD,
US long-term interest rates get locked
in the 1%-2% range, and the Nikkei 225
falls to around 8,000. In their opinion,
an upturn in the US economy rather
than policy is likely to be the turning
point for the equity market.
Citi analysts have revised their TOPIX
fair value forecasts from 950 to 900
for end-2010 and from 1050 to 1000
for end-2011. In terms of investment
strategy, they continue to focus on a
good balance between stocks related
to Asia, resources and energy on the
one hand, and stocks of companies
that are oriented toward domestic
demand on the other.
back at their peaks of 7%. Citi analysts
note that over the past decade, Asia-
ex-Japan has remained free cash flow
positive and that free cash flow has been
put to good use – leverage has been
reduced and dividend pay-outs raised.
In fact, dividend payouts have doubled
over the past 10 years. They highlight
that investing with an eye on free cash
flow yield has been a profitable strategy
13000
11800
10600
9400
8200
7000
NIKKEI 225 Index
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Data source: Bloomberg as of September 30, 2010
Asia Pacific Equities�
600
550
500
450
400
350
300
250
200
150 the bias of global policymakers towards historically, with dividends accounting
keeping monetary policy looser for for almost half of total returns since
longer may continue to channel money 1990. The total return of 6% for the
into the region’s equity markets. MSCI Asia ex-Japan index over the past
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According to Citi analysts, Asian equities decade suggests that investors may not
MSCI Asia Pacific Ex-Japan�Data source: Bloomberg as of September 30, 2010
as measured by the MSCI AC Asia ex-want to overlook high yielding stocks in
Japan index, are currently trading near their portfolio.
their historic averages in terms of both Within Asia, Citi analysts continue to
price-to-earnings and price-to-book – favour Hong Kong, Korea and Taiwan and
neither cheap nor expensive. Free cash in terms of sectors, Banks, Telecom, Info
flow yields in Asia ex-Japan however are Tech, Industrial and Energy.
Forecasts may not be attained. Past performance is no guarantee of future results.�There are additional risks associated with foreign investments. Standpoint Q4 | 10� 5
MSCI F EM EMEA
MSCI F EM Latin America
CEEMEA and Latin America
equity markets for the remainder of the
year, albeit with the possibility of high
market volatility.
Among the headwinds that may
challenge Latin American stock markets
through the end of 2010 are the risks of
a worsening fiscal situation in the Euro
Area, uncertainty on Fed action, or a
Strong outlook for equities across Latin
America
The third quarter saw a broad recovery
for Latin American equities, with the
MSCI Emerging Markets Latin America
index rising by 16% between its close
on June 30 and September 22. Amid
worries about slower global growth
from the continuing European sovereign
debt problems and from softness in
How cheap is cheap?
Citi analysts highlight that the most
attractive feature of CEEMEA equities is
probably their valuations. However, they
believe this apparently attractive
valuation picture in CEEMEA markets
should be married up with the
deterioration of the global economic
outlook and the risk of earnings
downgrades as the ratio of net analysts’
forecasts upgrades in CEEMEA is
negative and continues to deteriorate.
With the combination of a strong
rebound in corporate earnings and
relatively flat equity market
performances in the first three quarters
of 2010, price-to-earnings ratios have not
only come back to record low levels,
from 14.2x in 2009 to 9.8x this year, but
they also are cheaper than any other
market. In Citi analysts’ view, the level of
earnings could continue to rise on the
back of a positive although uneven
Earnings growth was particularly
strong in Brazil (+31%) and, at a sector
level, in materials (+87%). 56% of the
companies in Citi’s Latin America equity
coverage universe reported results
that were in line or beat Citi analysts’
earnings estimates for 2Q10. Excluding
the more volatile Materials, Energy and
quicker than anticipated slowdown in
Chinese GDP growth. The rising trend
of interest rates across the region
could also weigh on stocks. However,
Citi analysts forecast the US dollar
holding essentially steady against most
regional currencies, which removes a
traditional source of weakness for Latin
American equities.
