global asset allocation | 2019 - mashreq bank€¦ · support em assets. we therefore prefer em...

Annual Outlook

GLOBAL ASSET ALLOCATION | 2019

Contents

Overview .............................................................................................................................................................. 1

Macro backdrop ................................................................................................................................................... 1

Asset allocation strategy ................................................................................................................................... 2

Equities

Global

Recap 2018: An eventful year ............................................................................................................... 4

United States

Stimulus fades, but growth remains..................................................................................................... 4

Political risks remain .............................................................................................................................. 4

Fading effect of tax reforms to take a bite on earnings ..................................................................... 5

Trade war still in the limelight .............................................................................................................. 5

Volatility makes a comeback ................................................................................................................ 5

Rate hikes: Fed vs Trump ....................................................................................................................... 5

Normalising valuations .......................................................................................................................... 6

Europe

European equities slump ....................................................................................................................... 6

Germany: Politically stable ................................................................................................................... 6

Italy: Fading budget concerns ............................................................................................................... 6

France: Could overshoot budget deficit target ................................................................................... 6

Low interest rates to continue despite the end of QE ....................................................................... 7

Trade spat to keep a lid on markets ..................................................................................................... 7

Earnings and valuations seem appealing ............................................................................................. 7

Neutral on European equities ............................................................................................................... 7

United Kingdom

UK: Offers compelling dividend yield ................................................................................................... 8

Japan

Japan: Stimulus intact ............................................................................................................................ 8

Emerging Markets & Others

EM equities seem overdone .................................................................................................................. 9

India: Overvalued amidst general elections in 2019 .......................................................................... 9

China: Enough ammunition to deal with headwinds ahead ............................................................ 10

Pakistan: Gaining traction on compelling valuations ....................................................................... 11

Brazil: Expectations of pro-market policies to drive markets .......................................................... 12

Russia: Economic framework and oil prices should remain favourable for growth ...................... 12

Mexico: Policy uncertainty to affect the investment climate ......................................................... 13

Turkey: Macro concerns persist .......................................................................................................... 13

South Africa: Structural problems and political risks remain intact ............................................... 14

Egypt: Flexible currency and the tourism sector to boost economic competitiveness ................ 15

GCC: Stuctural reforms to underpin equities .................................................................................... 15

UAE: Reforms and growth to drive indices higher ............................................................................ 15

Saudi Arabia: EM index inclusion and a record budget to boost optimism .................................... 16

Oman: Lack of structural reforms to weigh on equities ................................................................... 17

Kuwait: EMs' passive inflows are key growth drivers ...................................................................... 18

Bahrain: Aid supports economic stability .......................................................................................... 18

Fixed Income

Central Banks

Major central banks to gradually tighten liquidity ........................................................................... 19

FOMC maintains steady guidance ...................................................................................................... 19

US Fed hikes percolate through GCC banks ...................................................................................... 20

ECB caps monetary support ................................................................................................................ 20

Lack of clarity on Brexit puts BOE in dilemma .................................................................................. 21

Bank of Japan in wait and see mode .................................................................................................. 21

Developed Markets

2018: Bond market returns swing into the red ................................................................................. 21

Treasuries to act as a cushion amidst rising volatility...................................................................... 22

Bund yields set to rise .......................................................................................................................... 22

Budget proposals weigh on Italian and French bonds ...................................................................... 22

Portuguese bonds outshine ................................................................................................................. 23

Brexit to influence gilts ....................................................................................................................... 23

Emerging Markets

EM debt set to comeback .................................................................................................................... 23

EM positioned well for upside ............................................................................................................ 23

Russia: Well prepared for uncertainty ............................................................................................... 24

China: Economic rebalancing continues ............................................................................................ 25

Brazil: Central bank to hold interest rates ......................................................................................... 25

GCC outperformed EMs ....................................................................................................................... 25

Credit Markets

US IG credits spreads to grind tighter ................................................................................................ 26

Fallen angel risk .................................................................................................................................... 27

EU credits- focus on financials ............................................................................................................ 27

Commodities

Oil & Gas

2018: A volatile year for oil markets.................................................................................................. 28

Fears of oil supply glut ......................................................................................................................... 28

US becomes the top oil producer ....................................................................................................... 28

Oil demand may ease in 2019 ............................................................................................................. 29

Brent–WTI spread to narrow ............................................................................................................... 29

OPEC cuts production .......................................................................................................................... 29

Natural gas: Higher production limits upside .................................................................................... 30

Precious Metals

Several tailwinds for gold in 2019 ...................................................................................................... 30

Silver may ride gold’s coattails ........................................................................................................... 31

Platinum to be in supply surplus......................................................................................................... 31

Palladium: Riding high ......................................................................................................................... 31

Industrial metals likely to experience a challenging year................................................................ 32

Copper: Easing demand overshadows supply shortfall .................................................................... 32

Aluminium: Looming oversupply risk ................................................................................................. 32

Nickel: China steals the lustre ............................................................................................................ 33

Zinc: Benefitting from supply shortfall .............................................................................................. 33

Agricultural Commodities

Coffee: Bumper harvest floods the market........................................................................................ 33

Soyabean: Caught in the US–China spat ............................................................................................ 33

Sugar price ready to rally .................................................................................................................... 34

Currencies

Developed Markets

USD: On a softening mode .................................................................................................................. 35

EUR: Softening in USD could support EUR ......................................................................................... 36

GBP: Brexit uncertainty masks its upside potential .......................................................................... 37

JPY: Ailing banking sector questions over BOJ’s ubiquitous easing policy ..................................... 37

CAD: Cautious monetary policy tone amidst benign oil prices ....................................................... 38

Emerging Markets

EM currencies to benefit from improving external financial position and a weaker USD ........... 38

INR: Election uncertainty underwhelms positive economic outlook ............................................. 39

CNY: Slowing growth warrants more liquidity ................................................................................. 40

BRL: Fixing pension liabilities will be the key catalyst for BRL ........................................................ 40

MXN: To stay volatile amidst policy uncertainty ............................................................................. 40

TRY: Susceptible to weak macroeconomic conditions .................................................................... 41

ZAR: Elections and reforms remain in focus ...................................................................................... 41

Sustainable Investing ......................................................................................................................................... 43

Charts ................................................................................................................................................................... 46

Tables ................................................................................................................................................................... 49

Glossary ............................................................................................................................................................... 53

Annual Outlook – 2019

GLOBAL ASSET ALLOCATION

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Overview The global economy marked another year of steady expansion in 2018, though some divergence of growth was witnessed across advanced economies. The strong performance of the US economy driven by large fiscal stimulus was the key contributor to global growth. In contrast, Euro zone growth momentum faded, particularly in the second half of the year. Uncertainty over Brexit was a dominant theme and negatively affected sentiment. Several emerging economies, including China, were buffeted by growing concerns over escalating trade protectionism. More importantly, the US Federal Reserve’s ongoing monetary tightening and the stronger dollar induced high volatility across the globe. Fading risk appetite was evident from the correction in equities and wider risk premiums in corporate credit markets. The impact was more pronounced in emerging markets, where local currencies depreciated sharply on account of substantial capital outflows, before showing signs of stabilisation towards the end of 2018.

Moving ahead into 2019, we expect the global economic expansion to continue, albeit at a gradual pace as the US economy slows slightly. The Eurozone and China are also anticipated to grow at a slower pace. Should the global economic expansion continues, the major central banks may maintain their policy normalisation stance. The European Central Bank (ECB) and the Bank of England (BOE) are expected to tighten their monetary policies in 2019 to anchor any inflationary pressure led by the ongoing rise in wage growth in both economies. While the Bank of Japan (BOJ) has committed to remain accommodative for now, it may tweak its policy towards normalisation later in the year to support its banking sector. In contrast, the Fed looks set to ease the pace of its tightening in order to mitigate the downside risk of slowing growth and expectations of benign inflation due to favourable energy prices so far.

Aside from central bank policy, some of the events which are expected to further guide financial markets in 2019 include developments over the United States-Mexico-Canada Agreement (USMCA), the outcome of the ongoing US-China negotiations, European Parliamentary elections, and Brexit. Global trade policy remains the key risk, with China being the main driver of global growth which is expected to decelerate due to weaker trade and structural adjustments. However, if the trade conflict gets resolved, the downside risk to the global economy could eventually fade as the year progresses. Alongside this, Brexit is another global event with an uncertain outlook which could be a major factor influencing investor sentiment. Elections in emerging markets (EMs), including India, Indonesia, South Africa and Argentina are likely to stir volatility.

MACRO BACKDROP

The US economy displayed solid growth at an average annualised pace of 3.9% q/q each in 2Q18 and 3Q18, reaping benefits from large tax cuts and fiscal spending. However, this momentum is likely to moderate as the effect of fiscal stimulus begins to fade by 2H 2019. Also, with dwindling spare capacity, businesses are experiencing input price pressures due to tariffs and wage growth. However, inflation is unlikely to deviate significantly from Fed’s target of 2%.

After two years of robust growth, Eurozone economic activity has been through a soft patch in 2018, dropping to the lowest rate in four years in 3Q18. Nevertheless, stronger employment and wage growth are expected to encourage higher consumer spending. This, coupled with an accommodative ECB monetary policy stance, should support economic growth in 2019 amidst Brexit uncertainty.

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GLOBAL ASSET ALLOCATION


Going forward in early 2019, the lack of clarity over the UK’s future relationship with the EU is expected to continue to stifle business investments and export growth. The UK growth outlook remains a function of how Brexit will unfold.

