August 2012

Dont get carried away with growth fears

The dominant theme of slower growth persists, but Citi analysts think the sources of growth concern has shifted West-ward amidst signs that Chinas growth has stabilized in 2Q12, while focus may now be centred on persistent data disappointments in the US. Indeed, there are five reasons why Citi analysts do not expect a prolonged downturn in Asia.

Dont get carried away with growth fears

Growth worries migrate from China to the US
The dominant theme of slower growth has not changed, but the sources of growth concern have shifted West-ward. Chinas growth momentum has managed to avert the worst fears producing a 7.6% YoY GDP growth in 2Q12 with momentum stabilizing via help of policy easing. Nonetheless, Chinese policymakers clearly cannot be complacent. While there are signs infrastructure investment pickup has helped support fixed asset investment (FAI) growth, other segments like property/construction are still weak, and even as new loans an important leading indicator for economic activity picks up, likely with the help of kick-starting government projects, Citi analysts remain concerned that the share of medium- to long-term loans have fallen slightly from 35% to 32% in June, suggesting that some of the loan growth remains fragile to reversal without continued policy support, especially given weakness in the export markets.

While leading indicators do not point to a compelling turnaround in China, coincident activity indicators such as the acceleration of FAI and retail sales growth for the second consecutive month in June and the lagged impact of policy easing (Citi expects one rate cut, two more reserve requirement ratio (RRR) cuts, some relaxation of loan-deposit ratio (LDR) restrictions, continued pick up in fiscal spending), could ensure some mild rebound in the second half of 2012. There are some promising signs that housing starts, cement and new loans have picked up, but despite signs of infrastructure pick up, this has not been enough to boost steel production given lingering excess capacities, and the outlook for industrial production and exports are still looking rather fragile. Citi analysts think the newer concern now is the decelerating growth we are seeing out of the US, as economic data continues to disappoint, with sharp slowing of momentum in consumption and worries that the upcoming US elections and uncertain global backdrop could point to a still weaker than expected momentum in 2H12. Not only has the US ISM manufacturing index receded to sub-50 reading for the first time since mid-2009, prospects for income growth supporting consumption has been somewhat dashed by the disappointing pace of non-farm payrolls. Thus, from a commodity-heavy slowdown on a China hard landing, Citi analysts think we are now moving towards a more conventional cyclical slowdown in the region led by US growth concerns.

Expecting a slowdown, not catastrophe

While Asia appears poised for a slowdown, barring a major financial shock, Citi analysts expect only a shallow and short-lived slowdown for the reasons below. #1 No double-dip recession is expected in the US Slowdown risks in the US have risen, but Citis base case is for no double-dip recession. While US growth in 2Q12 is looking weaker than expected, some upside from housing and moderately better labour gauges counterbalanced by weaker business investments ahead of the November Presidential elections could continue to keep growth in an expansionary mode, albeit at a slower pace. #2 Asias financial system continues to function well Citi analysts do not see any signs of a financial shock in the region, which tends to prolong downturns. Despite lingering signs of European bank deleveraging, Asias local financial system appears in relatively good shape, and even amidst European bank deleveraging, the ability to maintain lending growth and intermediate lower real rates look relatively healthy for many as reliance on cross-border funding is relatively limited, plus prospects for loan substation from non-European/regional bank players are high. Exposures to European ex UK banks are also not very high outside of Singapore and Hong Kong, and have been declining. Even in Singapore and Hong Kongs case, Citi analysts think this is highly distorted because of its role as a regional financial centre not just of local banks but global banks as well

Dont get carried away with growth fears

#3 Domestic demand drivers appear to be holding up While the manufacturing/export outlook may seem more challenging, Citi analysts have yet to see signs of a material impact on labour markets that would dampen income expectations and consumption growth, especially as receding inflation pressures (so far, barring continued oil/food price shocks) cushion real incomes. While this may be a lagging indicator, so far, unemployment rates are still close to historic lows in many countries. Consumer confidence indicators in the more dynamic domestic economies of Philippines, Indonesia, Thailand, and even China, have also held up fairly well. Moreover, the recent acceleration of retail sales and FAI growth in China gives some confidence that domestic demand there may be turning, albeit only mildly. #4 Room for counter-cyclical policy easing alive and well Despite surfacing concerns about food inflation (which many are keeping a close eye on), Citi analysts think there is still sufficient room for central banks in the region China, India, Korea, Philippines and Thailand to cut interest rates and for others to keep rates on prolonged hold at low levels.

