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Special Feature on Market Volatility

Feb 6, 2018
Wealth Management Investment Strategy Team, GCB HK
Sell-off in US stocks 2

Sell-off in US stocks
S&P 500 Index
► US stocks plunged following a surge in bond yields, triggered by
heightened inflation expectation.
► The Dow Jones Industrial Average fell 1175pts, or 4.6%, to 24,345,
the biggest decline since Aug 2011. The S&P 500 Index fell 113pts,
or 4.1%, to 2,648.
► The VIX Index spiked 84% on Monday.

Citi analysts’ view

► Citi analysts caution that oil prices may start to head lower as early
as Q2 2018. This may help to lower inflation expectations. Source: Bloomberg L.P., data as of Feb 5, 2018

► The speed of the rise and subsequent market selloff tells us

VIX Index
markets may move fast in their corrective mode now.
► 1) Once market define the new trading range for US 10-year yields,
then cross-market implied volatility may start to fall.
► 2) When implied volatility in equities starts to fall, the worst of the
correction may be out of the way in US and global equities.

Investment Strategy
► Be Prepared for Market Volatility, Continue to Diversify into different
asset class.
► Look for buy-on-dip opportunities in EM equities and European Source: Bloomberg L.P., data as of Feb 5, 2018
Equities, EM Bonds, corporate bonds.

Please note and carefully read the Important Disclosure on the last part
Our stance – A correction, not bear market 3

Asset Performance
Dec 31 2016 - Jan 26 2018 Jan 26 – Feb 5 2018
S&P 500 Index 28.3% S&P 500 Index -7.8%
Nikkei 225 23.6% Nikkei 225 -8.9%
Hang Seng Index 50.7% Hang Seng Index -6.5%
HSCEI 46.1% HSCEI -6.3%
Shanghai Comp. 14.6% Shanghai Comp. -3.7%
STOXX Europe 600 10.8% STOXX Europe 600 -4.6%
US Gov't Bond Index ^ 1.1% US Gov't Bond Index ^ -0.6%
World IG Corp Bond Index ^ 4.2% World IG Corp Bond Index ^ -0.5%
EM Gov't Bond Index ^ 10.3% EM Gov't Bond Index ^ -0.1%
US HY Bond Index ^ 8.2% US HY Bond Index ^ -1.0%
US Dollar Index -12.9% US Dollar Index 0.6%
COMEX Gold Futures 17.4%
COMEX Gold Futures -0.7%
WTI Crude Oil Futures
WTI Crude Oil Futures -4.1%

Source: Bloomberg L.P., data as of Feb 5, 2018

 Global Equities have enjoyed a year-long rally, with US stocks posting a return of 28% (Dec 31 2016 - Jan 26 2018)
and HK stocks up 51%.
 Citi analysts expect global real GDP growth at an above-consensus 3.4% in 2018 the highest rate since 2010.
 Continued strength in the global economy suggests another year of synchronised earnings growth. Global EPS
expected up 12% in 2018.
 As such, we believe the recent 5-8% decline in equity markets is likely to be a correction, not the beginning of a
bear market.

Please note and carefully read the Important Disclosure on the last part
Bear Market Checklist – Only 3.5/18 Factors Flashing Sell 4

Bear Market Checklist

 Our Bear Market Checklist (link) helps us
compare current global market variables to
those before previous major downturns.

 In January 2018, only 3.5/18 factors are

flashing sell compared to 17.5/18 in 2000 and
13/18 in 2007.

 The Bear Market Checklist may not tell us that

another short-term correction in global equities
is imminent, but it may tell us what to do when
that correction occurs. Right now, it is likely to
tell us to buy the next dip.

as of Jan 4, 2018

Please note and carefully read the Important Disclosure on the last part
Past Experience of a 1-day Sell-off in US stocks 5

S&P 500 Performance Following One-Day

US stocks tend to recover following a Declines Since 1962
substantial 1-day sell-off

 Drops of greater than 4% have a tendency to

rebound but fundamentals may be needed to
generate a pickup later this year.

 In the past, a better-than-random probability of

a bounce occurs when sharp daily declines are
experienced. Nonetheless, fundamentals may
be needed to support a renewed rally.

 On average, S&P 500 rebounded 2.69% after

60 days of a sharp daily decline of greater than
4% and the probability of a rebound is 65%.