ASSET ALLOCATION STRATEGY

Navigating through 2019, equity markets around the globe will continue to face challenges, owing to slower economic growth. However, we believe the US economy still benefits from its current expansionary cycle, albeit in the late stages. Normalising valuations in the US and European markets offer investors attractive opportunities. As a result, we hold Neutral view on US equities, with a Positive Tilt. Considering political risks from Italy and Brexit, we are Neutral on Europe including the UK. Emerging markets (EMs) could see rising inflows, supported by tailwinds from growth opportunities, a weaker dollar and compelling valuations following 2018 rout. Additionally, favourable oil prices and signs of reversal in local currencies should support EM assets. We therefore prefer EM assets over DMs and are particularly Positive on Brazil, Saudi Arabia, Egypt and Pakistan.

Riskier parts of fixed income assets, typically the developed market's high-yield corporate bonds, may experience some pressure as volatility continues due to the gradual withdrawal of stimulus by the major central banks. Meanwhile, with prospects of slowing global growth and low inflation expectations becoming more apparent, the safe-haven appeal of sovereign bonds and demand for high quality corporate bonds should remain intact. We are Neutral with a Positive Tilt on Treasuries and Positive on corporate investment-grade bonds. Improving fundamentals in many EMs, along with an inflection in EM currencies, could act as potential catalyst for the outperformance of hard currency EM debt, which offers compelling yields. Furthermore, any moderation in the US-China trade conflict would be supportive for sentiment.

The turbulence in energy markets is expected to continue in 2019 due to fears of the global economic slowdown and rising US oil production. That being said, we believe the upward pressure on oil prices will build up gradually over the course of the year as a result of production cuts implemented by OPEC along with less supply expected from Venezuela, Iran and Libya. OPEC has also indicated that it will not shy away from further cuts to keep the oil market in balance. Moreover, the inability of the Permian drillers to sustain lower crude prices may keep their supply growth in check. Thus, we are Positive on oil and expect Brent crude oil prices to trade between $65 and $75/bbl range in 2019. We prefer gold amongst precious metals due to its safe-haven appeal and our view of a relatively weaker US dollar going forward.

The USD may weaken as the Fed gradually begins to slow the pace of monetary tightening. The downside risk of the recent increase in the fiscal and current account deficits may become more visible in the face of moderating US economic growth. Thus, we are Cautious on USD. However, we are Neutral with a Positive Tilt on the EUR driven by rate differentials and of course the weakening of the USD. We hold a Cautious stance on the GBP amidst Brexit uncertainty. We are Positive on the JPY as the country's depressed financial sector may warrant higher yields, which remains in focus for the BOJ. We are Neutral with a Positive Tilt on EM currencies as it is likely to benefit from a benign USD in 2019.


ASSET CLASS VIEWS CHART


#IG – Investment grade, HY – High yield; EMs – Emerging Markets

Asset Allocation Strategic Tactical

Source: Mashreq Bank Source: Mashreq Bank

CAUTIOUS NEUTRAL POSITIVE

Equities

Fixed Income

Commodities

US

Europe ex-UK

UK

EM ex-GCC

GCC

SUB-CLASS

US Treasuries

Euro (Bunds)

UK Gilts

US IG#

US HY#

Europe IG

EMs#

Precious Metals

USD

EUR

GBP

EMs#

ASSET CLASS

Main Asset Classes

Equities

Fixed Income

Commodities

Currencies

Oil

Industrial Metals

45%

30%

10%

15%

Equities Fixed Income Commodities Cash

45%

30%

15%

10%

Equities Fixed Income Commodities Cash

Annual Outlook | 2019

EQUITIES


Navigating through 2019, equity markets around the globe will continue to face challenges, owing to slower economic growth. However, we believe the US economy still benefits from its current expansionary cycle, albeit in the late stages. Normalising valuations in the US and European markets offer investors attractive opportunities. As a result, we hold Neutral view on US equities, with a Positive Tilt. Considering political risks from Italy and Brexit, we are Neutral on Europe including the UK. Emerging markets (EMs) could see rising inflows, supported by tailwinds from growth opportunities, a weaker dollar and compelling valuations following 2018 rout. Additionally, favourable oil prices and signs of reversal in local currencies should support EM assets. We therefore prefer EM assets over DMs and are particularly Positive on Brazil, Saudi Arabia, Egypt and Pakistan.

RECAP 2018: AN EVENTFUL YEAR Global equity markets started 2018 steadily, but quickly lost ground in the first quarter as fears of rising interest rates in the US and the initial barrage of tariff imposition between the US and China weighed on sentiment. Markets however pulled back, driven by US equities, displaying resilience until 3Q. Subsequently the EMs suffered, as falling currencies along with rising rates in the US led to material outflows. Overall, US equities led the global markets performance for most of the year, driven by the strong performance in tech sector stocks and a robust economy, before fears of an economic slowdown and rising geopolitical risks pulled the markets down drastically towards the end of the year. Altogether, 2018 proved to be a disappointing year for global equities, with the MSCI ACWI Index, which includes both DMs and EMs, retreating about 11% over the year, with the MSCI World Index (DMs) down about 10% and the MSCI EM Index falling even further by around 17%.

Exhibit 01: Major MSCI Indices

Source: Bloomberg, Rebased as on 1st January 2018

STIMULUS FADES, BUT GROWTH REMAINS With the Fed reiterating its commitment to normalizing policy, economic growth is expected to moderate. The IMF expects US GDP growth to soften to 2.5% in 2019, compared to 2.9% in 2018. The signs of slowing growth were evident as the US Treasury yield curve (2s-5s) inverted briefly for the first time in 10 years in early December, thereby increasing recessionary fears. The rise in interest rates and resulting higher

borrowing costs could impact capital investments going ahead. Furthermore, the fiscal deficit has been on a rise as revenues remain constrained from tax cuts. The Conference Board’s Leading Economic Index readings from the past 2-3 months indicate a slowing economic trend.

Exhibit 02: US Leading Indicators

Source: Conference Board, Markit

Nonetheless, we still expect the US economy to deliver another decent year. The current economic cycle, while appearing in its late stages of growth, is still expected to move in the positive direction. The US economy continued to perform exceptionally well in 2018, on the back of an expansionary fiscal policy. Indeed, 2Q GDP growth of 4.2% was the highest in nearly four years. The economy has been performing at nearly full capacity, with the unemployment rate at 3.7%, the lowest since 1969. Consumer confidence has been soaring, which reached an 18-year high in October. US wage growth has been steadily climbing, with the current level of ~3% trending at nine-year highs. The business activity index as measured by the composite PMI continues to trend within healthy bands, albeit demonstrating a slight softening.

POLITICAL RISKS REMAIN The November mid-term elections resulted in the Democrats regaining control of the House of Representatives, while the Republicans kept control of the Senate. The bipartisan nature of the government now opens more room for disagreements on key issues such as government funding. A democratic majority in the House also likely signals heightened political risks, given their power to open up investigations into

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MSCI World MSCI Emerging MarketMSCI US MSCI Europe

US rate hikes fear

1st round of tariff hikes

Trade war intensifies

Slowdown concerns in US

Major US sell-off

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Dec-15 Jun-16 Dec-16 Jun-17 Dec-17 May-18 Nov-18

US Leading Indicators Index US Composite PMI (RHS)

Growth has tapered off


EQUITIES


controversial issues surrounding President Trump’s tax filings and links with the Russian government. Apart from the tussle with the Democrats, the markets may face risks from Trump’s unpredictability in handling matters of national and economic significance. The resignation of Defence Secretary Jim Mattis over the decision to withdraw US troops in Syria and Afghanistan puts US foreign policy under the spotlight.

FADING EFFECT OF TAX REFORMS TO TAKE A BITE ON EARNINGS The stock market rally in the past two years was underlined by excellent growth in corporate earnings, which managed to consistently surprise market expectations with ~75% of S&P 500 earnings reported above the estimates for the past four quarters. In 2018, corporate earnings were boosted by the tax reforms with financials, industrials, materials and technology sectors being the top performers. However, going forward, earnings growth is expected to slow down, presumably as interest rates rise, risks of a larger trade dispute grow, the effects of tax reforms fade, and global growth momentum eases. According to Thomson Reuters, the earnings growth rate from 1Q–3Q 2019 is estimated to slow down to mid-high single digits after growing >20% for the past three quarters.

Exhibit 03: Corporate Earnings Expectations – S&P 500

Source: Thomson Reuters, *Forecasted

TRADE WAR STILL IN THE LIMELIGHT The impact of the ongoing trade war between the US and China has been an overarching theme in every major market in the world. The US has now imposed tariffs on $250bn worth of Chinese goods, with China reciprocating by imposing their own tariffs on US goods. Having said that, the two countries have recently struck a conciliatory tone, after agreeing not to escalate the trade war for 90 days starting from December 1st, while China also recently cut tariffs on US auto imports. However, it would be too early to conclude that a resolution is in sight. Notably, according to the

IMF, the impact of the trade spat is anticipated to be higher on US real GDP than on China.