On the fiscal front, Citi analysts believe there is sufficient room for easing in many countries, though most are still keeping their powder dry. Outside of South Asia, many Asian countries have room for counter-cyclical fiscal stimulus to support growth but only a few have visibly started with additional fiscal spending. The fiscal constraints, however, are particularly acute in South Asia. For example, in the first two months of fiscal year 2013, Indias budget deficit is already 27% of the fiscal year deficit target, up 8.3% YoY. This highlights considerable fiscal slippage. However, most of East Asia has sufficient fiscal room. So far, only Malaysia (given pre-election spending), Thailand (though this is now losing momentum) and Vietnam (various fiscal relief for industries/small and medium-sized enterprises) have announced additional fiscal stimulus. The key country to watch is China. There has been a lot of talk that China will announce additional stimulus but Citi analysts argue that Chinas fiscal stance this year is already relatively simulative, with a budget deficit roughly about 2.5% of GDP versus 1.3% of GDP in 2011. In 1H12, the budget balance (official definition) is still in surplus to the tune of 1.9% of GDP, though this may be somewhat seasonal (1H11 saw a budget surplus of 2.6%). The good news is that revenues appear to have outperformed, up 12% YoY when the full year program has revenue growth of 10.5% YoY. So, while the pace of spending looks like it has outperformed its target, +21% YoY in 1H12 relative to the 9.3% expenditure growth target for the full year, if revenues sustain outperformance, there is room for expenditures to ramp up beyond the target. Thus, Citi analysts believe China still has room to increase net fiscal deficit spending by over 3% of GDP in 2H12. Alongside a more accommodative monetary stance, Citi analysts think policymakers may not announce extra fiscal stimulus at this juncture. #5 Inventory overhang looks milder than last year, especially in electronics Even as exports/shipments could potentially slow on global growth challenges, Citi analysts do not expect a significant inventory build-up that could catalyze abrupt de-stocking, especially in the electronics cycle, which tend to a be a significant driver of the export/manufacturing cycle in parts of Asia (especially Singapore, Malaysia, Philippines and Korea). Unlike last year when we had some inventory build-up, especially in the electronics cycle by mid-2011, which amplified the export slowdown amidst worsening Eurozone concerns; this time around, electronics leading indicators, while softening, look in better shape. Inventory-to-shipment ratios in Korea and Taiwan do not look unusually elevated relative to history, and especially in Singapores case, electronics exports appear to have moved beyond production which could signal leaner inventory.

Nonetheless, when Citi analysts look at the broader manufacturing outlook, uncertainties about global demand lingers. Despite surprisingly resilient exports, Chinas industrial production growth has disappointed mostly this year. Based on recent PMI finished goods inventory relative to new orders, Citi analysts believe China may still have a bit more broader inventory de-stocking to go. But all in all, risks to Asias electronics de-stocking cycle may be much shorter this time around, notwithstanding softer final demand.

