Seeking Opportunities in Volatile Markets

By Paul Hodes, Florence Tan, Jaideep Tiwari, Tae-Hyon Ahn, Celestee Tan | June 2016

With global market volatility in 1H 2016, there have been definite winners and losers. Since its trough in mid-February 2016, oil price has increased 89%, crossing US$ 50/bbl, helping inflation to pick up modestly. Equity markets performance was mixed while gains from bonds range upward of 9%.

A soft earnings outlook leads us to retain only a modest overweight in equities. We believe that greater opportunities lie within selected sectors, as highlighted in this report.

The commodity complex has turned the corner, led by oil, and is unlikely to return to its 1Q16 lows. As Citi analysts warm up to the commodity theme, we prefer to express it via an overweight on the Energy sector. We are reluctant to chase any positive short term momentum in the Materials sector, as it may take a few years for the excess capacity, especially in the bulk commodities, to be absorbed.

The political and economic uncertainties arising from Brexit are likely to keep global policy rates low. This, coupled with a weak economic backdrop, bodes well for fixed income. Importantly, inflationary expectations are expected to remain contained.

In an environment where long term bond yields are expected to remain anchored, we believe that longer duration investment grade corporate bonds offer relatively attractive carry. High yield bonds are also expected to generate positive returns although we prefer to retain a quality bias within the sector.

On the currency front, Citi analysts expect USD strength in the short term but the upside may be more limited over the next 6-12 months. With Asian currencies expected to be weighed down by a weaker CNY, USD assets are likely to remain attractive for Asian investors.

The slower growth environment has potentially made investors more sensitive to risk events globally. The outcome of the UK vote to leave the European Union after 43 years of membership had surprised financial markets. Citi analysts are monitoring market developments but acknowledge that both risks and opportunities exist. While current market dynamics may be challenging, reforms in various markets could bring about positive changes.


Citi's Top 10 Themes


Although fears around a global recession have receded, global growth remains low. Citi expects global real GDP growth of 2.4% in 2016. Against a weak global growth backdrop, accommodative monetary policy may be needed to support equity markets.

  • Low growth tends to be accompanied by low interest rates. In a low/negative interest rate world, investors may be taking on more risk than they are used to. This adds to market volatility
  • The search for yield is likely to remain a dominant market driver for the rest of 2016 and potentially beyond
  • In a low growth environment, we remain highly selective. Our strategy continues to focus on high quality credits, dividends and selected equity sector opportunities


After a short-lived credit-fueled recovery in 1Q16, the Chinese authorities have re-affirmed their commitment to structural reforms. Citi analysts continue to favour sectors that are likely to benefit from China's ongoing economic transition.

  • The Chinese government is likely to continue focusing on cutting excess capacity, deleveraging, allowing unviable companies to fail and targeted infrastructure spending
  • Citi analysts continue to prefer H-shares over A-shares on the back of more attractive valuations and favour the Technology, Airlines and Consumer discretionary sectors
  • Citi analysts expect more CNY weakness ahead, which could in turn weigh on most Asian currencies in 2H16


Citi analysts believe that heightened Brexit uncertainty has raised the bar for normalisation in the US. Previous cycles prove that the path of tightening, and not the timing is more critical for market direction. With a gradual path of tightening expected, Citi analysts believe that the backdrop remains constructive for fixed income assets.

  • With a slower pace of rate hikes than previously expected, the impact of the actual lift-off may not be as severe as the market capitulation in 2013
  • Rising rates can lead to stronger equity market performance if accompanied by stronger economic and earnings growth
  • While emerging market (EM) currencies may come under more pressure from higher US rates, Citi analysts note that the current account positions are healthier now than during the previous market rout in 2013


Stabilising commodity prices may start to lift inflation readings in the second half of 2016. This is positive even if it leads to gradual rate hikes by the Fed. Rate hikes reflect greater confidence in the US economy, which can have spillover benefits for the rest of the world.

  • Citi expects US inflation to rise gradually while deflationary forces remain dominant in Japan
  • Post Brexit, the inflation outlook in Europe and the UK may be buffeted by conflicting forces of weaker currencies and slower economic growth
  • With only a modest rise in interest rates in the US, US investment grade credits remain attractive


Citi analysts expect broad USD strength for the rest of 2016 with Fed tightening and policy divergence re-emerging as major drivers. Longer term, global fundamentals and the evolving risk backdrop could matter more to the FX market than rate differentials.

  • Citi analysts see the GBP lower medium term as the UK economy adjusts to the Brexit outcome
  • Citi analysts expect USD strength in the short term but the upside may be more limited over the next 6-12 months
  • With Asian currencies expected to be weighed down by a weaker CNY, USD assets are likely to remain attractive to Asian investors


Although fears around a global recession have receded, global growth remains low. Citi expects global real GDP growth of 2.4% in 2016. Against a weak global growth backdrop, accommodative monetary policy may be needed to support equity markets.

  • Citi's current forecast of 2.4 for global economic growth is consistent with Earnings-Per-Share (EPS) growth of 2.7 in 2016
  • Given the low interest rate environment in most economies, the dividend yields from equities are likely to remain attractive to investors
  • Within Emerging Markets, we favour Asia over CEEMEA and LatAm. Asia remains attractively valued and continues to have the best earnings story in the region


Rising oil prices, structural trends and shifting dynamics reveal selected sector opportunities. Citi analysts are overweight Energy, Technology and Health Care.

  • We are Overweight Technology as it scores well on free cashflows and balance sheets remain strong
  • Expectations of a higher oil price mean we upgrade Energy to Overweight. The sector is trading at a 40% discount to MSCI World, while dividend yield of 4% appears attractive
  • Amongst the defensives, our favourite is Health Care. Recent underperformance has brought valuations back into attractive territory


Citi analysts expect yields to be anchored as the bar for the Fed's normalisation rises post Brexit. Investment Grade and High Yield credits remain attractive from a risk reward perspective.

  • Inflationary pressures are projected to remain weak. This supports our favourable view on longer duration assets as the US yield curve flattens further and long-dated Treasury yields remain anchored near current levels
  • Pockets of opportunities still exist in US Investment Grade corporates, especially in Financials and Energy-related sectors
  • Citi analysts favour both the US and European High Yield markets. Energy-related sectors remain attractive, though performance will be reliant upon stability in crude oil prices


Commodities have turned the corner and are unlikely to return to their early 1Q16 lows.

  • Citi analysts believe Brent crude oil may continue to stay above $50 a barrel in 3Q16 and around $65 by the end of 2017
  • Gold is likely to reaffirm its safe haven status in 2H16 on the back of increased volatility. Further signs of demand stabilisation in China point to a supportive 2H16 for Copper
  • Citi remains bearish on iron ore, and expect iron ore prices to average $47/t for the full year of 2016. We are neutral on Agriculture and think a price recovery is likely into 2017/18


Investors are no strangers to individual events which have affected markets in recent years. Some examples include Brexit, the Chinese currency regime and the UK referendum on EU membership. This section highlights some key events which Citi analysts are monitoring globally and their potential implications for markets.

  • The slower growth environment has made investors more sensitive to potential risk events globally
  • While current market dynamics may be challenging, this could be a catalyst for change. The reforms being undertaken in China, Saudi Arabia and India, if successful, are likely to be positive for their economies and markets in the longer term
  • The decisions of the Fed are likely to have greater impact on the trajectory of the US economy, than the outcome of the US presidential election

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