Exhibit 04: Impact of Trade War on Real GDPs

Source: IMF

VOLATILITY MAKES A COMEBACK Market volatility remained at lower levels for the better part of 2018, before staging a return in December. The CBOE Volatility Index (VIX) reached its highest levels in December since February 2018 as growth concerns and trade war fears rose. The VIX averaged 16.6 in 2018, compared to 11.1 in 2017 and 15.8 in 2016. Interestingly, volatility has been on a persistent rise over the past couple of months, a trend unlike previous historical examples, where markets displayed sufficient resilience to absorb temporary shocks. We believe volatility would continue to be a dominant theme in 2019, as investors might look to shift focus from high-growth sectors to value-driven ones in the face of persistent volatility.

Exhibit 05: VIX Index

Source: Bloomberg

RATE HIKES: FED VS TRUMP The Federal Reserve hiked benchmark interest rates for the fourth time in December 2018. While the Fed projected two more hikes in 2019 (instead of three earlier), the general consensus of financial markets is for no rate hike. The Fed made a downward revision in its economic growth outlook by 0.2% to 2.3% for 2019. At a time when fears of a slowdown have taken centre-stage, the Fed’s rather less-dovish stance rattled markets. With President Trump’s open criticism of the Fed decision, the future path of

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24%

32%Earnings losing steam

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0.0%Japan US China World USMCA

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Jan-17 May-17 Sep-17 Jan-18 May-18 Sep-18 Dec-18

Persistent rise in volatility


EQUITIES


rate hikes could become less clear yet.

NORMALISING VALUATIONS With stock prices getting battered towards the end of 2018, market valuations now stand at almost five-year lows. The S&P 500 forward P/E stands at 15.4x, slightly lower than the 10-year average of 17.8x. Although attractive, we advise caution as volatility concerns continue to weigh heavily on these valuations. In addition, moderating economic growth could further adjust these valuations to a lower level.

Exhibit 06: S&P 500 1-Yr Forward P/E

Source: Bloomberg

Overall, we see a mixed picture on US equities, where a fundamentally strong economy is balanced by risks that we are in the late stages of the business cycle (implying slower growth ahead). Valuations have undergone substantial corrections, thereby limiting the scope for downside. Hence, we are Neutral on US Equities with a Positive Tilt.

EUROPEAN EQUITIES SLUMP European equity markets lagged their US counterparts for the better part of the year as concerns over growth and US–China trade tariffs along with idiosyncratic political risks mainly from Italy and UK weighed on markets. The newly formed government in Italy has proven to be Europe’s newest problem child as it grapples with anaemic growth.

Exhibit 07: European Markets Performance


Additionally, the outcome from Brexit remains as uncertain as it had been at the beginning of the

year. We briefly describe our views on three major economies in Europe, combined with key themes, which would likely dominate markets in 2019.

GERMANY: POLITICALLY STABLE The German economy remains the bellwether state for the European Union. The widely followed Ifo business climate index fell to a two-year low in December as company executives dimmed their outlook on increasing trade concerns. The Deutsche Bundesbank lowered its GDP growth forecast to 1.6%y/y (from 1.9% earlier) for 2019. Having said that, we believe consistently declining unemployment (from 6.9% at January 2013 to 5.0% at November 2018) coupled with low interest rates and rising wages and salaries (from 3.9% at 3Q16 to 5.0% at 3Q18) should help the German hold steady in the near term, as consumption is likely to emerge as a main driver of growth, offsetting tepid exports. Politically, Germany offers a stable government, despite rising populism fuelled by anti-immigration parties.

ITALY: FADING BUDGET CONCERNS Italy remained one of the biggest sources of political risk for the EU in 2018. The new government has been at loggerheads with the EU over the 2019 budget deficit. Italy has the second largest debt/GDP ratio (132% as of 2017) in Europe, thereby leaving the government with narrow room for any budgetary leeway. After the EU rejected Italy’s initial budget draft for 2019, which saw the budget deficit rising to 2.4% of GDP, it approved the final draft that lowered the deficit to 2.0%. This compromise involves major spending cuts, thereby constraining GDP growth. The government scaled back its growth expectations to 1.0% in 2019 from an initial 1.5%.

FRANCE: COULD OVERSHOOT BUDGET DEFICIT TARGET Europe’s second largest economy has been besieged by political protests over rising costs of living against the Macron government. These ‘yellow vest’ protests, which largely impacted the year-end holiday sales season, could potentially fuel populist measures, such as wage rises, and pension increases, etc. The concessions already made by the French government to accept the demands of anti-government protests could likely overshoot the budget deficit over the EU’s 3% of GDP limit in 2019, which would likely result in greater friction with Brussels.

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5.0

10.0

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25.0

08 10 12 14 16 18

10 Yr Average

84.7

79.0

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80.2 82.1

75.0

85.0

95.0

105.0

115.0

Jan-18 Mar-18 May-18 Jul-18 Aug-18 Oct-18 Dec-18

STOXX 600 Germany FranceItaly Spain


EQUITIES


Exhibit 08: Euro zone Unemployment Rate and Wage Growth

Source: Eurostat

LOW INTEREST RATES TO CONTINUE DESPITE THE END OF QE The ECB ended its massive quantitative easing programme in December, thereby ending a stimulus spanning two years and €2.5tn. The monthly asset purchase programme, along with the ECB’s previous programmes, including Long-Term Refinancing Operations (LTRO), was instrumental in pulling the Eurozone out of recession since the sovereign debt crisis. However, the ECB intends to reinvest the proceeds of maturing bonds purchased under the programme for an extended period, which means the degree of accommodation in Europe will remain significant, even after the official asset purchase programme comes to an end. Meanwhile, the ECB downgraded its 2019 GDP growth forecast for the Eurozone from 1.8% to 1.7% in December. The inflation forecast for 2019 also remains well below the ECB’s 2% target. The ECB has vowed to keep interest rates unchanged until summer 2019, and market participants expect interest rates to remain broadly stable over the course of the entire year. Meanwhile, business growth seems to have come under pressure, with the PMI for November 2018 (51.4) reaching a four-year low.

Exhibit 09: Euro zone PMI

Source: Markit

TRADE SPAT TO KEEP A LID ON MARKETS As the US followed up on its threat of imposing tariffs on Chinese goods, the matter quickly escalated into a global trade war, involving

multiple continents. Europe too was not spared, as Trump imposed duties on steel and aluminium, and has further threatened to tax European car imports, particularly from Germany. This put the entire sector under pressure with original equipment manufacturers being amongst the hardest hit, as their P/E ratios fell to multi-year lows relative to the broader market. We view the trade spat as a risk to equities as it could adversely impact Europe’s anaemic growth picture.

EARNINGS AND VALUATIONS SEEM APPEALING European markets have generally lagged their global peers’ performance over the past year. The MSCI Europe Index lost around 13% in 2018, compared to the MSCI US Index (down 6%). The uncertain political and economic environments were largely responsible for substantial outflows from European markets. Having said that, markets are currently offering attractive opportunities based on their valuations. Market valuations for the STOXX 600 currently stand below the 10-year average. Moreover, the steep market fall in December resulted in market valuations at a 5-year low. On the earnings front, growth expectations for 2019 remain solid, with 1Q19, 2Q19 and 3Q19 earnings growth forecasted at ~6%, ~8% and ~5%, respectively, according to Thomson Reuters.

Exhibit 10: STOXX 600 1-Yr Forward P/E

Source: Bloomberg

NEUTRAL ON EUROPEAN EQUITIES The events of 2018 left investors little to cheer as European markets ended 2018 as one of the worst years since the global financial crisis, with the STOXX 600 down ~13%. The European equity market performance in 2019 is subject to both global and domestic developments, including trade policies, global financial conditions, Brexit uncertainty and evolving political risks. Weak global trade conditions and growth concerns in China could exacerbate growth-starved European economies. Nonetheless, the ECB’s reinvestment

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%

%

Unemployment Rate Wage Growth (RHS)

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Jan-17 May-17 Sep-17 Jan-18 May-18 Aug-18 Dec-18

Manufacturing PMI Services PMI

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13.5

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13 14 15 16 17 18


EQUITIES


programmes of maturing bonds and dim prospects of a rate hike in 2019 could lend support to European equities. Attractive valuations in Europe could therefore offer investment opportunities.

UK: OFFERS COMPELLING DIVIDEND YIELD UK equities had a choppy ride in 2018 as political leaders in the UK and EU scrambled to reach an agreement over the Irish border, the last hurdle that decides the future relationship of the UK and the EU. As the Brexit deadline drew closer, the sell-off in equities intensified, losing ~15% since mid-August. Such pressure on equities was not seen before or even after the Brexit referendum that took place in June 2016.

Exhibit 11: FTSE 100 1-Yr Forward P/E

Source: Bloomberg

The FTSE 100 index lost 12.5% in 2018, although this was more or less in line with other European markets. The index is trading at a PE of 11.9x based on the 12-month earnings forecast, reflecting a discount of 17% compared to the last five years’ average multiple. However, UK equity valuations remain in line with other European markets, such as the German DAX (12.2x), STOXX 600 (13.2x) and French CAC 40 (12.2x).

In terms of dividend yield, UK equities look quite compelling compared to other developed markets. Consensus expects a dividend yield of 5.2% in 2019 for the FTSE 100, more than that of the CAC 40 (4.1%), DAX (3.9%), Nikkei 225 (2.3%) and the S&P 500 (2.3%). Thus, we are of the view that UK equities may gain traction in 2019, most probably post 1Q19 when the UK begins to exit from the EU and markets get more clarification over the future relationship with Brussels. Until then, equities may continue to trade with a downward bias. However, we believe the downside should be less pronounced as equities appear to have largely discounted the fall in the British pound (depreciated 12% versus the USD since the referendum). The pound remains the key driver for UK equities, as roughly 70% of revenue for FTSE 100 firms come from

overseas and 48% of FTSE 100 market capitalisation reports in the US dollar. Therefore, we are Neutral on UK equities.

