Market
Outlook.
September 2013.
Feature Article
01
Equity Markets
03
Bond Markets
06
Currencies
07
Feature Article
Fed Tapering and its Implications for Emerging Markets
Ongoing uncertainty surrounding Fed QE tapering and fears of the potential reduction of global liquidity have shifted focus to
markets especially vulnerable to possible capital outflows. Indeed, we are seeing accelerating capital outflows and currency
depreciation in EM countries with large external deficits, especially in Indonesia and India.
The United States Federal Reserve (the Fed) is expected to begin tapering following the 17-18 September meeting, scaling
down bond purchases from US$85 billion per month probably to US$60 billion, while signalling its intention to end the
programme around the middle of 2014.
Moreover, the Fed is likely to accompany the start of tapering with other announcements, in particular, lower forecasts for
the jobless rate, a signal that the jobless threshold for rate guidance may be reduced below 6.5% over time, and outline
projections by the Federal Open Market Committee (FOMC) members for the path of the economy and Fed Funds in 2016.
The Fed’s overall message may shift its emphasis from asset purchases, to keeping rates on hold until recovery is well
advanced and gradual tightening thereafter. This prospect appears to be already reflected in the prices of US asset markets.
US financial conditions remain highly supportive of growth prospects and would continue to be supportive, even if conditions
tighten slightly).
Impact to Emerging Markets
However, it is unclear whether the inevitable declines in global liquidity amidst slowing Emerging Market (EM) growth is fully
discounted in prices of non-US assets. Sluggish EM growth reflects various country-specific factors, but common themes are
weak export growth due to modest advanced economy growth, the deterioration in private sector balance sheets, and the
vulnerability of many EMs to Yen depreciation and China’s slowdown.
Chart 1: CPI Inflation and Current Balance Forecast
CPI Inflation
Current Balance (% of GDP)
2012
2013F
2014F
2012
2013F
2014F
Asia
3.9%
3.5%
3.7%
1.8%
1.6%
1.5%
China
2.6
2.7
3.0
2.3
2.2
2.0
Hong Kong
4.1
4.3
3.6
1.1
2.2
3.7
India*
7.3
5.5
5.0
-4.8
-4.3
-3.2
Indonesia
4.3
7.1
5.5
-2.8
-3.2
-2.3
Korea
2.2
1.5
2.6
3.8
4.3
2.5
Malaysia
1.6
2.0
2.6
6.1
2.3
3.9
Philippines
3.2
2.8
3.2
2.8
2.5
2.1
Singapore
4.6
2.5
2.8
18.6
14.0
13.5
Taiwan
1.9
1.5
1.9
10.5
9.1
8.5
Thailand
3.0
2.4
2.3
0.0
-0.1
-0.4
*Note: In India, policymakers look at the wholesale price index
Sources: National sources and Citi Research as of 21 August 2013.
Feature Article
1
With US long-term interest rates on the rise, it is not surprising that EM countries with current account deficits have
seen their currencies under pressure. Hence, the last two weeks have seen accelerating capital outflows and currency
depreciation in EM countries with large external deficits, especially in Indonesia and India. These countries remain
vulnerable to the scaling back of the Fed’s asset purchases, with limited policy options to revive growth given the
worsening current account, thin reserves and high inflation rates.
India and Indonesia
Although Citi analysts expect both currencies to weaken further, they do not expect a full-scale crisis given that both
countries retain far greater capacity to contain the outflows in the current environment than previously, suggesting that
a repeat of earlier episodes is unlikely. While countries with stronger fundamentals may begin to stabilize as soon as
the cyclical recovery gathers pace, those countries with the largest current account deficits and the weakest domestic
fundamentals will need to prove their policy credentials.
Chart 2: India and Indonesia with biggest external funding need
Sources: Haver Analytics as of 22 August 2013.
Feature Article
2
Equity Markets
S&P500
Chart 1:
ASX200 Index
Chart 2:
S&P 500 Index
*Denotes cumulative performance
Performance data as of 31 August 2013
Source: Bloomberg
*Denotes cumulative performance
Performance data as of 31 August 2013
Source: Bloomberg
Australia
United States
At a turning point?
Job growth and private
demand have held up well
Topix
•The RBA cut rates by 0.25% to 2.50% in August. Whilst
the Board did not want to rule out further rate cuts,
they did not communicate that rates were likely to be
cut again in the near future. Inflation remains in the
lower half of the 2%-3% target range, leaving the Bank
relatively unconstrained in its efforts to promote growth.