Corporate earnings growth was strong
CEEMEA Equities�
Latin America Equities�
the US economy, Latin America has in Latin America during 2Q10 with Citi’s provided a relatively strong alternative. Latin America equity coverage universe On balance, Citi analysts maintain reporting aggregate year-over-year net their positive outlook for the region’s income growth of 21% (in USD terms). MSCI EM Latin America
In addition, Citi analysts observe that
cash generation is recovering faster
than in other emerging markets. They
indeed expect US$47 billion in free
cash flow this year in CEEMEA, 12%
higher than in the previous record year.
The combination of piling cash, cheap
financing on debt markets and low
equity valuations increases the likelihood
global economic backdrop – even if 400
forward forecast growth rates ease
further. They expect corporate earnings 350
in the region to grow by 45% in 2010
and by 22% in 2011. Therefore, Citi 300
analysts estimate that CEEMEA equity
markets indeed look very attractively 250
valued, even if earnings forward
forecasts may be easing and there 200
is a risk of a period of significant 150
earnings downgrades. They estimate
that these attractive valuations are
likely to support equity performances
in the coming months. MSCI EM EMEA�
Data source: Bloomberg as of September 30, 2010
Industrials sectors, the number would
have been approximately 64%.
Data source: Bloomberg as of September 30, 2010
of a revival of merger and acquisition
transactions in the region.
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Forecasts may not be attained. Past performance is no guarantee of future results. 6 Standpoint Q4 | 10 There are additional risks associated with foreign investments.
EPRA/NAREIT Global Index
Golds US$/troy oz.
Global REITs and commodities
Long term story intact, though
susceptible to near term volatility
Downside risk to US activity growth,
combined with subdued and weakening
core inflation, signals that equity markets
may be vulnerable in the US. And given
their recent tight link with commodity
prices, Citi analysts remain cautious
about the short term prospects for the
latter as well. However, the outlook
for activity growth in emerging markets
is brighter relative to the developed
economies and the fact that they
provide a fundamental underpinning
to commodity markets suggests that
the latter could outperform other risky
assets over the medium term.
Citi analysts see limited upside for crude
oil prices in the near term, given very
high US inventories and downside risks
to US activity growth. Base metals, on
the other hand, look well supported by
are up 2.6% year-to-date (+6.9% with
dividends included), outperforming
TOPIX (-9.2%), as of September 3,
2010. J-REIT shares, which exhibit little
correlation with the market (i.e., TOPIX),
have recovered their traditional share
price behaviour. Citi analysts expect
Potential to benefit from low payout
ratios and increasing cash flows
In the current low yield environment,
income oriented investors’ hunt for
extra income looks to have fuelled
US REITs’ 19% return year-to-date
as of September 1, 2010, significantly
outpacing the broad market. While
REITs dividend yield spread to other
equity yields remains historically low,
Citi analysts note that REITs tend
to benefit from low payout ratios,
increasing cash flows, and the likelihood
of dividend growth in the future.
the prospect of physically backed ETFs,
strong emerging market demand and
potential supply constraints.
Gold has crossed the US$1,300 mark, as
investors turned to safe-haven assets.
Anaemic western world growth and the
likelihood of interest rates in the major
economies remaining on hold for many
quarters, have boosted demand. With
the Obama Administration set to release
plans for new stimulus spending, the
state of US public finances may become
an issue in 4Q10. This implies that gold
may again benefit from concerns over
sovereign finance. On the other hand,
if equity markets continue to gain and
the US dollar holds its own, gold could
potentially struggle to set new highs. Citi
analysts think the latter risk could prevail
and therefore expect prices at around
US$1300/oz over the next few months.
positives for the property sector.
Real Estate Investment Trusts (REITs)�
Meanwhile in Japan, J-REIT share prices
Commodities�
Data source: Bloomberg as of September 30, 2010
2200
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Golds US$/troy oz.