Exhibit 12: UK Offers Highest Dividend Yield in DMs in 2018

Source: Bloomberg

Fundamentally, the UK has not reaped much benefit from the tailwinds stemming from strong US growth as well as the recovery in the Eurozone over the last two years. That being said, UK macro data has surprised more on the upside than the downside despite Brexit uncertainty. The unemployment rate remains at a historical low. As a result, retail sales and wage growth have been rising, surpassing expectations. Inflation risk has also subsided as lower oil prices are anticipated to bring it to below the central bank’s target of 2.0% from 2.3% currently. GDP grew 0.6% q/q in 3Q18 following 0.4% growth in 2Q18, although the growth outlook remains highly uncertain amidst increasing risk of a ‘No Deal’ Brexit. During the meeting in December 2018, the Bank of England revised its 4Q18 growth to 0.2% (vs. 0.3% earlier) while stating similar growth for 1Q19. For 2019, the bank expects 1.7% growth, assuming a smooth withdrawal from the EU. In the case of a ‘Hard’ Brexit, GDP is expected to collapse by 8% and unemployment to rise from the current level of 4.1% to 7.5%. Meanwhile, as per the IMF, even a ‘soft’ exit would lead to long-run output losses of around 5–8% of GDP due to higher tariff and non-tariff trade barriers, lower migration and reduced foreign direct investment. As a result, the IMF expects UK growth to be just above 1.5% in 2019.

JAPAN: STIMULUS INTACT After a correction in early 2018 induced by the global sell-off, Japan’s benchmark Nikkei index regained strength in March and catapulted to a 27-year high in October. Continued earning upgrades (+22% in 2018), currency depreciation and Abe’s re-election were all factors that reignited investor confidence in Japanese equities. Buoyant economic indicators such as falling unemployment rates as well as improving wage

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and export growth also shored up sentiment. However, markets came under pressure in December over global growth concerns, and this dragged the market down by 12% in 2018.

Moving into 2019, Japan is not immune to global geopolitical concerns. However, substantial political capital, underpinned by Prime Minister Abe and his party’s majority in both the houses of parliament, could be leveraged to endure most headwinds. Moreover, corporate governance reforms initiated by the government are anticipated to have a long-term positive effect. On the monetary policy front, the Japanese central bank harboured a cautious tone in its latest monetary policy meeting stating that it is faced with risks such as next year’s tax hike from 8% to 10% (scheduled for October 2019) and the weakness in its largest markets (i.e. the US and China). That being said, the central bank is expected to remain accommodative in case the economy shows signs of weakness and deflationary pressure appears again. Despite this, we hold a Neutral view on Japanese equities due to concerns over the global economic slowdown and possible downward earning revisions.

Exhibit 13: Nikkei Attains 27-Yr High in 2018

Source: Bloomberg

EM EQUITIES SEEM OVERDONE Rising interest rates in the US, the Sino-US trade dispute, new economic sanctions by the US against Russia, combined with policy uncertainty in Turkey and Mexico led to risk-off sentiment towards emerging markets. While macroeconomic risks are going to be carried into 2019 as well, EM governments’ policy responses should offset some of the negative effects from these external shocks. Looking at the economic data, there are only some EM countries having idiosyncratic risks, while the poor sentiment has dampened valuations and created attractive investment opportunities in key EMs. We anticipate the EM equity underperformance in 2018 to reverse in 2019, underpinned by the possibility of ongoing Asian growth along with well-anchored inflation, moderating US growth

preventing more aggressive US interest rate hikes and US dollar appreciation. Corporate earnings growth in EMs is expected to be higher than in developed markets as the effects of the US tax cuts fade in 2019, which should lead to a reversal in fund flows. Moreover, governments in key EMs have shown their commitments to structural reforms and corporates have remained disciplined when it comes to capital spending, which should bolster returns on investment for EM companies. Against this backdrop, we have a Neutral view with a Positive Tilt on EM equities.

INDIA: OVERVALUED AMIDST GENERAL ELECTIONS IN 2019 Indian equities delivered modest returns in 2018, with the benchmark Nifty 50 index closing 3.2% higher after witnessing an impressive run (~+28%) in 2017. India outperformed most of its peers as evident from the MSCI EM, which plummeted by 17% in 2018. That being said, small and mid-cap companies underperformed, with the Nifty Mid Cap index losing 11%. Despite this, Indian equities including the large caps are trading at a slight premium in relation to their 10-year historical average. Such premium amidst the turmoil in other EMs might reflect India’s growth story and positive economic outlook.

The sweeping reforms brought by the ruling government in the form of the Goods and Services Tax (July 2017), the Insolvency and Bankruptcy Code (2016) and the bank recapitalisation (2018) continued to act as tailwinds, even though their implementation led to the slowdown in economic growth in some quarters. Amongst others, the late 2016 demonetisation had a pronounced impact on growth. However, growth has bottomed-out since mid-2017 and peaked at 8.2% in 1QFY19 before slowing down to 7.1% in 2QFY19.

Exhibit 14: India’s GDP Growth Rate (%)

Source: Bloomberg

This should not be interpreted as saying that Indian equities decoupled from other EMs in 2018. Along with regional equities, India also witnessed

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significant volatility, particularly after August, due to fears of rising inflation following the spike in crude oil prices and a depreciating domestic currency. Furthermore, the liquidity crisis in the non-banking sector, leading to the default of India’s infrastructure development and finance company, IL&FS in September exacerbated the sell-off. As a result, the Nifty 50 index lost approximately 15% in just two months from its peak attained in late August, before paring half of its losses towards the end of the year.

Looking forward to 2019, we expect Indian equity markets to remain volatile due to general elections in April/May. Investors are believed to favour the ruling government (Bharatiya Janata Party, BJP) due to its market-friendly policies and a strong anti-corruption campaign. However, following the recent defeat in five state elections, of which three big states were ruled by the BJP, it looks as if the ruling government led by Narendra Modi may face a tough battle to maintain its majority. Against this backdrop, we expect the government to table a populist budget for the fiscal year 2020 to attract investors, which could further derail ongoing fiscal consolidation efforts (yet act as a short-term stimulus to the economy). The government is already running behind its fiscal deficit target of 3.3% of GDP for FY19. Having said that, India still remains in a sweet spot relative to other EMs, given robust economic fundamentals. The central bank expects GDP growth of 7.5% for FY20 on the heels of 7.4% growth expectations for FY19. Inflation remains below the central bank’s comfort level and interest rate cuts look likely ahead of the elections as the government intends to boost growth. However, given high valuations amidst the mixed corporate earnings outlook and election risks, we maintain our Neutral stance on Indian equities.

Exhibit 15: Indian Equities Remain Overvalued

Source: Bloomberg

CHINA: ENOUGH AMMUNITION TO DEAL WITH HEADWINDS AHEAD After growing 6.6% in 2017, China’s benchmark Shanghai Stock Exchange Composite Index (SSE) lost 24.6% (~$2tn of market capitalisation) in 2018, primarily due to escalating trade tensions with the US. In addition, the gradual weakness in the economic performance dragged down domestic equities. China’s third quarter GDP growth rate of 6.5% is the lowest since the global financial crises of 2008. Industrial production and manufacturing Purchasing Managers’ Indices (PMI) are on a downtrend, indicating slowing economic activity. Indeed, the PMI is heading towards contraction. The central bank’s decision to reduce the Reserve Ratio Requirement (RRR) from 17% during the start of the year to currently 14.5% did very little to boost investor confidence.

Exhibit 16: Impact of Trade War on Chinese Equities (SSE)

Source: Bloomberg

As the government was already struggling with de-leveraging efforts amidst the economic slowdown, the trade war with the US further derailed economic growth. So far, the US imposed import tariffs on almost half of Chinese goods worth $250bn entering into its territory, and remaining goods worth $267bn are on its target list of potential sanctions in the future. China and the US eventually announced a truce to refrain from imposing tariffs on each other for 90 days. The Chinese government’s move of suspending import tariffs on US vehicles for three months from January to March 2019, and pledging to resume buying American soybeans, shows it is at least making an effort to resolve the dispute. The trade talks scheduled in the second week of January in Beijing will be important to watch. A positive development should certainly drive risk-on sentiment, but it may be too early to conclude that China and the US will find common ground in light of the latter’s demand for wide-ranging trade reforms.

Aside from resolving trade issues, China has to fight multiple battles simultaneously without

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losing a further grip on its economy. For now, the deleveraging efforts have been kept at the back burner, and the focus has shifted to expand fiscal and monetary policy to prop up economic growth. The People's Bank of China (PBoC) is expected to further infuse liquidity through the reduction of RRRs as well as buy bonds issued by private firms. On the fiscal front, the government has announced several measures such as the approval of issuing more special purpose bonds for infrastructure projects, raising the fiscal deficit target for 2019 and cutting taxes for households, corporates, VAT, exports and imports. The government’s ambitious ‘Belt and Road’ initiative would also help in propping up domestic industry growth.

We believe the government has enough ammunition to overcome ongoing challenges, particularly trade and growth concerns. Markets have factored these risks into account however. Any positive outcome from trade negotiations would lead to capital inflows into Chinese equities. At the current level, the Shanghai Composite index is trading at a significant discount of 43% relative to its 10-year PE multiple, offering huge upside potential. Earnings growth for 2019 is also expected to be in double digits, which is likely to support equities.