Chart 1:

Chart 2:

S&P 500 Index

45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 1-Mth YTD 1-Yr 3-Yr*
*Denotes cumulative performance

Dow Jones Stoxx 600 Index

39.68%

9.68% 1.26%

6.74%

18% 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% -4%

16.22%

6.89% 4.06%

-1.46% 1-Mth YTD 1-Yr 3-Yr*

*Denotes cumulative performance

Performance data as of 31 July 2012 Source: Bloomberg

Performance data as of 31 July 2012 Source: Bloomberg

United States
Fed likely to focus on easing in coming months
Expansions pace appears to have slowed to a meagre 1.5% or less in 2Q12. Although some softening reflects payback from temporary factors, the pullback in hiring and retail sales has raised doubts about 2H12. Consumer finances have benefited from slowing inflation and easier credit, while numerous housing indicators are pointing higher. But the upside appears checked for now by economic policy uncertainty and ongoing fiscal drag. Citis base case assumes the US will avoid massive fiscal tightening in 2013 but meaningful restraint from the public sector is still likely next year and beyond.

Euro-Area
90% probability of a Grexit over the next 12-18 months
While market pressure is rising rapidly especially on Spain Moodys decision to put Germany, the Netherlands and Luxembourg Aaa ratings on Negative Outlook imply that the core and softcore countries may also be increasingly affected by the crisis. Taking into account the increasing reluctance in core countries to provide extra support to Greece and the problems of the Greek government to implement the existing programme, Citi analysts have increased the probability of Grexit in the next 12-18 months to about 90% from 50%-75% previously.

With more negative news on the economy, inflation may undershoot the Worries about financial headwinds from Europe and the threatened 4% US fiscal cliff amid already subpar growth have pushed the Federal Reserve (Fed) closer to another major easing step. Although Operation Twist has been extended, officials are weighing a new lending effort or asset purchases as well as enhanced communications. Citi analysts do not rule out an early August move but September seems more likely. European Central Banks (ECB) target of below, but close to 2%. Citi expects the ECB to cut the refi rate to 0.5% in 3Q12, and by a further 25 bps in 4Q12. Regarding non-standard measures, Spain and Italy are expected to request support from the European Financial Stability Facility/European Stability Mechanism, and the ECB could then provide more multi-year long-term refinancing operations (LTROs) and also extend the eligible collateral pool. A variety of metrics, including sentiment, valuation, implied earnings expectations, and credit conditions have been instrumental to the more bullish stance outlined in late June, and thus one can derive that a higher beta tilt to portfolios may be appropriate. Moreover, nearer-term triggers like the Citi Economic Surprise Index and high intra-stock realized price correlation argue for the recent rally to continue. If we look at historical data, industry groups such as Diversified Financials, Autos, Insurance, and Materials have demonstrated high beta over the past five years relative to low beta areas such as Telecom Services, Utilities, Pharma & Biotech, and Food & Staples Retailing. The Utilities sector has also been raised to Neutral from Underweight. Outside Spain, Citi analysts see reduced earnings risk across this group Having said that, while Citi analysts believe that higher beta names could outperform, they do not favour Autos and Materials given European economic woes. Instead, Insurance and Diversified over the next 12 months and relative earnings trends for the sector have recently turned positive. Finally, Citi analysts have lowered the Oil & Gas sector to Underweight (from Neutral) as they continue to see an uninspiring combination of low growth and low returns. Citi analysts have raised Media to Overweight (from Underweight) and lowered Health Care to Neutral (from Overweight). In their view, the Media group offers exposure to defensive growth at a reasonable price. For instance, while the Media sector earnings have performed in line with Health Care over the past 12-15 months, price performance has lagged. As such, Citi analysts believe there is an opportunity for that relative performance to reverse somewhat in the coming months.

Financials are their preferred plays for beta positioning.

Chart 3:

Chart 4:

Topix Index
5% 1.06% 0% -5% -10% -15% -20% -25% 1-Mth YTD 1-Yr -22.51% 3-Yr* -12.49% -4.39%

MSCI Asia ex Japan Index

20% 16.16% 15% 10% 5% 0% -5% -10% -15% 1-Mth YTD -12.49% 1-Yr 3-Yr* 3.55% 7.27%

*Denotes cumulative performance

*Denotes cumulative performance

Performance data as of 31 July 2012 Source: Bloomberg

Performance data as of 31 July 2012 Source: Bloomberg

Japan
Growth may slow in 2014 due to tax hike
Economic growth in this year and next could be pushed up to an above 2% pace by reconstruction demand from the earthquake and frontloaded spending ahead of the consumption tax hike. But GDP growth in 2014 will inevitably slow sharply due to a payback to frontloaded spending and erosion in real household disposable income driven by tax hikes. Citi expects a sharp contraction in GDP right after the tax hike in April 2014, which could in turn make the second tax hike slated for October 2015 less likely.