2200 J-REITs to attract the interest of a wider
range of investors moving forward given 2000
their stable share prices and their track 1800
record of dividend distribution. 1600
Finally in Australia, the A-REIT 1400
accumulation index outperformed the 1200
ASX200 accumulation index by 5.73%
in the month of August, following a 1000
3.45% underperformance in July. While 800
the A-REIT sector is not without its 600
risks, the stable nature of trust earnings
streams is likely to continue supporting
this sector. At the same time, lower than
anticipated CPI, and a reduced threat EPRA/NAREIT Global Index Data source: Bloomberg as of September 30, 2010 of near term interest rate rises are
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Forecasts may not be attained. Past performance is no guarantee of future results.�There are additional risks associated with foreign investments. Standpoint Q4 | 10� 7
Euro Yen Pound
Currencies
Euro Yen Pound sterling�
Citi analysts observe that from June,
receding concerns on the fallout from
the sovereign debt crisis on European
financials, relative growth expectations
and interest rate differentials seem to
have left the Euro well positioned to
gain on USD weakness. Given positive
technical momentum, some further
short-term Euro appreciation may be
in store. However, the policy response
to the crisis still presenting a short-
term hurdle for the Euro, they doubt
the currency is likely to continue to
outpace its peers. In addition, recent
weak data in the periphery countries
contrast starkly with the strength of
those in the core, notably Germany.
This continued divergence between
rich and poor may also pose headwinds
to the Euro. Finally, Citi analysts
caution that a period of disappointing
macroeconomic performance in the
US could result in a new wave of risk
aversion among investors, which tends
to be accompanied by a weakness of the
Euro against the US dollar. As a result,
Citi analysts forecast $1.32/€ over the
next 6-12 months.
2.0
1.9
1.8
1.7
1.6
1.5
1.4
1.3
1.2
1.1
1.0
With USD/JPY having temporarily
reached the 83 level in early September,
strong downside pressure on the
exchange rate appears to remain in
place, according to Citi analysts. This
comes against a backdrop in which
data indicate that beginning from
April outbound portfolio investment
from Japan has rapidly increased. In
particular, the current 3-month outbound
securities investment is expected to
reach a record high. The amount of the
outbound portfolio investment is large
enough to cover the trade surplus, and it
appears that investment flows may have
absorbed speculative JPY long positions.
Citi analysts estimate that, to change the
strong-JPY paradigm, rises in US yields
are likely needed. The very low level
of global yields provides indeed little
incentive for accelerated investment
abroad among Japanese investors.
However, once yields starts rising,
they think USD/JPY could potentially
recover by more than what the market
may anticipate. Citi analysts forecast
an exchange rate of ¥87/USD on a 6-12
months horizon.
140
130
120
110
100
90
80
70
Lingering concerns about the recovery
in the US could continue to weigh on
market risk sentiment and keep sterling
close to its recent lows against USD
and JPY in the near term. However, Citi
analysts doubt that Sterling is likely
to move to retest the lows reached in
the aftermath of the May election. For
one, the political uncertainty receded
quickly following the formation of the
Tory-led coalition government. Gilt
investors also seem willing to reward the
aggressive government plans to cut the
fiscal deficit by 2014-15. In October, the
Finance Minister will unveil government’s
three year comprehensive spending
program which should reaffirm officials’
commitment to fiscal reforms. This is
likely to lead credit rating agencies to
keep UK’s credit rating unchanged and
perhaps, potentially upgrade their UK
credit outlook. Moreover, they think that
sterling may be in a good position to
gain from a potential weakening of the
safe-havens once sentiment shows more
signs of recovery. Citi analysts forecast
an exchange rate of $1.50/£ on a 6-12
months horizon.
2.10
2.00
1.90
1.80
1.70
1.60
1.50
1.40
1.30
1.20
1.10
Sep
–09
Oct
–09
Nov
–09
Dec
–09
Jan
–10
Feb–10
Mar
–10
Apr
-10
May
-10
Jun-
10
Sep
–09
Oct
–09
Nov
–09
Dec
–09
Jan
–10
Feb–10
Mar
–10
Apr
-10
May
-10
Jun-
10
Sep
–09
Oct
–09
Nov
–09
Dec
–09
Jan
–10
Feb–10
Mar
–10
Apr
-10
May
-10
Jun-
10
Euro-Dollar (USD/EUR) Dollar-Yen (JPY/USD) Pound-Dollar (USD/GBP) Data source: Bloomberg as of September 30, 2010 Data source: Bloomberg as of September 30, 2010 Data source: Bloomberg as of September 30, 2010
Forecasts may not be attained. Past performance is no guarantee of future results. 8 Standpoint Q4 | 10 There are additional risks associated with foreign investments.
