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Citibank 2009 Investment Outlook: Volatility in Near Term; Opportunities in Later Half


Market uncertainty to dominate in the near-term but Citi analysts continue to overweight equities over 12-month period, favouring US and emerging markets

Investors encouraged to use the bottoming process of equities to rebalance portfolios back to long-term allocations.

Singapore – The world is now in the middle of a global recession and financial markets remain under stress. Major industrial economies, in particular, are expected to contract well into the year, with the first half characterized by continued market volatility.

Mitigating this cautious outlook is the fact that many asset markets already seem to have priced in very negative outcomes. Moreover, global governments are responding in a three-pronged approach by cushioning the real economy, stabilizing risk appetites and improving the financial system.

As such, Citi analysts view 2009 as a year of two halves: In the near term, investment returns are likely to be driven by ongoing trends of economic contraction, policy easing and de-leveraging, resulting in highly volatile financial markets.

At some point in the year however, the extreme valuations seen currently in equity and credit markets should provide attractive opportunities, as downside risks to economic growth dissipate and de-leveraging pressures ease.

While economic growth is likely to remain below trend for now, global equities should find a base in 2009 on anticipation of economic stabilization. This may gain a further boost with a pickup in corporate earnings in 2010 as economic recovery, albeit moderate, takes hold.

Because Citi analysts believe that the bottoming of equities is likely to be a process, rather than a singular event, they recommend that long-term investors use the bottoming process to begin a series of rebalancing in their portfolios back to their long-term allocations or enter the accumulation phase for long-term equity exposure.

Citi analysts are keeping their overweight recommendation to stocks over a 12-month period. Regionally, they continue to favor the US and emerging markets. With bonds, they prefer investment-grade corporate bonds to developed-country sovereign debt. While high yield bonds are enticing, Citi analysts believe it may be too early to increase exposure.

Said Mr Salman Haider, Managing Director and Head of Wealth Management, Citibank Singapore Limited: "We expect equity markets to complete the bottoming process this year if current policies succeed. Investors can expect significant volatility in the first half; and provided we see economic headwinds receding in the latter half, we could be setting the base for the market to recover.

“As always, and even more so in this environment, risk management will be key. Investors should not be shunning any asset class altogether, or become enamored with single bets. It is therefore important that investors review their portfolios accordingly, with diversification at the centre of their investment strategy.”

On the Singapore economy, our Citi economist forecasts negative growth of 2.8 per cent for 2009, with risks still to the downside. Our inflation forecast was lowered further to –0.9 per cent, reflecting a deflationary environment. However, we believe some temporary supply side-driven deflation may not be a negative, if it helps restore a measure of the cost competitiveness that was eroded in the period of high inflation last year.
Highlights from the 2009 Investment Outlook:
Global Equities

* Opportunities in value stocks: Although a meaningful global economic recovery is likely only in 2010 if current policies are successful, market performance should anticipate this, translating into a potential turnaround in share prices in the latter half of this year.

While growth stocks have historically provided shelter for investors when entering a recession, investors should find opportunities in value stocks which, by virtue of low valuations, outperform growth stocks as the recession ebbs. In Asia, the region historically bottomed out between 21 and 23 months after the valuation peak (third quarter 2007 in this cycle), suggesting a trough may be reached in the second half of this year.

Citi analysts are keeping their overweight recommendation to stocks over a 12-month asset allocation period. They continue to favor the US and emerging markets.
* Global infrastructure: Investors can also look to the global infrastructure sector, which should benefit from government focus on fiscal programs around the world.

Fixed Income

* Investment grade corporate bonds favored: Down-beaten high-grade corporates offer opportunities with attractive valuations. By contrast, Citi analysts are less positive on high yield bonds as high-yield defaults are likely to increase given the weak economic outlook.
* Cautious on government bonds: With long-term interest rates having fallen dramatically, government bonds, treasuries and high-grade sovereign debt appear to offer little long-term value. In addition, government debt issuance is likely to rise next year to fund expansionary monetary policies but this increased supply may not be met by a rise in demand, tempering any further rise in government bond prices.

Distressed Assets

* Normalizing credit markets: With 2009 looking to be a year of two halves, the transition between the two distinct stages could be catalyzed by distressed asset investors who notably, were key to the normalization of credit markets in Asia during the 1997-98 financial crisis.

The entry of distressed asset investors provides an opportunity for banks to once again generate liquidity on their balance sheets by selling assets, allowing for the broader financial system to begin to reverse the credit tightness that has dominated the global economy in the past year.

The current global financial market backdrop, characterized by high equity market volatility and wide credit spreads, have historically been favorable for distressed asset strategies. Citi analysts believe the current downturn may translate into attractive prospects for the distressed asset space over the next two to three years.


* US dollar and yen to strengthen: Risk aversion and the recessionary outlook are causing investors and companies to sell assets they bought with dollar loans in a process called de-leveraging. As they do so, they buy back dollars to repay the loans, raising demand for the currency. However, unprecedented easing by the Fed along with huge fiscal spending should eventually put the dollar on a depreciation path.

Given Japan’s low interest rates, the yen was a favored funding currency for foreign investments but market volatility and narrowing interest rate differentials have prompted a reversal of those carry trades. This unwinding is expected to continue well into 2009, lending further strength to the yen.
* Euro and sterling weak, Asian currencies likely to decline in Q1: The euro-area and UK economies appear headed for a more severe downturn than the US and this is likely to drag down the euro and sterling pound against the dollar.

Asian currency weakness may also continue over the rest of the first quarter on concerns over China’s slowdown, among others. However, if financial risks recede and economic activities stabilize in the US and Asia from the second half of the year, we expect emerging Asian currencies as a group to resume the trend of modest appreciation against the US dollar.


* Investor demand tempered in the near term: It appears that recent investor demand for gold as a safe haven has had to contend with an opposing force: the liquidation of gold holdings to meet other cash needs.

Additionally, US dollar strength could temper investor demand in the near term. The price of the metal has tended to have a negative correlation with the US dollar, rallying during times of US dollar weakness and vice versa. Citi analysts have a price forecast of US$825/oz in 2009 and US$900/oz in 2010 for the metal.


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