Exhibit 17: Chinese Equities Remain Undervalued

Source: Bloomberg

Moreover, in August 2018, MSCI completed the second phase of the partial inclusion of China A shares into the MSCI Emerging Market Index, allowing higher inflows of foreign capital, which would help stabilise the stock market going forward. Hence, we are Neutral with a Positive Tilt on China.

PAKISTAN: GAINING TRACTION ON COMPELLING VALUATIONS Pakistan’s equities continued their downward journey in 2018, albeit the decline was significantly smaller relative to 2017. The Karachi Stock Exchange 100 Index (KSE-100 Index) fell 8.4% after losing 17% in 2017. All of the interest

rate-sensitive stocks suffered due to the aggressive monetary policy adopted by the central bank, the State Bank of Pakistan (SBP). The SBP hiked its benchmark interest rate by 425bps to 10% in 2018, the highest in four years, to help stabilize the Pakistani Rupee (PKR), which depreciated by approximately 25% to around 140 against the USD at the end of the year. The latest bout of rate hikes by 150bps in November came as a surprise to markets that were expecting a 50–100bps increase.

The economy is undergoing a difficult phase with high inflation, an elevated fiscal deficit, depleting reserves and a balance of payment crisis. The SBP expects growth to slow down in FY19, revising its forecast for the pace of growth downward from 4.7% to slightly above 4% (FY18: 5.8%). Inflation is expected at 6.5-7.5% for FY19, which is above the central bank’s target of 6.0%. As a result, monetary policy is likely to remain tight going forward. Fiscal policy is also anticipated to remain restrictive to contain the rising budget deficit. Thus, growth looks set for a further deceleration. However, the country is making efforts to strengthen macroeconomic stability by addressing its fiscal situation, debt obligations and more importantly, external financial position, which remains the key to garner investors’ confidence in Pakistan.

Markets are hoping for a turnaround under the recently elected Prime Minister Imran Khan-led Pakistan Tehreek-e-Insaf (PTI) government. Financial aid has started to flow into Pakistan from its friendly countries, with the country securing $6bn from Saudi Arabia in October and $3bn from the UAE in December 2018. Furthermore, the country is looking for financial aid of roughly $8bn from the IMF. However, the conditions associated with the bailout fund are likely to be stringent, and initial indications suggest the IMF has asked the country to reduce its budget deficit to 4–5%, which could entail cutting defence or development expenditure. The fund also wanted Pakistan to move from a pegged to a free float of the exchange rate, and raise power tariffs by 22%.

However, China remains supportive of Pakistan, which is seeking to raise about $2.0bn through issuing Yuan-denominated Panda bonds. Pakistan is expected to benefit from the ongoing $60bn China-Pakistan Economic Corridor (CPEC), which aims to modernise and strengthen infrastructure. This, along with the inclusion of Pakistan into the

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MSCI global index in 2017 is expected to attract diverse global investors. Stocks are now undervalued following a 20% decline from its peak reached in early April 2018. The KSE-100 index is trading at a PE multiple of just 7.9x based on 2019 earnings projections. This reflects a discount of 25% over the last five-year average PE multiple. Consensus expects strong corporate earnings in 2019, with earnings per share growth of close to 25% and 7% in dividend yields. Pakistani corporates are under leveraged, with debt comprising just 16% of GDP. Most of the debt is with the government and not in the private sector. We believe that once the government manages to deal with the ongoing balance of payment crises, the economy may not take much time to begin its recovery. Thus, we are Positive on Pakistan.

Exhibit 18: Attractive Valuations

Source: Bloomberg

BRAZIL: EXPECTATIONS OF PRO-MARKET POLICIES TO DRIVE MARKETS Brazilian equities stood out amongst EMs despite protests by truck drivers causing economic disruptions. The benchmark Ibovespa index gained 15% in 2018, largely in the second half of the year as the prospect of the right-wing conservative candidate Jair Bolsonaro’s winning the presidential election increased. His victory boosted investors’ confidence on expectations that he would steer the economy towards privatisations, overhaul the pension and tax systems, and pursue market-friendly policies.

Exhibit 19: Brazil Public Net Debt As % Of GDP

Source: Bloomberg

However, alongside pension reforms, the new government has to lift growth, which remains subdued since the country came out of recession in 2016. The economy witnessed meagre growth of 1.0% in 2017 despite global growth expanding around 4%. In its October 2018 World Economic Outlook (WEO), the IMF downgraded Brazil’s growth forecast to 1.4% and 2.4% for 2018 and 2019, respectively (from 2.3% and 2.5% as per the April 2018 WEO), on account of disruptions caused by the nationwide strike of truck drivers and tighter external financial conditions. To supplement growth, the central bank has maintained the Selic rate at 6.50% since June 2018. With inflation still under control, interest rates are likely to remain unchanged in the near to medium term. The central bank expects inflation at 4.2% in 2019, which is within its target band of 4% (+/- 1.5%). The combination of subdued inflation and low interest rates bolstered earnings in 2018. Furthermore, Brazil is expected to benefit from the ongoing bilateral trade dispute between the US and China as it offers an opportunity to increase its export market share for commodities, such as soybeans.

Having said that, the focus of 2019 would be on the new government’s economic policies, including pension and tax reforms and the privatisation of large state-owned firms, which are expected to have a meaningful impact on Brazil’s fiscal position (public debt: ~74% of GDP; budget deficit: 7.8% of GDP in 2017). Surging confidence indicators along with supportive monetary policy and strong corporate earnings expectations (+12% y/y in 2019) could provide a strong growth impetus. However, the growth path would depend in large part on how fiscal reforms pan out through the year. Hence, we have a Positive outlook on Brazilian equities.

RUSSIA: ECONOMIC FRAMEWORK AND OIL PRICES SHOULD REMAIN FAVOURABLE FOR GROWTH Russian equities remained volatile during 2018 owing to simmering geopolitical tensions and volatile crude oil prices. The markets, which started on a positive note, faced hurdles in April when the US imposed additional sanctions on Russian oligarchs (including 12 companies), bringing the benchmark index MOEX down by 11% in a single day. Nevertheless, equities regained strength later in the year after sanctions were eased and crude oil prices reached a new high of 2018 in October. The MOEX index clocked

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a return of 12% in 2018 despite the relationship with Ukraine flaring up in November after Russia seized and fired at Ukrainian naval ships.

The past five years have been a rollercoaster ride for investors in Russia as Moscow’s annexation of Crimea led to sanctions in 2014, which reduced Russian energy and defence companies’ financing options from the western world. However, this brought some positive impact on the corporate governance front as well as encouraged Russian companies to boost efficiency, improve balance sheets and capital structures. Despite sanctions, Russian state-owned companies such as Sberbank, Rosneft and Lukoil have posted strong profits and free cash flow, and adopted new dividend policies (offering higher dividends). In terms of monetary policy, Russia seems prepared for the possibility of further sanctions being imposed in February 2019 as the central bank raised interest rates in December to shore up the rouble despite well-anchored inflation. It has also curtailed buying currency to build up reserves. Despite the aforementioned catalysts and attractive valuations (12-month forward P/E of 5.2x as compared to 10-year average of 7.6x), we are Neutral on Russian equities as the sanctions could create more volatility similar to 2018. Moreover, while corporate governance is improving, there is still significant room for improvement. Russia’s overwhelming dependency on oil & gas and other commodities could stir market volatility due to concerns over a global growth slowdown.

Exhibit 20: Russian Corporate Profit

Source: Bloomberg

MEXICO: POLICY UNCERTAINTY TO AFFECT THE INVESTMENT CLIMATE Mexico’s benchmark Index, Bolsa IPC, was one of the worst performing indices amongst EMs, declining by 16% in 2018. Despite reaching a deal with the US on the new trade agreement known as US MCA, equities underperformed due to new President Lopez Obrador’s unexpected policies. A series of announcements including the scrapping

of the $13bn airport project in Mexico City and limiting bank fees charged to customers led to concerns amongst investors about how friendly the new president would be to the business and financial market community. Nevertheless, Mexico’s 2019 budget announcement in mid-December aiming for an 1% primary budget surplus met consensus expectations and provided some support to domestic assets.

Going into 2019, President Lopez Obrador’s taste for unorthodox policies and changes to laws governing everything from banking to mining and pension funds will continue to raise concerns on Mexico as an investment and trade destination. Furthermore, the central bank has raised interest rates at its latest monetary policy meeting citing uncertainty caused in part by the new administration’s economic policies, and risks of higher inflation. On a positive note, corporate earnings are estimated to increase by 11% in 2019. The IMF has also projected a better economic outlook, as it expects GDP to grow by 2.5% from 2.2% estimated in 2018. On top of that, the market-friendly budget in mid-December has led to a reassessment in the risk appetite for Mexican assets. Given the expectation that policy uncertainty might stir volatility in markets, we take a Neutral stance on Mexican equities.

TURKEY: MACRO CONCERNS PERSIST Turkey’s financial markets came under stress during 2018 with the Borsa Istanbul XU100 index dropping 21% owing to policy paralysis and weak liquidity conditions. Despite mounting inflation, President Recep Tayyip Erdogan’s pressure to keep interest rates low raised concerns over the central bank’s independence and undermined foreign investor confidence. Furthermore, US action to double tariffs on Turkish steel and aluminium due to the detention of an American pastor Andrew Brunson also weighed heavily on Turkey’s investment profile. However, in a surprise move, the September rate hikes of 625bps to 24% by the Central Bank of the Republic of Turkey (CBRT) and the release of pastor Brunson in October provided some respite to the currency and equities.