Guest corner
Global Equity Strategist: The End of a Cult�By Robert Buckland, Global Equity Strategist
The investment debate continues to
focus on the likelihood of a double-
dip in the global economy and the
implications for markets. However,
we suspect that this overtly cyclical
debate is occurring against an ongoing
and profound reassessment of the
merits of particular asset classes by
both savers and borrowers.
Back in 1952, US private sector pension
funds held just 17% of their assets
in equities compared with 67% in
fixed interest. Over the next 50 years,
these weightings reversed – at the
peak in 2006, the same funds held
69% in equities and 18% in fixed
interest. There are many academic
justifications for the emergence of the
cult of equity, but perhaps the most
convincing argument is that it was
the product of a period of spectacular
outperformance from the asset class:
$100 invested in the S&P500 in 1950
would have been worth $58,380 at the
end of 1999 compared with $1,651 in US
Government Treasuries.
It has taken 10 years, and two 50%
bear markets, to reverse this cult.
Since the end of 1999, global equities
have returned just 4% in total. Not
only have equity returns been trivial,
but also the volatility has been brutal.
Just as strong returns helped to build
the cult of the equity in the 1950s so
weak returns are tearing it down now.
European and Japanese equities are
already trading on dividend yields
above government bond yields. US
equities are almost there as well. An
immediate reincarnation of the equity
cult seems unlikely.
How far could this go? A reduction in buybacks or breakups (or preferably
equity holdings back to pre-1959 levels both). They were quick to exploit the
would indicate considerable selling rise of the equity cult but have been
pressure to come. For US private sector slow to respond to its subsequent
pension funds alone that would imply demise. Investors should position
a further $1,900bn reduction in equity themselves for a period in which
weightings. The story looks similar the marginal buyer of equity is the
among retail investors. Equity inflows corporate, not other equity investors.
into US mutual funds, for example, This would imply tilting portfolios
have not recovered from the bear towards M&A and buyback candidates.
market of 2007-2009. We would be very suspicious of serial
But all is not lost for global equities. equity issuers.
While it seems that conventional Emerging Markets remain a refreshing
investors could remain sellers for some exception to these gloomy trends.
time yet, corporates have the means Investor appetites for equity remain
to step in as buyers. The combination healthy. Equity financing is competitive
of low equity valuations, surplus relative to debt. Capex is booming.
cashflows and cheap debt financing Larger-cap stocks are not under
suggests that global de-equitisation consistent pressure to break up. It
is likely to return. This should help to all feels very 1990s – companies and
soak up the continued equity overhang investors should enjoy it while it lasts.
from the late 1990s, but it will be a
long process. At least it means that
global equities will likely not settle at
pre 1959 valuations – shareholders
and corporates would not allow this
to happen. The doubling of European
equities in 2003-07 showed how
de-equitisation can help markets rise
even when conventional investors are
consistent sellers.
The demise of the equity cult will
continue to have profound implications
for the global economy and markets.
It is likely to keep capex levels subdued.
Why bother to build when you can buy
existing assets cheaply? Mega caps are
likely to trade at discount valuations
until they show a more meaningful
intention to address their equity
oversupply problems, perhaps through
Forecasts may not be attained. Past performance is no guarantee of future results.�There are additional risks associated with foreign investments. Standpoint Q4 | 10� 9
Forecasts may not be attained. Past performance is no guarantee of future results. 10 Standpoint Q4 | 10 There are additional risks associated with foreign investments.
The suggested allocations are intended to be general in nature and are not to be construed as specific investment advice. Investors are encouraged to consult with their Financial Professional to determine their allocation needs based on their risk tolerance, suitability and goals. [Note that there are additional risks associated with hedge funds, as such funds are speculative. Please refer to page 12 for important information about hedge funds.]
