perspectives · 2020. 4. 22. · transacting online out of necessity. citi analysts believe the...

Q4 2020

PERSPECTIVES

VIEWS

4Q20: Positioning in a

New Economic Cycle

INSIGHT

Asia’s Faster Rebound

from COVID-19, but

Scars Remain

ISSUE 18

QUARTERLY PERSPECTIVES

PERSPECTIVES | 2

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.

Dear Clients,

In Q3, there was a strong but uneven market rally, supported by

signs of an economic recovery as countries emerged from COVID-

19 lockdowns and the US$25 trillion stimulus commitment by

Central Banks. Global equities rose 8% in the last quarter, with

certain sectors like technology outperforming. As we enter the last

quarter of a challenging year, COVID-19 continues to dominate

headlines, along with concerns on the US Presidential elections

and US-China political tensions as well as the absence of further

fiscal stimulus in the US.

In Citi’s view, a New Economic Cycle began six months ago with a

larger economic recovery ahead. The pandemic is now expected to

abate in 2021 with the arrival of vaccines and improved treatments.

Citi analysts believe it may be time for portfolios to be positioned to

take advantage of the likely rebound in many impacted sectors and

countries.

The US election in November is expected be a major source of

higher market volatility. Markets are straddling the possibility of a

change in government – and the implications of future taxation and

regulatory differences in the event of a Biden win – while weighing

the impacts of a second Trump administration.

In this quarter’s insights, Citi analysts also discuss the hurdles that

could impact Asia’s return to pre COVID-19 trend growth. Despite

these challenges, parts of Asia are buffered by the dynamic

technology sector and a more robust management of the pandemic.

Asia banks are also better capitalized relative to the 1997-2000

Asian Financial Crisis period, which took an average three years for

crisis-hit economies to return to pre-crisis levels. This time around,

Asia is expected to lead global output, and return to pre COVID-19

levels by Q4 2021.

We hope you are staying healthy in these challenging times. Please

approach your Citigold Private Client Relationship Manager to

understand how these developments can affect your portfolio.

Best regards,

Paul

Paul Hodes

Head of Wealth Management

Asia Pacific and EMEA

Citibank N.A.


PERSPECTIVES | 3



Positioning in a New Economic Cycle

Views

Key Takeaways

• Global markets face greater uncertainty with the looming US election and no clarity as to

its outcome. Furthermore, there is a risk of rising COVID-19 infection rates as winter

approaches, with many areas already experiencing second waves.

• Despite these two near-term uncertainties, a supportive macroeconomic policy backdrop

and a better-prepared health sector suggest the challenges may not be nearly as severe

as COVID-19’s initial global shock. Citi’s Global Investment Committee (GIC) thus

increased its Overweight in Equities, and increased its Underweight in Bonds. Gold and

Real Estate Investment Trusts (REITs) remain Overweight while Cash remains

Underweight.

• After the COVID-19 collapse, massive stimulus has laid the foundations for a new

economic cycle. Citi’s strategy is to maintain a long-term commitment to our “Unstoppable

trends” in healthcare, digital disruption, and Asia. They also favor selected cyclical sectors

such as Industrials, Financials, and REITs and Global small/mid cap which may

outperform over the next 12-18 months when markets normalize.

Negative 2020 global growth

in before rebounding in 2021

After plummeting in the first half of 2020, global

economic activity has rebounded as lockdowns

eased. Citi analysts expect global GDP to

contract by 3.9% in 2020, followed by a

rebound of 5.4% in 2021.

As a result, Citi analysts believe that global

Earnings-Per-Share (EPS) could contract by

25% in 2020, followed by a 20% rebound in

2021. Consensus on the other hand is more

optimistic and expects a 18% contraction in

2020, followed by a 28% rebound.

Central Banks providing

support

Central banks reacted to collapsing markets

in March by announcing an aggressive

expansion in Quantitative Easing (QE)

policies. Notably, the Federal Reserve (Fed)

said that it would buy both investment-grade

and high yield corporate bonds/ETFs,

something not even done back in the 2008

financial crisis.