But with the AUDUSD exchange having fallen more than
10% in recent weeks and the oil price at high levels, the
next quarterly inflation release in October is likely to
have a bearing on whether the RBA cuts rates again in
November. At this stage, Citi views further cuts as unlikely.
•Recovery appears to be weathering the worst of the
fiscal headwinds, with growth estimated at a 1.5% annual
rate in 1H and signs that activity was picking up heading
into Q3. Housing, capex, car sales and payrolls all are on
healthy upswings and new cyclical lows in jobless claims
in mid-August suggest little spillover from cuts in federal
spending.
•Economic growth has been sluggish thus far in 2013 and
business conditions remain challenging across a number
of industries. But recent months have seen forecasts
amended to reflect that the recovery is still taking place,
though taking longer than previously estimated. Citi
currently forecasts GDP growth of 2.5% in 2013 and 3.1%
in 2014.
•The semi-annual reporting season is drawing to a close
with 82% of S&P/ASX200 constituents having reported
so far. On the whole, results have not been as bad as
many had feared. Bloomberg reports earnings per share
(EPS) to be down 3.54% on consensus estimates, which
is better than each of the previous four years which were
followed by a series of analyst downgrades. The market
is currently at approximately 14.5x 1yr forward EPS, very
close to the long run average.
•Whilst the headline numbers are neither good nor bad,
the dispersion of results underlines how different sectors
are performing in a multi-speed economy. Encouragingly,
consumer-related stocks have tended to surprise to
the upside and valuations have adjusted in most cases
back towards the market average. Cyclical industrials
on the other hand have tended to disappoint. Overall,
the outlook has generally improved for companies that
derive a significant proportion of their earnings from
overseas since the fall in the exchange rate. Citi expects
the market to finish the year at a target of 5400, rising
to 5600 in mid-2014.
Equity Markets
•Fed officials continue to emphasise that scaling back
QE still would leave policy on a highly accommodative
path where no rate hikes are planned for a long time.
Citi analysts expect that tapering in September could
mark a shift to greater reliance on forward guidance to
supplant QE and possibly enhance accommodation by
altering thresholds for exit strategies. Citi analysts think
unemployment
may
be belowMarkets
7% before QE ends and
MSCI
Emerging
that rate hikes may be delayed until the jobless rate is
closer to 6%.
•From an equity perspective, with more than 92% of
companies in the S&P 500 having reported 2Q results,
EPS trends appear to have come in about $0.20-$0.25
below forecast at $27.33. Moreover, lower tax rates have
been supporting profits and this may not be sustainable
in the future. Accordingly, some downward adjustments
to forward estimates are required as recent guidance
has become more negative.
•Citi’s 2013 and 2014 S&P 500 EPS estimates are being
trimmed to $109.50 and $116.25 from $110.00 and
$117.00, respectively, reflecting a review of margins and
earnings results, recognizing that the 2H13 “hockey
stick” consensus bottom-up trend seems quite unlikely.
Indeed, investors may have been a tad too focused on a
rising stock market in recent weeks rather than earnings,
especially since many management teams highlighted
back half optimism that some have just started to cut
in the past few days, with more probably coming in the
next month. Citi’s new roughly 6% EPS growth outlook
for 2014 is meaningfully lower than the 10%-like bottomup view, though more in-line with buy-side surveys.
3
Equity Markets
Topix
Chart 3:
DJ Stoxx 600
Dow Jones Stoxx 600 Index
Chart 4:
Topix Index
*Denotes cumulative performance
Performance data as of 31 August 2013
Source: Bloomberg
*Denotes cumulative performance
Performance data as of 31 August 2013
Source: Bloomberg
Euro-Area
Japan
No longer expect the ECB to cut rates in Q4
Consumption tax hike is key event to monitor
•The better-than-expected 2Q GDP data, showing the
first gain in seven quarters, together with the more
constructive tone from recent surveys, lead Citi analysts
to raise their 2013 GDP forecasts by 0.2ppt to -0.5% and
the 2014 average by 0.4ppt to 0.6%.