Asia Pacific
Most central banks likely to remain on hold
The theme of slower growth continues to dominate, though the source of growth worries appears to be shifting from China to the US. After rate cuts by China and Korea, Citi analysts think risks are now tilted towards Philippines, Singapore and Thailand to ease monetary policy. Others are likely to remain on prolonged hold.

Asian exporters have kept their currencies broadly stable against both USD and CNY but this is unlikely to be sustained if domestic data continues to weaken and USD strengthens as expected over the

Citi expects additional Bank of Japan (BoJ) easing in late October. But the most likely measure may be to raise the ceiling for short- and longer-term JGB purchases under the asset purchase programme. A reduction in the interest rate on excess reserve appears unlikely given the Governors stance, and the hurdle for extending the maturity of JGBs that the BoJ purchases also appears high.

medium term. As such, export intensive Asian currencies, in particular the Korean Won (KRW), Taiwan Dollar (TWD) and Philippine Peso (PHP) are expected to face the largest downside risks.

August and September have historically been the heaviest months of corporate earnings revisions post the mid-year results. The latest revisions have taken on the same pattern as in prior years. With

Citi analysts believe capex and in particular, in-out merger and acquisition (M&A) are likely to increase in FY12. In the BoJs Tankan survey, manufacturers say they plan to increase capex by 7.2% in FY12. Management sentiment deteriorated in the wake of the March 2011 disaster, resulting in capex being held below depreciation costs. However, management sentiment has since improved, and capex is likely to rise, in part as a rebound after previous curtailment.

Institutional Brokers' Estimate System (IBES) expectations still running at 13.8% for this year, Citi analysts see room for disappointment. They expect earnings-per-share (EPS) growth to come in between 4-8% for this year. But markets already appear to be pricing in much weaker earnings revisions than we have seen thus far.

The worst revisions are in Taiwan, China and Thailand. By sector, the worst near term revisions have been with the Material and Energy

Indeed, the number of in-out M&A by Japanese firms appears to be recovering. If the pace seen since the start of the year continues, in-out M&A numbers would hit a record level in 2012. Citi analysts see three main reasons for the increase in in-out M&A: 1) management sees the need to make forays overseas from the standpoint of long-term growth as the domestic population is declining; 2) the yen is strong at around 80/$; and 3) the emergency facility to combat yen strength set up by the government in August 2011 is being used.

space. Compared to historical revisions versus price-to-book, Hong Kong, Singapore, Taiwan and Thailand are all pricing in a significant worsening of revisions. Banks, Real Estate and Technology are pricing in worse revisions than what we have currently, while Consumers are priced for significantly better revisions. Overall investor positioning remains very cautious with the relative performance or risk versus quality only having been worse in 1997/98, 9/11 and SARS.

Chart 5:

MSCI Emerging Markets Index

15% 10% 5% 0% -5% -10% -15% -20% 1-Mth YTD 1-Yr 3-Yr* -16.28% 1.62% 3.94% 12.85%

Positive on High-grade corporates and Emerging market debt

US Treasuries
Citi analysts expect yield curves to flatten, and for gains to be potentially generated in the intermediate- to longer-dated maturity range.

US Corporates
A strengthening technical backdrop, large cash balances, low default rates, decreasing net issuance, and a smaller universe of safe haven assets continue to remain supportive. Meanwhile, although high yield valuations have become more attractive, Citi analysts remain cautious due to festering concerns in Europe and expectations that global growth will continue to slow. As such, they selectively favour high quality, double-B rated issuers and select single-B rated issuers with strong fundamentals.