Recent changes in unconventional monetary

policies of major central banks mean that net

12 month rolling central bank asset

purchases are expected to exceed US$6trn,

nearly 3x previous peaks. This measure is

expected to roll over in February 2021.


PERSPECTIVES | 4



Asia is favored

Chinese shares, particularly those in the

technology and internet sector have risen

sharply in recent months. While there may

be some consolidation near-term, after such

a sharp rally, Citi analysts remain long-term

optimistic on Asian consumption, technology

and healthcare themes.

In Latin America (LatAm), valuations have

improved sharply after a deep selloff. Given

the severe underperformance relative to

other markets, Citi analysts believe the

region may have room to perform. The

correction has adjusted real exchange rates

to levels not seen since the 1990s and may

provide a cushion to economies and may

help equities recover. However, Citi analysts

are cautious on the long-term outlook

beyond the potential global equity rebound.

In EMEA, a brighter cyclical outlook for oil,

and a likely prolonged period of easing by

the European Central Bank (ECB) and Fed

could provide support. Nevertheless, Citi’s

still small underweight in EMEA is driven by

a higher conviction in both Asia and LatAm.

Preference for US Small

and Mid Caps

Rapid policy steps from the Fed and US

congress have boosted markets after a

significant drop in March. Broad market

valuations are no longer cheap – even when

pricing in recovery from the COVID-19

shock. However, this is largely a function of

the powerful rally in IT-related shares, with

the NASDAQ composite up 29% year-to-

date as of 9 October 2020.

While TMT (Tech, Media, Telecom)

fundamentals are strong and improving, Citi

analysts prefer COVID-19 cyclical sectors

such as Industrials, Financials, and REITs

as well as small and mid-cap stocks, as they

have been oversold and may be poised for

recovery.

Investors should also keep an eye on the

upcoming US election in November as that

could be a source of volatility. Given the very

high expected number of mail-in ballots

across the US, it is possible that the results

of the US election may not be known on

election day and, if it is a close election, for

weeks thereafter.

Implied volatility in US equity markets is

priced about 12% higher by the November

3rd US election day and then rises another

3% in the month beyond.

Equities


PERSPECTIVES | 5



US Sovereign bonds –

Neutral

The yield on US Treasuries has fallen to

about 0.2%. While still higher in yield than

other developed market government bonds,

their low price sensitivity to changes in

interest rates (duration), provides little

diversification in the event of a correction.

Investment Grade (IG)

bonds – Neutral

US: Citi analysts look for opportunities in

sectors that have been hit by COVID-19, but

where fundamentals still remain intact.

Europe: Yield differentials versus the US

have narrowed and Citi analysts prefer

cyclical sectors.

High Yield (HY) bonds –

Overweight US

US: “Fallen Angels” (HY downgraded to IG)

offer an interesting opportunity. Europe:

Spreads are cheap, though growth may

contract severely. ECB purchases could end

up indirectly supporting prices.

Emerging Market (EM)

bonds – Overweight

USD: Fundamentals have deteriorated, but a

lot has been priced in. Citi analysts favor

Asia and LatAm. Local currency: Yields have

fallen to lowest levels on record, though EM

FX remains volatile. Unhedged returns may

eventually benefit from a prolonged period of

Fed easing and USD weakness.

ECB providing

support to stimulate

growth

The European Union has unified around a

stronger fiscal expansion. The European

Central Bank (ECB) may now have a source

of credit demand growth to stimulate

economic activity. A weaker USD and

weakening of COVID-19 infections in the

region relative to the US may provide

support to depressed equity markets.

With close to 70% of overseas revenue

exposure, UK equities have been hit hard by

a combination of the global slowdown and a

delayed virus containment strategy. UK-

Eurozone trade negotiations are unlikely to

have progressed amid COVID-19 fears.

However, clarity on this or a delay in the

trade deadline (currently year-end) could

boost sentiment and lift a weak sterling.

A softer Yen may help

boost equities

Japanese large cap stocks sold off in March

along with global markets but have

rebounded more sharply, likely as a result of

seemingly lower levels of virus spreading

and less extreme economic shutdown

measures as well as ample stimulus. The

JPY has fallen since March, following Fed

measures to restore global liquidity,

removing a key headwind.