•Citi analysts expect solid growth to continue until the
1Q14 before the consumption tax hike in April 2014
puts a strong brake on activity. Meanwhile, under the
assumption that the tax hike is implemented as planned,
Citi analysts expect a sharp contraction in activity, driven
by plunging household demand, in 2Q14. While GDP
could likely return to positive growth in the 3Q14, a sharp
fall in household demand is likely to hit smaller firms
(especially nonmanufacturers) and to weaken growth in
incomes and profits, as in 1997.
MSCI AC Asia ex Japan
•As a result of better growth dynamics, Citi analysts
no longer expect the ECB to cut rates in Q4, with the
main refi rate and the deposit rate staying unchanged
(at 0.5% and 0% respectively) for a long period. A cut
in one or both interest rates could come back on the
agenda in the event of a sharp strengthening of the euro
or ‘unwarranted’ increases in market rates, but even
then the authorities would probably aim to talk down the
currency and rate expectations first.
•In terms of strategy, Citi analysts have backed Defensive
Growth since mid-2009. These are companies which
had low (or no) earnings drawdown during the 2008-09
earnings recession, but which also offer investors 2-year
compound earnings growth at/above market growth
rates. Defensive Growth includes many Health Care and
Food & Beverage stocks.
•Indeed, Defensive Growth has outperformed the market
by 70% over the past 5 years. This low beta group has
led a strong rise in European equity markets. Defensive
Growth has out-gunned Financials and Offensives
since the 2008-09 financial crisis, with an attractive
combination of less risk and more growth. But the
prospect of higher GDP growth and lower macro risks in
the US and Europe over the next 1-2 years suggests that:
1) there may be less need for investors to seek downside
protection, 2) there may be a broader growth menu
to choose from, and 3) recovery plays become more
important within the market.
Equity Markets
MSCI Emerging Markets
•The most important factor to monitor over the nearterm is PM Abe’s final decision on whether or not
to implement the consumption tax hike (likely in
late September or early October). In Citi’s view, the
probability that PM Abe will go ahead with the current
plan is 60-70% while the possibility of postponement of
the tax hike is 30- 40%. If the tax hike is implemented,
the government is very likely to introduce another
fiscal stimulus package, in order to mitigate its negative
impact.
•Citi analysts have revised up their TOPIX EPS estimate to
89.3, above the pre-Lehman peak of 80.4 (FY3/08) given
corporate revenues and profits may rise in both FY3/14
and FY3/15 and forecast FY3/15 TOPIX to be 1,590. Even
if nuclear plant restarts are slower than expected this
would only cut around 1.8pts from the TOPIX EPS in
Citi’s view.
•PBRs of Japanese equities tend to move in line with
RoE and the ¥/$ rate. Based on this relationship, Citi’s
PBR estimate is 1.48x for FY3/14 and 1.64x for FY3/15.
Citi’s FY3/15 estimate is still below the average of 1.67x
since July 1993, after the dust had settled on the asset
bubble of the 1980s. Citi analysts expect peak levels are
auto-related companies to post FY3/15 RP well ahead
of post-FY3/01. While share price performance at these
companies has been firm, valuations and other factors
suggest more upside potential.
4
Equity Markets
Chart 5: MSCI AC Asia ex Japan
MSCI Asia ex Japan Index
Chart 6:
MSCI Emerging
Markets
MSCI Emerging Markets
Index
*Denotes cumulative performance
Performance data as of 31 August 2013
Source: Bloomberg
*Denotes cumulative performance
Performance data as of 31 August 2013
Source: Bloomberg
Asia Pacific
Emerging Markets
Accelerating capital outflows
Neutral on Latam equities
•EM Asia countries with large external deficits recently
have seen accelerating capital outflows and currency
falls, especially in India and Indonesia. Moreover,
policymakers in these countries probably have limited
options to revive growth, given worsening current
account and fiscal balances, declines in reserves and
high interest rates.
•Although CEEMEA1 is often considered to be the most
‘risky’ part of EM, currency sell-offs in the past 3 months
have treated EMs in the European time zone relatively
lightly. While the ZAR and TRY have depreciated sharply
given large current account deficits financed by volatile
capital flows, other currencies in the region have fared
better. Better Eurozone data is one reason for this, and
another is the relative lack of direct exposure to China
among CEEMEA economies.
•Although Citi analysts do not expect a full-scale crisis,
these countries remain vulnerable to the rising US rates
on the rise, and their currencies remain under pressure.