While valuations have reached extremely low levels (12-month forward PE of 6.7x vs. the 10-year average of 10.7x), risks in Turkish equities remains high as the government and policymakers have a lot more work to do in order to restore investor confidence.

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Exhibit 21: Borsa Istanbul vs. TRY In 2018

Source: Bloomberg

The economy is suffering from lofty inflation (21.6% in November) and a high current account deficit (12-month rolling deficit of $39bn in October). The financial sector came under stress due to substantial borrowing in foreign currency, which becomes more expensive as the Lira depreciates. With the economic outlook being dim and real GDP to grow by 3.5% in 2018 and 0.4% in 2019, the financial sector is likely to be under pressure as non-performing assets increase. Hence, we are Cautious on Turkish equities. However, the export sector could provide some opportunities in externally-oriented firms as the Lira is likely to remain weak.

SOUTH AFRICA: STRUCTURAL PROBLEMS AND POLITICAL RISKS REMAIN INTACT South Africa’s benchmark JSE FTSE All Share index plunged 11.4% in 2018, the worst performance on an annual basis since the financial crisis of 2008. The performance looked even worse in dollar terms, with the index losing roughly 26%, the fifth worst returns in the world. This was due to global macro weakness and the new President’s inability to deliver the much-anticipated economic turnaround for the most part of the year through structural reforms. The trade conflict had badly hit South African equities as it impacted mining companies as well as the heavyweight Naspers that has one-fifth of the weightage in the JSE All Share index and has about a 31% stake in the Chinese company, Tencent. The initial euphoria brought by the change in the country’s leadership proved to be short-lived as a stronger US dollar and political divisions within the ruling African National Congress (ANC) undermined investor confidence. Notably, overseas investors sold about $3.3bn during the year. Adding to the woes, South Africa temporarily slipped into recession in 2Q18, although bounced back in 3Q18 with 2.2% growth. Liquidity-sapped state-owned firms, a widening budget deficit and the proposed controversial land reforms policy of expropriation

without compensation also spooked investors.

Exhibit 22: South Africa’s GDP Growth Rate and Budget Deficit

Source: Bloomberg

In November 2018, the South African Reserve Bank (SARB) surprisingly raised its interest rate after almost three years to contain inflation, following the Rand’s depreciation amidst high crude prices. The SARB set a hawkish tone, hinting at four more hikes through 2020, which is negative for equity markets in the wake of high debt levels in corporate balance sheets and the resulting rise in the interest burden.

Exhibit 23: South Africa Debt as % of GDP

Source: Bloomberg, *Forecasted

Equity valuations look attractive with the JSE FTSE All Share index trading at a discount of 30% (12 months forward PE) in relation to its 10-year historical average. However, the risk-reward does not look favourable due to political uncertainty ahead of the general elections in May 2019. If President Cyril Ramaphosa fails to win a majority, economic reforms may get delayed. Markets are worried about the ANC’s attempts to make farm land expropriation easier in the country. This could put a further burden on the government as it will be forced to repay creditors, particularly the Land and Agricultural Development Bank, immediately for about $2.8bn. The bank has warned that such expropriation without compensation to land owners and without protecting the bank’s rights as a creditor could breach the covenant causing an event of default. Fundamentally, South Africa’s macro profile is weak with its high fiscal deficit and debt levels. Thus, we are Cautious on South Africa, even though equities maintain attractive valuations.

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EGYPT: FLEXIBLE CURRENCY AND THE TOURISM SECTOR TO BOOST ECONOMIC COMPETITIVENESS After reaching an all-time high at 18,414 in April, Egypt’s EGX30 declined significantly by 13% to 13,036 in 2018. Continuing structural improvements, a narrowing current account deficit, a revival of the tourism sector, and a better business environment have moved Egypt eight places up to 120 in the World Bank’s 2019 Doing Business Report. Revenue from tourism soared by 77%y/y to $4.8bn in H118, while the number of visitors jumped by 41%y/y to a little over 5mn.

Looking ahead in 2019, momentum in the tourism sector is likely to continue, given the Central Bank of Egypt (CBE) has extended its initiative to support the industry until the end of December 2019. The bank is extending its retail lending initiative and deferring dues for an additional six months to people engaged in the tourism sector. On the other hand, Egypt is continuously making progress in increasing its natural gas output, which has risen to 6.6 bn cubic feet per day in September 2018. The country is likely to gain from an acceleration of its natural gas production from recently discovered fields, with the aim of achieving self-sufficiency, thereby ending gas imports from 2019. Moreover, inflation is currently hovering within the central bank’s target range of 13%, plus or minus 3 percentage points, which is likely to force policymakers to hold interest rates steady in early 2019. However, if inflation drops further, we expect interest rate cuts, which could prompt another rally for the Egyptian stock market.

Exhibit 24: Inflation Remained Under Control

Source: Bloomberg

We are Positive on Egyptian equities, given the continued momentum of economic reforms, rising foreign investment and stabilisation of the EGP. Furthermore, opportunities in the form of higher investment in the natural gas sector, improving tourism and downward trending inflation should

aid the government in addressing structural headwinds in the near future. The benchmark index (EGX30) is trading at a 12-month forward PE of 10.0x which in our view should be an attractive entry point for long-term investors. The key risk to our recommendation remains in terms of the IMF $12bn aid programme, which will end in June 2019 and is likely to increase the country’s borrowing costs and may prompt the government to roll back certain investment projects, given Egypt’s high fiscal deficit target of 8.4% for FY18–19 (June ending).

GCC: STUCTURAL REFORMS TO UNDERPIN EQUITIES The performance of the GCC indices has been mixed in 2018, with Abu Dhabi, Saudi Arabia and Kuwait benchmark indices rising by 12%, 8.3% and 10%, respectively, while Dubai and Oman indices lost 25% and 15%, respectively. Idiosyncratic events played a key role in relative equity performance during 2018. Saudi Arabia’s upgrade to emerging market (EM) status and Kuwait’s possibility of upgrade to EM in 2019 in the MSCI index boosted foreign inflows in their equity markets. While rising interest rates bolstered banking sector profitability in Abu Dhabi, Dubai experienced a slowdown in its real estate market. Meanwhile, Bahrain and Oman lacked in structural reforms. Furthermore, GCC equities were impacted by volatility in oil prices, which entered into a downward trajectory, after rising ~19% during the first half of 2018.

Going forward, the easing of geopolitical concerns as indicated by the withdrawal of US troops from Yemen and Syria is likely to improve sentiment in the region, in our view. Moreover, the rebound in oil prices is likely to ease budget deficits for most GCC economies in 2019. The structural reforms initiated by most GCC countries should also start reflecting in a stronger equity performance. Although the trade war has no direct impact on GCC countries, its indirect effect could be visible through oil prices. Accordingly, we are Neutral on GCC equities.

UAE: REFORMS AND GROWTH TO DRIVE INDICES HIGHER In 2018, UAE stock markets had a mixed picture. While Abu Dhabi’s ADX index soared 12%, Dubai’s DFM lost 25%. The diverging performance reflected the difference in their constituent members. In Abu Dhabi, the performance of the ADX index was well supported by banking stocks, benefiting from rising rates and ongoing

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consolidation in the sector. Additionally, investor sentiment got a boost from the government-led stimulus measures and rising oil prices, which translated into higher profits for energy companies. However, the story was different for Dubai, where the DFM index suffered due to continued uncertainty over the real estate outlook and poor earnings by blue-chip real estate companies. Ongoing concerns on oversupply in the real estate market have put downward pressure on prices and rentals. Shares of Emaar Properties PJSC and Damac Properties Dubai Co PJSC tumbled by 40% and 54% during the year, respectively. Several macro factors such as a steep decline in oil prices in late 2018 and trade war concerns also dampened investor sentiment. That being said, the correlation between the drop in oil prices and share price declines seemed to have weakened in recent times, reflecting efforts by the UAE government in supporting the non-oil economy with significant spending focused on key non-oil sectors such as education, tourism and healthcare.

Exhibit 25: ADX Index Decoupling With Brent Lately

Source: Bloomberg

The government of the UAE has undertaken a range of structural reforms aimed at stimulating the non-oil sectors of the economy. The government has unveiled an AED50bn stimulus plan that includes various measures to prop up investment and facilitate doing business in the country. Economic reforms were complimented by the recent approval of the largest federal budget in the country’s history (AED60.3bn, an increase of 17.3% from 2018’s AED51.4bn budget), which also prioritised community development and education. Abu Dhabi’s exemption of license fees for the private sector should help reduce the short-term cost pressure on corporates and strengthen the competitiveness of the economy. Although the government’s decision to levy a 5% VAT (beginning January 2018) and excise duty to widen the government’s revenue sources has weighed negatively on retail spending, the effects

are anticipated to be temporary as retail spending has been in the recovery mode lately. Moreover, the recent approval of additional long-term visas for talented professionals should promote the investment climate and boost consumer demand. Furthermore, foreign direct investment should get a boost from the government’s decision to allow 100% foreign ownership in UAE companies in specific industries. The government’s infrastructure spending ahead of Dubai Expo 2020 is likely to directly benefit sectors such as hospitality, travel and tourism, aviation, construction, retail and real estate. However, the Dubai real estate market, suffering from oversupply issues and slack demand, has yet to show signs of recovery. As the overall macroeconomic conditions continue to improve, supported by improvement in oil prices, real estate prices should gradually recover, in our view.