Fixed Income


PERSPECTIVES | 6



Overweight Global Equities and Underweight Bonds.

Gold and REITs remain Overweight while Cash remains Underweight.

After the COVID-19 collapse, massive stimulus has laid the foundations for a new economic

cycle. Citi analysts believe this is a new economic cycle and it is just six months old. The

larger economic recovery is still almost entirely ahead.

Citi’s strategy is to maintain a long-term commitment to “Unstoppable trends” in healthcare,

digital disruption, and Asia. They also favor selected cyclical sectors, and Global small/mid

caps which may have stronger returns over the next 12-18 months when markets normalize.

REITs – Overweight

Against a backdrop of sharply lower interest

rates, central bank credit easing steps and a

likely rebound in social engagement, Citi

analysts think many real estate assets may

be pricing in fairly extreme pessimism and

this could present opportunities.

Gold – Overweight

Given dramatic declines in global bond

yields, Citi analysts continue to see gold as

a hedge during volatile markets.

Commodities

Fixed Income Equities

Europe

Japan

Asia ex Japan

Emerging ex Asia

• Emerging EMEA

• Emerging Latin America

USGlobal Investment Grade

Global High-Yield

APAC ex Japan / EM

• Global Sovereign

• Corporate Investment Grade

Asset ClassWEIGHT

OVERWEIGHT

UNDERWEIGHT

Cash CommoditiesOVERWEIGHT

UNDERWEIGHT

UNDERWEIGHT

NEUTRAL

OVERWEIGHT

UNDERWEIGHT

OVERWEIGHT

REITs

OVERWEIGHT

OVERWEIGHT

OVERWEIGHT

UNDERWEIGHT

NEUTRAL

OVERWEIGHT

OVERWEIGHT

NEUTRAL


PERSPECTIVES | 7



Deeper fall, sharper

rebound

As the ravages of the COVID-19 pandemic

gradually wane in major parts of Asia, it

begs the question – how much recovery can

be envisioned? Once infection fears abate,

how much pent-up demand can power a

recovery? This needs to be balanced with

the longer term scarring that may result from

the impact of permanent losses of

income/savings, lasting behavioral and

policy changes and the transition costs

incurred as some businesses lose out more

permanently.

Global output is not expected to return to pre

COVID-19 levels until 2022, but Asia is

forecast to do so by Q4 2021. In Citi

analysts’ view, countries like China, Taiwan

Insights

Key Takeaways

• Compared to the Asian Financial Crisis (AFC), the relatively bigger plunge and lack of

comparable balance sheet vulnerabilities could lead to a sharper recovery by Asia this

time.

• The world has gotten used to having Asia led by China as an engine for global growth.

However, Citi analysts see five major sources of economic scarring that present

themselves as potential hurdles for Asia to return to pre COVID-19 trend growth.

• Much of these are not unique to Asia and with parts of Asia better managing the pandemic

and buffered by exposure to the dynamic technology sector, Asia as a whole is likely to

fare relatively better.

and Vietnam could bounce back even faster

having managed the virus well and as they

retain competitive advantages in production

of in-demand goods (e.g. electronics,

medical equipment).

With Asia expected to return to pre COVID-

19 levels within 2 years, the shape of the

recovery is assumed to be less protracted

than during the AFC, where it took an

average of three years for crisis-hit

economies to return to pre-AFC levels of

output.

Compared to the

Asian financial

crisis, Asia is

expected to see a

faster rebound this

time.

Asia’s Faster Rebound from COVID-19, but Scars Remain


PERSPECTIVES | 8



Chart 2: Asia’s technology exports far outperform non-

technology exports

However, the size of the economic shock is

analogous. Citi analysts estimate about

4.6% of lost annualized real output in Asia

before returning to pre COVID-19 levels. But

if outperformers like China, Taiwan and

Vietnam are excluded, the real output loss is

estimated at around 9%, which is slightly

below the 10.3% real output loss among the

five worse-hit economies during the AFC in

1997-2000.