In Citi’s view, best they can do now is to smooth the
macro adjustment (weaker FX, higher risk premiums,
slower growth) through improved policy credibility and
find offsets to portfolio flows.
•In Indonesia, Citi analysts believe that BI needs to signal a
more hawkish stance with rate hikes to stabilize local FX
markets. Indonesia’s portfolio equity flows are far smaller
than debt flows, and debt investors tend to put greater
premium on stabilizing FX than supporting growth. On
the other hand, India needs to keep liquidity tight and
mobilize more external funding sources. RBI has recently
stepped up FX intervention alongside import curbs
and significant liquidity tightening, dampening growth
expectations in the process. To avoid losing credibility on
its intervention ammunition, mobilizing more external
funding may help.
•In China, better earnings, expectation of policy support
and economic stabilization had triggered recent market
rebound from June’s low. However, the market may
remain choppy and its upside may likely be capped by
ongoing earnings downgrades, Fed tapering, and 4Q
growth uncertainty.
•Citi analysts maintain their call to overweight IT, health
care, renewable energy, consumer, and property sectors
which have resilient organic growth and could benefit
from structural reform, while further rebound in cyclical
sectors could be largely driven by earnings visibility,
rather than valuation expansion.
Equity Markets
•Although valuations are attractive, sentiment on
CEEMEA remains poor and growth prospects remain
uninspiring. Preferred market is Russia due to cheap
valuations. Both South Africa and Turkey sit as neutral,
given their shaky social and political backdrops, as
well as valuations which shows neither market looks
particularly cheap.
•Collectively, Latam currencies face fairly adverse
headwinds, including: weak macro (BRL, CLP, COP); twin
deficits on the current and fiscal accounts (all four);
commodity reliance (all four); deep China exposure
(BRL, CLP) and, except for COP, relatively overvalued
currencies.
•Within Latin America, Citi analysts have downgraded
their 2013 and 2014 real GDP growth estimates for Brazil
to 2.1% and to 2.0% (from 2.2% and 2.5% respectively).
In Mexico, they have cut their 2013 growth forecast to
2% from 2.7%.
•As for Latam equities, Citi analysts are neutral. Despite
expected double-digit EPS growth for 2013, Latam’s
relative earnings momentum has been weak. Preferred
market is Mexico. The market has been held up by close
links to the improving US economy, lower commodity
exposure, low debt levels and prospects for structural
reforms.
1. CEEMEA is the collective term for Central and Eastern Europe, Middle East and Africa.
5
Bond Markets
Overweight High Yield
US Treasuries
Diminished liquidity and elevated volatility is likely to persist as carry trades and long positions continue to unwind,
fostering choppy market conditions in the months ahead. Citi analysts prefer to maintain only shortdated positions in
Treasuries and to use any rallies to shed duration.
US Corporates
While Citi analysts are relatively constructive in 2H13, they remain defensive. The biggest risk is a further significant rise
in interest rates. Therefore, Citi analysts prefer to be selective and favour maturities in the 3-year to 7- year range.
US High-Yield
The sell-off in high yield has not been fundamentally driven. Concerns about higher US interest rates and the potential
impact on the broader macro environment have weighed heavily on valuations. Indeed, valuations have become attractive
given that Citi analysts expect default rates to remain low for the next several years.
Emerging Market Debt
External (hard currency) and local currency emerging market sovereign debt remains volatile as investors re-evaluate risk
exposures. Citi analysts prefer to keep duration short and hedge currency exposures.
Euro Bonds
While central bank actions (such as forward guidance introduced by the ECB and BoE, or tapering of asset purchases
by the Fed) are critical to rate expectations, any sustainable divergence in longer-term yields is more likely to be fuelled
by economic factors, not central bank policy. As such, Citi analysts continue to expect “lower for longer” yields in the
Eurozone to bolster Bunds and Gilts relative to Treasuries.
Japan Bonds
The Bank of Japan’s (BoJ) easing measures far exceeded market expectations. It introduced monetary base in order to
aggressively expand Japan’s aggregate money base. Also it expanded the JGB purchase amount and the maturity of JGBs
eligible for purchase to 40 years to keep JGB long-term yields low. With these measures in place, long-term interest rates
are setting record lows for the time being.