*Denotes cumulative performance

Performance data as of 31 July 2012 Source: Bloomberg

Emerging Markets
Outlook for CEEMA equities appears challenging
CEEMEA1 remains hostage to growth and deleveraging risks from the Eurozone. In fact, Citis growth forecasts for the Czech Republic, Slovakia, Ukraine and Kazakhstan have all been taken down slightly for 2012/13, reflecting weak European demand and retrenchment by European banks.

Euro Bonds
As global growth slows further and heightened uncertainties persist, high quality government bonds in safe haven markets, particularly UK Gilts are likely to be well-supported.

In Latam, stability appears to be still the name of the game when it comes to monetary policy (except in Brazil). Resilient growth has kept most central banks in "wait-and-see" mode but Citi analysts continue to expect easing later in the year.

Emerging Market Debt

Increased corporate bond issuance in emerging markets may present opportunities to pick up yield while benefiting from stronger domestic growth.

While Citi analysts expect some CEEMEA currencies, like the Czech Koruna (CZK) and Turkish Lira (TRY), to regain some lost ground, others, particularly the Hungarian Forint (HUF), Israeli Shekel (ILS), and Russian Ruble (RUB) are forecast to remain under pressure. Meanwhile in Latam, the Chilean Peso (CLP) is expected to weaken in the medium term given that its currency is intimately linked to both copper prices and the weakening Chinese economy, and the central bank has turned more dovish recently.
General Disclosure Citi analysts refers to investment professionals within Citi Research (CR), Citi Global Markets Inc. (CGMI) and voting members of the Citi Global Investment Committee. Citibank N.A. and its affiliates / subsidiaries provide no independent research or analysis in the substance or preparation of this document. The information in this document has been obtained from reports issued by CGMI. Such information is based on sources CGMI believes to be reliable. CGMI, however, does not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute CGMI's judgment as of the date of the report and are subject to change without notice. This document is for general information purposes only and is not intended as a recommendation or an offer or solicitation for the purchase or sale of any security or currency. No part of this document may be reproduced in any manner without the written consent of Citibank N.A. Information in this document has been prepared without taking account of the objectives, financial situation, or needs of any particular investor. Any person considering an investment should consider the appropriateness of the investment having regard to their objectives, financial situation, or needs, and should seek independent advice on the suitability or otherwise of a particular investment. Investments are not deposits, are not obligations of, or guaranteed or insured by Citibank N.A., Citigroup Inc., or any of their affiliates or subsidiaries, or by any local government or insurance agency, and are subject to investment risk, including the possible loss of the principal amount invested. Investors investing in funds denominated in non-local currency should be aware of the risk of exchange rate fluctuations that may cause a loss of principal. Past performance is not indicative of future performance, prices can go up or down. Some investment products (including mutual funds) are not available to US persons and may not be available in all jurisdictions. Investors should be aware that it is his/her responsibility to seek legal and/or tax advice regarding the legal and tax consequences of his/her investment transactions. If an investor changes residence, citizenship, nationality, or place of work, it is his/her responsibility to understand how his/her investment transactions are affected by such change and comply with all applicable laws and regulations as and when such becomes applicable. Citibank does not provide legal and/or tax advice and is not responsible for advising an investor on the laws pertaining to his/her transaction.

Citi analysts have an end-2012 target of 4,300 on the MSCI Latam index. Although earnings-per-share (EPS) growth appears to be slowing, policy flexibility implies that the region can weather the European economic slowdown. They favour Brazil and Peru, and prefer the Financials, Telecoms and Consumer Discretionary sectors.

While the CEEMEA region is attractively valued, there is reason for continued caution given relatively weak growth and higher exposure to the Euro Area. Under such conditions, Citis preferred market is South Africa thanks largely to its strong and resilient earnings growth outlook. Their end-2012 target for the MSCI EM EMEA index stands at 350.
1. CEEMEA is the collective term for Central and Eastern Europe, Middle East and Africa.