Asia as a whole may be better off than

during AFC, with Asia banks being

significantly better capitalized, and an

absence of balance sheet vulnerabilities.

Asia is also buffered by strong global

technology demand. One sectoral winner of

social distancing has been the consumer

electronic exports, and thus EM Asia’s

electronic exports – accounting for about

36% of exports (ex India and Indonesia) –

have been outperforming.

Assessing Economic

Scarring

While a faster rebound to pre COVID-19

levels output is expected, Asia may face

significant hurdles to return to pre COVID-19

levels of trend growth. Citi analysts see five

sources of lasting economic scarring either

directly from the pandemic or exacerbated

by it:

1. Long-term unemployment and

underemployment that erodes skills,

leads to withdrawal from the labor force.

Some job losses may be structural due to

changing post COVID-19 behavior. Shifting

of shopping habits online could be net

negative for employment, alongside reduced

retail margins. E-commerce take off in Asia

this year appears highly uneven – more

pronounced in economics with strong IT

infrastructure (e.g. Korea, China, Singapore)

– but less so in other countries like Malaysia.

Automation / Artificial Intelligence (AI) may

also accelerate and post structural

challenges. China, next to the US, appears

to be at the forefront of competitiveness in AI

breakthroughs, along more developed part

of Asia (Japan, Singapore, Korea and

Taiwan), and could benefit from their role in

AI supply chains. However, while skilled

labor, particularly those that collaborate with

robots, may see improved productivity, some

may see displacement.

Source: Citi Research. As of 28 September 2020.


PERSPECTIVES | 9



4. Increased de-globalization tendencies.

Even prior to the pandemic, global value

chain participation has largely trended down,

partly reflecting China’s shift towards

increased on-shoring and domestic value-

added creation. US-China tensions and

trade interventions has exacerbated this

trend. Compounded by the pandemic,

supply chains are now increasingly about

resilience rather than focused on efficiency.

Technology decoupling and export controls

may lead firms to build bifurcated tech

supply chains – one catering to China and

another outside of China – at huge loss of

efficiency and increased cost pressures.

5. An increased role of the Chinese state

in the private sector, which could also be a

source of diminishing productivity growth.

Widening the role of state intervention in

industrial policies or functioning of the

private sector, could create risks if not

properly formulated and implemented to

address a specific market failure.

2. Heightened uncertainty could drag

down business investment. This could

lead to both aging of capital stock and

diminished labor productivity growth, in turn

impacting wages and living standards.

However, Asia’s bright spot is in the

technology space, with much stronger

demand driving renewed capital expenditure

(capex) cycles.

3. Capital misallocation from prolonged

low rates / loose liquidity. With the Federal

Reserve (Fed) expected to keep rates near

zero until 2023, this is likely to influence

monetary policy in Asia through the channel

of capital flows. Protracted monetary

accommodation could potentially led to

asset bubbles, particularly in the real estate

sector, and the propagation of zombie firms

that drag down productivity growth. There

are various definitions on a zombie firm, but

China’s State Council basically treats a firm

as a zombie if it is has made three years of

successive losses.

Chart 3: Share of Trade (in goods & services) to GDP has already peaked



PERSPECTIVES | 10



Conclusion – Lasting scars,

but unlikely worse than

other markets globally

The world has gotten used to having Asia

led by China as an engine for global growth.

But the lasting scars may lead to weaker

post-pandemic trend growth beyond what

Citi analysts have forecast without the

pandemic.

Citi analysts highlight five sources of

economic scarring. Much of these sources

are not unique to Asia except for the last

one.

The first two factors, labor slack and weaker

investment are highly pro-cyclical, with parts

of Asia better managing the pandemic and

buffered by its exposure to the dynamic tech

sector, Asia as a whole is likely to fare

relatively better.