Source: Haver Analytics and Citi, as of Feb 5, 2018

Please note and carefully read the Important Disclosure on the last part
Markets dips seen as buying opportunities 6

Asset Allocation
-2 -1 0 +1 +2
Core equities  -2 = Very underweight
► Developed Markets
► Emerging Markets  -1 = Underweight
Core Fixed Income
► Developed Sovereign  0 = Neutral
► Developed IG Corporate
 +1 = Overweight
► Developed Corporate HY
► EM Sovereign  +2 = Very overweight
Other Assets
► US Equities
► European Equities
► Asia ex Japan Equities
► Japanese Equities
Source: Citi, as of Jan 24, 2018

 Citi continues to view markets dips as buying opportunities.

 Markets and sectors that offer strong earnings momentum and reasonable valuations
include the Emerging Markets, as well as the global Financials and Materials sectors.
 Citi analysts are overweight on EM equities, European equities, corporate bonds and
EM bonds.

Please note and carefully read the Important Disclosure on the last part
Opportunities in Equities 7

 Global Equities
Global Equities Performance Break-Down
► Unlike in the late 1990s, the global equity rally has been driven
more by earnings than a re-rating of valuations. Based on 12 month forward
PE and EPS.
► Within sectors, higher 10-year Treasury bond yields may mean that
Financials outperform Technology, although Citi currently remains
overweight on both sectors.

 EM Equities
► EM equities may experience heightened volatility as the US dollar
finds support in the near term, but valuations and fundamentals
remain attractive over the medium term.
► EM is currently trading at a 30% Price to Earnings discount to the Source: Citi, IBES, Datastream, as of Feb 5, 2018
US and earnings are expected to grow 14.7% in 2018.
Estimated Price-to-Earning ratio of equity markets (x)
 European equities 18 17.0
► Economic growth is broadening to encompass all sectors and euro 16
area member states. The euro area’s economic sentiment index 14.0
14 13.5
reached 114.7 in January, close to an 18-year high. 12.9
► Citi’s analysis suggests that the stronger euro is more likely to 12

temper European inflation than European growth. 10

► While Italian election and German coalition issues may weigh on

performance in the near term, Citi analysts expect this to pass in
the coming months. 6
US Europe Emerging Asia ex JP Hong Kong China
► Europe is currently trading at a 20% discount to the US and Citi Market

sees upside to current consensus earnings growth forecast of 8% Source: Bloomberg L.P., as of Feb 5, 2018
for 2018.
► European equites (ex-UK) boast near 4% dividend yields.
Please note and carefully read the Important Disclosure on the last part
Opportunities in Equities 8

 HK Financial stocks
HK stock market Average Daily Turnover (Million HKD)
► HK Banks: Into 4Q17, the biggest positive for HK banks’ Net
Interest Margin is the rally in HIBOR (+39bps qoq), together with
higher LIBOR (+11bps) and rebounded SHIBOR (+26bps), we
expect HK banks’ NIM to be well supported.
► HK system loan growth outpaced the rest of Asia in 2017, up 14.7%
YTD in Nov 2017, after slower 2015 and 2016.
► We are comfortable with our high-single-digit to low-teens loan
growth for HK system in 2018.
► Loan growth in HK is robust across the segments, led by offshore,
commercial property and lending to financial institutions.
► HK stock market: Average Daily Turnover has further risen to over
Source: Bloomberg L.P., as of Feb 6, 2018
HK$158bn YTD from HK$107bn in 4Q17 (HK$88bn FY17)
► Southbound ADT grows (now c.7% of total ADT) and global fund
China equity market cap, new economy vs old economy
inflow possibly sets in.
► Past bull markets suggest current ADT may have further upside.

 HK-listed IT equities
► Overweight IT as new economy accounts for a bigger portion of
China equity market cap.
► IT is one of the fastest growing sectors in China, and are likely to
deliver 25-30% yoy EPS growth over the next two years. Quality
names with good track record to stand out.

Source: Bloomberg L.P., Citi., as of Dec 11, 2017

Please note and carefully read the Important Disclosure on the last part
Opportunities in Fixed Income 9

EM Bonds and HY outperform IG amid the surge in bond yield

EM Bonds


10-year Treasury yield • W 10-year

Source: Bloomberg L.P., as of Feb 1, 2018

 YTD, 10-year Treasury yield rose from 2.4% to 2.84%. EM Bonds and HY clearly outperform IG
during this period.
 Against rising interest rates, IG corp future returns may become more challenging.
 Within bonds, high yields and emerging market debt are expected to provide more buffer (credit
spread) against rising interest rates.
 For HY, while yields have fallen, a decrease in default rate reflects improvement in fundamentals.

Please note and carefully read the Important Disclosure on the last part
Citibank Wealth Management
Weekly Investment Insight
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