Exhibit 26: Dubai Residential Sale Prices and Rental Yield

Source: Central Bank of the UAE

We are Positive on the ADX, given the governments’ focus on structural reforms and investment focused on the non-oil sector coupled with improving fiscal consolidation on the back of rising oil prices. However, we are Neutral on the DFM, given the ongoing oversupply in the real estate sector where builders are facing increasing difficulties in selling already completed inventories.

SAUDI ARABIA: EM INDEX INCLUSION AND A RECORD BUDGET TO BOOST OPTIMISM Saudi Arabia’s TASI index witnessed a gain of 8.3% in 2018 as most of the gains accrued in 1H18 (+15.1%) were offset in 2H18 (-6.8%). Notably, the index crossed the 8,500 mark to touch its highest level in nearly three years in July 2018, primarily on account of higher capital inflows following news on the inclusion in the FTSE and MSCI EM indices amidst an improvement in oil prices. However, the concerns of domestic banks’ exposure to Turkey (which experienced a

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currency crisis), risk associated with the Saudi-US relationship over the killing of journalist Jamal Khashoggi, along with the drop in oil prices due to Iran’s temporary sanction waiver for a few countries, and anticipation of a slowdown in global growth, dragged the index lower in 2H18, capping the overall gain during the year.

In 2018, the Saudi government has undertaken a series of capital market reforms including listing and trading of government debt instruments, the introduction of a new price mechanism (Saudi Arabia moved from a volume weighted average price to an auction based method), and easing qualification requirements for Qualified Foreign Investors (QFIs), amongst others. Consequently, FTSE, MSCI and S&P announced the inclusion of Saudi Arabia into their EM indices, which is eventually anticipated to boost foreign money inflows as well as prop up market liquidity and broaden the investor base.

After contracting by 0.9% in 2017, economic growth has rebounded in 2018 as the economy is projected to grow by solid 2.2%, according to the IMF’s World Economic Outlook report published in October 2018. The international lender also revised the economic growth forecast to 2.4% (earlier 1.9%) for 2019 on account of the pick-up in the non-oil sector, coupled with a higher oil output. Furthermore, the Ministry of Finance (MoF) has projected upbeat real GDP growth of 2.3% in 2018 and 2.6% in 2019, higher than the IMF’s forecast, signalling confidence in the Kingdom’s economy. In addition, the MoF recently announced a record budget to help lower unemployment and spur growth. The budget expenditure is anticipated to rise by 7% to SAR1.1tn and revenue is projected to jump 9% to SAR975bn, reflecting a fiscal deficit of SAR131bn in 2019 (4.2% of GDP).

Exhibit 27: Saudi Budget Performance

Source: Ministry of Finance, *Forecasted

In order to give a boost to its Vision 2030 (which focuses on non-oil sector growth), the government has allocated SAR246bn (+20% rise

from 2018; 22% of the total 2019 budgeted expenditure) to the non-oil sector. The government has also taken several measures to diversify its revenue base and improve the long-term fiscal outlook, which includes the introduction of 5% VAT, a 130% hike in petrol prices, and an increase of household electricity tariffs. With the new economic model that the government is developing, a relatively looser fiscal position is warranted to support the domestic economy. The government’s radical steps have forced the corporate world to adapt to new changes, resulting in deleveraging rather than investing. Having said that, new opportunities emerge as the government removes constraints on entertainment and tourism, as well as young entrepreneurs using digital platforms.

Exhibit 28: Saudi Arabia’s GDP Forecast Trend

Source: IMF, *Forecasted

With the new bankruptcy law now in place, the market should attract higher foreign direct investments (FDI) and eventually encourage consumption. With attractive valuations (2019E P/E of 14.8x vs. 10-year average of 16.9x), we remain Positive on the TASI for 2019 due to the anticipation of foreign fund inflows post its addition to the FTSE and MSCI EM indices in 2019 as well as the improving growth outlook. Furthermore, the government’s push towards privatisation and the improvement in female participation in the Kingdom’s economic development, which is in line with its Vision 2030, remain a long-term positive catalyst for the Kingdom. However, investors need to be mindful of the political risk associated with Saudi Arabia as the country has been fighting a proxy war with Iran and has a political stand-off with Qatar.

OMAN: LACK OF STRUCTURAL REFORMS TO WEIGH ON EQUITIES Oman’s MSM 30 index fell 15% in 2018, the second-worst performance in the GCC region. This mainly reflects a lack of structural reforms, which is impacting the country’s fiscal and external position, while corporate earnings were

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EQUITIES


mixed. Notably, major credit rating agencies downgraded Oman’s sovereign rating, with Fitch cutting it to junk status in December 2018, while Moody’s downgraded it to Baa3 from Baa2 with a Negative outlook due to rising government debt (which is expected to increase to 58% of GDP by 2020) and a high fiscal deficit that is expected to reach 10% in 2019. To support the fiscal imbalance, the Omani government is planning to sell its stake in Oman Electricity Transmission and Muscat Electricity Distribution through an IPO, the combined assets worth around $3.2bn. However, the government’s deferral in implementing VAT until 2019 and hiring freeze for expatriate workers in 10 major sectors including media, IT, insurance and others could be unfavourable from a fiscal perspective.

Thus, we are Cautious on the MSM 30, given the slow pace of structural reforms, weak participation from the private sector, and government constraints to increase public spending due to high levels of public debt.

KUWAIT: EMs' PASSIVE INFLOWS ARE KEY GROWTH DRIVERS Kuwait’s KWSPEM index gained 9.9%, the second best performing equity market following Qatar in the GCC, on the back of a sharp improvement in the fiscal situation aided by higher oil prices, high passive inflows due to inclusion in FTSE Russell (in two phases: September and December 2018) and a strong real estate’s revenue growth (+24%y/y). Kuwait posted a fiscal surplus of KWD3.1bn before transferring to the Future Generations Fund during April–October 2018 as compared to the deficit of KWD1.5bn in the same period in 2017. We are Neutral on KWSPEM with a Positive Tilt to reflect the potential risk of lower government spending in 2019.

BAHRAIN: AID SUPPORTS ECONOMIC STABILITY The Bahrain Stock Exchange (BAX) ended flat in 2018 as the economy suffered from deep structural problems, a very limited contribution from non-oil sectors and a high debt burden. In October 2018, Kuwait, Saudi Arabia and the UAE announced they would provide a $10bn aid package (~26% of country’s annual GDP) to Bahrain in order to support its financial stability. Accordingly, Moody’s has revised the country’s outlook to stable from negative with B2 rating as disbursements will directly support the country’s liquidity position and improve foreign exchange reserves. Thus, we are Neutral on the BAX index

for 2019 as the aid will provide some impetus to the economy.

Exhibit 29: Immune to Oil Volatility

Source: Bloomberg

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Riskier parts of fixed income assets, typically the developed market's high-yield corporate bonds, may experience some pressure as volatility continues due to the gradual withdrawal of stimulus by the major central banks. Meanwhile, with prospects of slowing global growth and low inflation expectations becoming more apparent, the safe-haven appeal of sovereign bonds and demand for high quality corporate bonds should remain intact. We are Neutral with a Positive Tilt on Treasuries and Positive on corporate investment-grade bonds. Improving fundamentals in many EMs, along with an inflection in EM currencies, could act as potential catalyst for the outperformance of hard currency EM debt, which offers compelling yields. Furthermore, any moderation in the US-China trade conflict would be supportive for sentiment.

MAJOR CENTRAL BANKS TO GRADUALLY TIGHTEN LIQUIDITY Major central banks’ policies focusing on injecting ample liquidity have been the key drivers in determining financial market returns in recent years. Policymakers’ accommodative stance has been responsible for compressed risk premiums. However, liquidity is now set to be reduced with the Federal Reserve poised to enter the tail end of its current tightening cycle in 2019, whereas the ECB and BOJ are stepping up their path towards normalisation, albeit at a very gradual pace. The unprecedented withdrawal of stimulus may increase volatility in the riskier space of the fixed income market, given issuers’ high leverage built up during the low interest rate environment. Nevertheless, with inflation not showing signs of rapid acceleration, central banks are expected to be more gradual in returning to normalcy. Hence, investors should now shift their focus to fundamentals and move up in credit quality as monetary conditions tighten.

Exhibit 30: Major Central Bank Balance Sheet Assets

Source: Bloomberg

FOMC MAINTAINS STEADY GUIDANCE In its current tightening cycle, the Federal Reserve hiked the short-term rate by 25bps for the ninth time to 2.25–2.5% at the December 2018 meeting. Looking further to 2019, grappling with conflicting forces on the inflation and growth front, Fed officials are forecasting fewer rate hikes while continuing with the systematic balance sheet reduction agenda. They have lowered the median forecast from three rate hikes of 25bps each to two in 2019 while expecting one more rate hike in 2020.

Furthermore, largely maintaining an upbeat outlook, central bank policymakers have modestly reined in their expectations for the economy noting the headwinds ahead. They slightly revised predictions for growth (3.0% and 2.3%, respectively, for 2018 and 2019 down from 3.1% and 2.5% earlier), unemployment (kept unchanged at 3.7% for 2018 while raising to 3.6% at the end of 2020) and PCE inflation (to dip from 2.1% to 1.9% in 2018 and stay at that level by the end of 2019, and core PCE inflation to decrease from 2.0% to 1.9% in 2018 and 2.0% by the end of 2019 versus 2.1% projections earlier).