GDP forecasts 2019 GDP 2020F GDP 2021F GDP

Pan-Asia 4.1% -1.4% 6.2%

China 6.1% 2.4% 8.2%

Hong Kong -1.2% -6.3% 2.8%

Indonesia 5.0% -1.5% 5.6%

Malaysia 4.3% -5.0% 7.0%

Philippines 6.0% -7.9% 7.0%

Singapore 0.7% -7.5% 6.0%

South Korea 2.0% -1.8% 2.6%

Taiwan 2.7% 1.7% 2.2%

Thailand 2.4% -8.6% 4.5%

Vietnam 7.0% 2.0% 7.0%

Chart 4: Citi’s Key Economic Forecasts for Asia



PERSPECTIVES | 11



World Market at a Glance

Source: Bloomberg, as of 16 October 2020.

Last price 52-Week 52-Week

16-Oct-20 High Low 1 week 1 month 1 year Year-to-date

US / Global

Dow Jones Industrial Average 28606.31 29568.57 18213.65 0.07% 2.05% 5.94% 0.24%

S&P 500 3483.81 3588.11 2191.86 0.19% 2.90% 16.53% 7.83%

NASDAQ 11671.56 12074.06 6631.42 0.79% 5.62% 43.66% 30.08%

Europe

MSCI Europe 437.39 492.21 306.80 -1.60% -2.71% -3.39% -9.93%

Stoxx Europe 600 367.48 433.90 268.57 -0.77% -1.51% -6.60% -11.63%

FTSE100 5919.58 7689.67 4898.79 -1.61% -2.61% -17.42% -21.52%

CAC40 4935.86 6111.41 3632.06 -0.22% -2.73% -13.36% -17.43%

DAX 12908.99 13795.24 8255.65 -1.09% -2.61% 1.89% -2.57%

Japan

NIKKEI225 23410.63 24115.95 16358.19 -0.89% -0.28% 4.17% -1.04%

Topix 1617.69 1747.20 1199.25 -1.80% -1.62% -0.85% -6.02%

Emerging Markets

MSCI Emerging Market 1124.08 1150.91 751.76 0.14% 0.63% 9.76% 0.85%

MSCI Latin America 1897.92 2988.77 1364.55 -1.34% -5.46% -29.94% -34.95%

MSCI Emerging Europe 130.23 201.86 100.91 -3.50% -9.68% -25.31% -32.52%

MSCI EM Middle East & Africa 209.65 271.86 158.71 -0.94% -3.52% -14.94% -21.65%

Brazil Bovespa 98309.10 119593.10 61690.50 0.85% -1.37% -6.75% -14.99%

Russia RTS 1132.80 1651.82 808.79 -2.71% -9.51% -15.93% -26.87%

Asia

MSCI Asia ex-Japan 741.83 752.00 495.22 0.26% 1.36% 17.02% 7.78%

Australia S&P/ASX 200 6176.79 7197.20 4402.50 1.22% 3.70% -8.31% -7.59%

China HSCEI (H-shares) 9914.90 11502.47 8290.34 3.09% 0.70% -5.86% -11.22%

China Shanghai Composite 3336.36 3458.79 2646.81 1.96% 1.60% 12.01% 9.38%

Hong Kong Hang Seng 24386.79 29174.92 21139.26 1.11% -1.37% -8.54% -13.49%

India Sensex30 39982.98 42273.87 25638.90 -1.30% 1.73% 3.59% -3.08%

Indonesia JCI 5103.41 6348.53 3911.72 0.98% 0.89% -17.28% -18.99%

Malaysia KLCI 1503.84 1618.01 1207.80 -1.73% -1.79% -4.51% -5.35%

Korea KOSPI 2341.53 2458.17 1439.43 -2.11% -3.87% 12.42% 6.55%

Philippines PSE 5898.47 8216.92 4039.15 -0.56% -0.81% -25.48% -24.53%

Singapore STI 2533.02 3285.72 2208.42 0.00% 1.11% -19.19% -21.40%

Taiwan TAIEX 12750.37 13031.70 8523.63 -1.06% -1.74% 14.22% 6.28%

Thailand SET 1233.68 1642.50 969.08 -2.64% -4.62% -24.52% -21.91%

Commodity

Oil 40.88 65.65 -40.32 0.69% 1.79% -23.39% -33.05%

Gold spot 1899.29 2075.47 1445.70 -1.61% -3.06% 27.46% 25.18%

Historical Returns (%)


12



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