Asia Bonds
Citi analysts are neutral PHP bonds as the pending SDA liquidity injection could help, and they also turned neutral VND
bonds given periodic USD liquidity risk amid SBV’s reluctant intervention that could undermine sentiment, amid some
foreign unwinds. Despite FX risks, they also favour INR and LKR government bonds.
Bond Markets
6
Currencies
USD: Moderate upside over 6-12 months
Short term consolidation in USD exchange rates over 0-3m may likely give way to further moderate USD upside over
6-12m. Indeed, Citi’s forecasts still envisage generalised USD strength medium term, driven by: (i) a relatively strong
cyclical performance in the US; (ii) an expected shift towards relatively less expansive US monetary policy as QE3 is
first tapered and then ended altogether by mid 2014; (iii) relatively looser monetary policies elsewhere focused on rates
guidance and, in Japan, ongoing QE; and (iv) deteriorating fundamentals and rising risk premia in EM economies.
EUR: Flows support EUR
EUR/USD has recently moved back to the upper end of the 1.28-1.34 range holding over the past 6 months. A generalised
USD correction reflecting rally fatigue and excessively long positioning contributed to this. But there were also EUR
positives in play. One factor is the recovery in European financials, which tend to be correlated with EUR performance.
Another factor arguably helping EUR is the stance of ECB monetary policy. Aside from these short term factors, Citi
analysts continue to think that medium term flows underpin the EUR. These include flows from the rising current account
and long term capital accounts on the balance of payments – the so called broad balance of payments. All in all, Citi’s
forecasts show EUR holding its own or even appreciating a little against a relatively strong USD over the medium term.
Citi analysts expect 1.35 over 0-3 months and think 1.30-1.35 may be a central trading range over 6-12 months.
GBP: Carney & forward guidance
Following the introduction of the widely expected forward rates guidance in the UK by BoE Governor Carney, the response
to the new policy details has been a modestly stronger sterling. Having previously broken upwards from the 0.84 – 0.86
range, EUR/GBP currently trades back within this band having failed at close to February and March highs. Citi analysts
expect EUR/GBP to continue to trend higher over time, partly because they remain constructive on the EUR. Citi analysts
forecast 0.87-0.88 for EUR/GBP over their forecast horizons. However, uncertainties around “guidance”, the markets’
initial response to it, and follow up policy actions in reaction mean that the GBP outlook is unusually cloudy.
JPY: Relative policy supports higher USD/JPY
USD/JPY fell slightly since the last forecast and is currently close to last month’s 0-3m projection of 98 which Citi analysts
leave unchanged this time. In recent months, the exchange rate has entered a relatively large sideways consolidation
pattern with still rising lows in corrections but highs receding in rallies since May. The expected fundamental drivers
for USD/JPY remain the same. Over time, Citi analysts expect the Fed to begin to withdraw maximum monetary
accommodation, first tapering in Q4 and then stopping QE3 altogether in around mid 2014. This is consistent with further
moderate upwards pressure on US 10y yields and similarly on yield spreads to Japan.
AUD: Further weakness anticipated
Medium term, Citi analysts still look for some further downside in AUD/USD based on a continued deterioration in the
terms of trade. Commodity prices should generally be weak over this time horizon according to Citi commodity market
strategists. In addition, US centric factors may help the USD against other major currencies and Citi analysts remain
concerned about Chinese economic developments which could yet impair AUD. Over 6-12 months, Citi analysts see AUD/
USD around 85-90c.
EM Asia: A weaker China and CNY
Citi analysts anticipate some stability now in most cases, with Asia overall forecast to be less weak in the next three
months than the last three. But there are fat tails around the distribution, from risks of a credit crunch in several Asian
economies including, crucially, China, and in twin deficit countries like India and Indonesia.
USD/CNY spot, fixings and market forwards have all been trading sideways/lower in a choppy range. Citi point forecasts
remain unchanged from last month, but with greater two way risks. On the one hand, weak growth may require exchange
rate depreciation to stimulate, especially given little or no fiscal wiggle room. Indeed, although very recent data have
been better, Citi economists have not turned more bullish, citing temporary stabilization and strong base effects. If, on
the other hand, China suffers a real credit crunch as some fear, CNY could strengthen as foreign assets are repatriated to
recapitalize banks. Citi analysts forecast USD/CNY trading between 6.15 and 6.18 over the next twelve months, with risks
skewed toward a weaker CNY near term.
Currencies
7
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Equity Markets
8