US Presidential Elections and Equity Market Performance

The US Presidential elections are just three months away (November) and the race remains tight between incumbent Barack Obama and challenger Mitt Romney. In this months issue, we take a peek at how the S&P 500 index historically performed during the Presidential cycle. Average S&P 500 Performance by Year in Presidential Cycle Since 1900

Source: Haver and Citi Research US Equity Strategy. As of July 24, 2012

The Presidential election cycle typically argues for a good year in equities in both the third and fourth year of a Presidents term, even though it did not hold true in 2008 (-38.5%) and 2011 (0.0%). Thus far in 2012, the S&P 500 is up around 6% year-to-date 24 July.

Average S&P 500 Performance after Incumbent Re-Election/Loss by Year in Presidential Cycle Since 1900
35% 30.5% 30% 25% 20% 15% 11.2% 10% 5% 1.2% 0% -0.3% -5% Year 1 Year 2 Year 3 Year 4 7.4% 8.7% 2.7% 13.2%

Average after incumbent wins re-election

Average following an incumbent loss

Notes: Franklin D. Roosevelt's last term is counted as Truman's first term and is not included in any incumbent averages. Years in Nixon's and McKinley's 2nd terms are not included in the incumbent averages if they did not serve for more than half of the year in question. The time served by their successor was counted as the successor's first term Source: MSCI, Datastream and Citi Investment Research and Analysis. As of June 13, 2012

Historically, in the year following an election, challenger wins tend to be more rewarding and this tends to be nonpartisan. But in general terms, Energy, Health Care, Utilities, Coal Miners and Defence sectors tend to fare better under Republicans, while Environmental and Generic Pharmaceuticals tend to fare better under Democrats.

Source: Citibank N.A., Singapore Branch, Regional Wealth Management.

Spotlight on Allocations

Spotlight on Allocations

Citi analysts refers to investment professionals within Citi Research (CR), Citi Global Markets Inc. (CGMI) and voting members of the Citi Global Investment Committee. Citibank N.A. and its affiliates / subsidiaries provide no independent research or analysis in the substance or preparation of this document. The information in this document has been obtained from reports issued by CGMI. Such information is based on sources CGMI believes to be reliable. CGMI, however, does not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute CGMI's judgment as of the date of the report and are subject to change without notice. This document is for general information purposes only and is not intended as a recommendation or an offer or solicitation for the purchase or sale of any security or currency. No part of this document may be reproduced in any manner without the written consent of Citibank N.A. Information in this document has been prepared without taking account of the objectives, financial situation, or needs of any particular investor. Any person considering an investment should consider the appropriateness of the investment having regard to their objectives, financial situation, or needs, and should seek independent advice on the suitability or otherwise of a particular investment. Investments are not deposits, are not obligations of, or guaranteed or insured by Citibank N.A., Citigroup Inc., or any of their affiliates or subsidiaries, or by any local government or insurance agency, and are subject to investment risk, including the possible loss of the principal amount invested. Investors investing in funds denominated in non-local currency should be aware of the risk of exchange rate fluctuations that may cause a loss of principal. Past performance is not indicative of future performance, prices can go up or down. Some investment products (including mutual funds) are not available to US persons and may not be available in all jurisdictions. Investors should be aware that it is his/her responsibility to seek legal and/or tax advice regarding the legal and tax consequences of his/her investment transactions. If an investor changes residence, citizenship, nationality, or place of work, it is his/her responsibility to understand how his/her investment transactions are affected by such change and comply with all applicable laws and regulations as and when such becomes applicable. Citibank does not provide legal and/or tax advice and is not responsible for advising an investor on the laws pertaining to his/her transaction.

GENERAL DISCLOSURE DISCLOSURES

COUNTRY SPECIFIC DISCLOSURES document is distributed in Australia by Citigroup Pty Limited ABN 88 004 325 080, AFSL 238098. For a full Australia : This
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