US Government Bonds 32%�US Corporate Bonds 29%�US High Yield Bonds 9%�US Equities 13%�Global Equities 12%�Global REITs 5%�
US Government Bonds 19%�US Corporate Bonds 20%�US High Yield Bonds 7%�Emerging Market Debt 4%�European Equities 15%�US Equities 22%�Pacific Equities 2%�Emerging Markets Equities 3%�Global REITs 8%�
US Government Bonds 8%�US Corporate Bonds 14%�US High Yield Bonds 8%�Emerging Market Debt 5%�European Equities 17%�US Equities 29%�Pacific Equities 4%�Emerging Markets Equities 5%�Global REITs 10%�
US Government Bonds 2%�US Corporate Bonds 5%�US High Yield Bonds 8%�Emerging Market Debt 5%�European Equities 20%�US Equities 36%�Pacific Equities 7%�Emerging Markets Equities 7%�Global REITs 10%�
Spotlight on allocations�About the Citi Asset Allocation Process
The Citibank tactical portfolio allocations are based on the work of the Global Investment Committee (GIC) of Citi Private Bank. The membership of the committee is comprised of experienced investment specialists from across Citi. The GIC deliberates on the macroeconomic and financial market environment in order to formulate an outlook across multiple asset classes and is responsible for maintaining tactical model portfolios based on this outlook. The tactical weights that are applied to the Citibank portfolios are aligned to the decisions of the GIC.
Allocation to bond and equity markets
•�We have maintained our neutral allocation to global equities and global bonds.
Citi analysts believe that corporate profit growth is likely to slow to a below historical trend pace beyond the rebound over the coming year or so. As such, they believe that the market’s assumptions of long-term profit growth may be subject to disappointment and that equity market returns may struggle. That said, they also note that US and German long-term government bond yields have fallen substantially over recent months and that market pessimism may be overdone. A moderate sell-off in government bonds could drag on bond portfolio returns going forward, in their view. Citi analysts consequently foresee even return prospects for global bonds and global equities.
Allocation to regional equity markets
•�We have maintained our allocation to European equities at overweight, our allocation to US equities at underweight and our allocations to Japan and emerging market equities at neutral.
Citi analysts believe that pessimism regarding the outlook for European stocks has been overdone and that core European equity markets, in countries that are less impacted by the sovereign debt crisis, may outperform other global equity markets going forward. In regards to Asian equities, they are concerned of a potential correction in the Chinese real estate market and a wider slowdown in Chinese economic activity, which could potentially weigh on commodity prices and consequently the corporate earnings in other emerging equity markets where commodity producers feature prominently.
Allocation to government and credit markets
•�We have maintained our allocations to investment-grade corporate bonds, high-yield corporate bonds and emerging market debt at overweight and have maintained an underweight position in government bonds
With corporate earnings stabilising, corporations world-wide deleveraging – using earnings to pay down debt – Citi analysts forecast that default rates on corporate bonds may continue to fall and the fundamental outlook for this asset class continues to improve. Furthermore, the recent uptick in corporate bond yields as a result of financial uncertainty in Europe has increased the attractiveness of corporate bonds, particularly high yield, relative to equities, in the view of Citi analysts. Concerning government bonds, they favour emerging market sovereign bonds over developed market sovereign bonds given that budget deficit concerns appear to be concentrated among the latter group.
Forecasts may not be attained. Past performance is no guarantee of future results.�There are additional risks associated with foreign investments. Standpoint Q4 | 10� 11
Important Disclosure
“Citi analysts” refers to investment professionals within Citi Investment Research and Analysis, Citigroup Global Markets and voting members of the Global Investment Committee and Global Portfolio Committee of Citi Private Bank.
This document is based on information provided by Citigroup Investment Research and Analysis, Citigroup Global Markets, Citi Private Bank and Citigroup Alternative Investments. 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 or its affiliates.
Although information has been obtained from and is based upon sources that Citibank believes to be reliable, we 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.
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.
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