Exhibit 31: US Unemployment Rate and ECI – Wages and Salaries* (y/y % Change)

Source: Bloomberg, ECI* Employment Cost Index – Wages and Salaries growth in private industry

In our opinion, tailwinds from recently implemented tax cuts are likely to fade in 2019. However, the intended increase in discretionary fiscal spending with the budget deficit forecast to exceed $1tn in 2020 is set to continue. Meanwhile, the uptick in real wages at a nine-year high amidst the tight labour market (refer to exhibit 31) is expected to further lift consumer spending. Business investments reflect a balanced profile supported by modest corporate earnings. As far as downside risks are concerned, any escalation on the trade conflict would weigh on growth momentum. Hence, having attained the dual mandate of price stability and maximum sustainable employment, the Fed’s path of future rate hikes should be more gradual considering the associated risk of financial market volatility emanating from the trade conflict and slowing global growth. Notably, the market is currently pricing no rate hike in 2019.

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Exhibit 32: Federal Reserve- Balance Sheet Assets

Source: Bloomberg, *Forecasted

On the other hand, the Fed has reduced its balance sheet by ~$295bn, since the start of its quantitative tightening program in October 2017. With the balance sheet tightening agenda now having systematically reached $50bn a month after almost a year from October 2018 onwards, a potential reduction in the asset holdings by an additional $600bn on an annual basis is forecasted. This creation of the additional bond supply in the market will further exert additional upward pressure on rates.

US FED HIKES PERCOLATE THROUGH GCC BANKS Following the FOMC’s rate hike at its December meeting, most GCC central banks followed the move by raising their key policy interest rates, barring Kuwait. Given the fixed currency regimes, the monetary authorities intend to keep local rates higher than the Fed in order to prevent potential capital outflows. However, the rising interest rate environment is expected to weigh on non-oil sector activity across the region.

Exhibit 33: GCC - Key Benchmark Rates

Country Particulars Previous (%) Current (%)

UAE Repo Rate 2.50 2.75

Bahrain Overnight Deposit Rate 2.25 2.50

One-month deposit rate 3.25 3.25

One-week deposit rate

2.50 2.75

Lending rate 4.25 4.50

Kuwait Discount Rate

3.00 3.00

Qatar Deposit rate 2.25 2.50

Saudi Arabia Reverse Repo rate

2.25 2.50

Repo Rate 2.75 3.00

Source: Bloomberg

Interbank rates have also continued to rise as GCC monetary policy tightens in tandem with the US. In 2018, 3-month LIBOR increased 111bps and the Emirates Interbank Offered Rate (EIBOR) widened 104bps, settling at 2.80% and 2.83%, respectively at 2018-end. The 3-month Saudi

Arabian Interbank Offered Rate SAIBOR) increased 107bps to 2.97%. Notably, the spread between 3-month EIBOR and 3-month LIBOR has narrowed to a mere 3bps from 12bps at the end of 2017, the lowest since the financial crisis. However, as pointed out by the IMF, a faster-than-anticipated tightening of credit conditions could disrupt financial markets and lead to asset price corrections, adding pressure on the asset quality of banks. This in turn could further lead to a credit crunch and slowing economic activity in the region.

Exhibit 34: GCC 3M - Interbank Offer Rates vs. 3M-LIBOR

Source: Bloomberg

ECB CAPS MONETARY SUPPORT Despite rising economic risks in the Euro region in terms of muted core inflation and weak growth, the ECB proceeded with halting its €2.6tn stimulus in December 2018 after almost four years of purchases. In addition, President Mario Draghi acknowledged that the balance of risks to the economy are skewed more to the downside due to concerns over geopolitics, trade protectionism and market volatility. Broadly assessing the economic factors and stating that downside risks have become more prominent, the ECB has revised its growth projections slightly down for 2018 and 2019 to 1.9% and 1.7%, respectively. On the inflation front, the central bank forecasts 1.8% in 2018 and 1.6% in 2019 before inching up to 1.7% in 2020.

Exhibit 35: Euro zone- GDP and Composite PMI Index

Source: Bloomberg

The recent Euro-area economic data highlights contractions in output growth in Germany and Italy. Also, purchasing manager indices are even

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Cap raised by $10bn each quarter until it reaches $50bn a month

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less optimistic about growth than they were before the onset of QE. These headwinds, including ongoing political uncertainties and a notable weakness in exports, are expected to challenge the ECB’s ability to raise interest rates in 2019. We expect the ECB to closely monitor underlying core inflation, which at 1.0% in November has failed to gain momentum while wage gains in the region are at the strongest in a decade. In the absence of any major catalyst to growth and inflation, we are not anticipating a rate hike until the end of 2019 or even early 2020. Moreover, the ECB’s plan to reinvest its maturing debt for an extended period will keep its balance sheet inflated.

LACK OF CLARITY ON BREXIT PUTS BOE IN DILEMMA Headwinds including slow economic growth and Brexit forced the Bank of England to hold rates unchanged post August 2018. Heading into 2019, we still expect Prime Minister Theresa May to eventually force a ratified Brexit deal through parliament. Meanwhile, employment at record highs and gradually rising wages could strengthen the case for an increase in interest rates by the BOE. Even if the BOE hikes rates, it is expected to be after the UK’s departure from the EU in March and at a gradual pace. Nevertheless, with ongoing political and economic uncertainties, the aforementioned steps forward could witness a reversal. The BOE has issued a stark warning for the rise in unemployment, GBP depreciation, soaring inflation and rising interest rates along with contraction in Britain’s economic growth, in case of a disruptive Brexit. Hence, in its latest policy meeting, the BOE reiterated its view that interest rates could move in either direction after Brexit, depending on Britain’s ability to avoid a potentially damaging ‘No-Deal’ scenario.

BANK OF JAPAN IN WAIT AND SEE MODE At the latest December policy meeting in 2018, the Bank of Japan voted 7-2 to keep its short-term rate target at -0.1% and 10-year yield target around zero percent under its yield curve control policy. The economy contracted in two of the past three quarters and inflation is only half of the bank’s target. Furthermore, BOJ governor Haruhiko Kuroda cautioned that risks to the economy remain tilted to the downside with oil prices tumbling, slowing growth in China and a disruptive Brexit, which could further hit the export-oriented economy. The BOJ also seems to have changed its tune stating that if government

bond yields fall into negative territory, it would not be a concern as long as yields remain within the target range. Hence, the BOJ’s stealth tapering looks uncertain on the back of the Fed becoming less aggressive and dimming prospects of further movements by the ECB. Moreover, the continuous appreciation of the Yen against the USD could be another reason for the BOJ to maintain its aggressive monetary accommodation. That being said, the BOJ is also concerned about the adverse impact of prolonged QE on the profitability of the financial sector, raising the risk for policy tweaks, most probably in the second half of the year.

Exhibit 36: 10-year Japanese Government Bond Yield and JPY/USD

Source: Bloomberg

2018: BOND MARKET RETURNS SWING INTO THE RED As evident from the exhibit below, the bond market experienced stress in the latter part of 2018, mainly as the Fed continued with its aggressive rate hike cycle on a quarterly basis, along with monthly balance sheet reduction. The emerging markets were the worst hit followed by US corporates. Going ahead into 2019, as markets face a further end to crisis-era central bank quantitative easing, volatility is set to rise. Nevertheless, in case of risk-off periods, safe-haven bids should benefit sovereign bonds, including Treasuries and Bunds, among others, thereby limiting the rise in bond yields.

Exhibit 37: Total Return Index


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Jan-18Global High Yield EM Local CurrencyUS Corporate US TreasuryUS TIPS European Credit


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TREASURIES TO ACT AS A CUSHION AMIDST RISING VOLATILITY In 2018, the Treasury yield curve continued its flattening trend with the 2-year and 10-year yield spread narrowing from 52bps at 2017-end to a mere 19bps at 2018-end, the lowest since 2007 (refer to exhibit 38) as a result of rising short-term rates combined with the increase in demand for longer-dated bonds. The demand for longer-dated bonds was mainly due to relatively higher interest rates compared to other developed market counterparts amidst a volatile environment. A brief inversion in the curve was noted towards the end of 2018, as the 2-year and 3-year yields exceeded the 5-year yield albeit marginally, suggesting a drop in market expectations for rate hikes in 2019. We believe as markets adjust to the end of a tighter monetary policy regime, volatility is likely to stay elevated. In 2019, the Fed’s expectations to continue with two rate hikes mean that short-term yields should move higher in the remainder of the hiking cycle. On the other hand, weaker global growth exacerbated by trade disputes may dampen growth and inflation prospects, which could drive more demand at the long end of the curve. Hence, we advocate US Treasuries to be a part of a diversified portfolio, which may act as a cushion against any risk event. Therefore, we are Neutral with a Positive Tilt on Treasuries.

Exhibit 38: US 2-10 Year Treasury Yield Spread and VIX Index

Source: Bloomberg

BUND YIELDS SET TO RISE Europe’s fiscal and political struggles are expected to continue to weigh on its economy. With the Euro region’s core inflation stuck at 1.0%, interest rates at historically low levels and limited Bund supply due to regulatory demands, Bunds booked a healthy profit in 2018. Notably, the spread between benchmark 10-year Treasury and Bund yields has narrowed since the Fed rate hike in December 2018 by 20bps to 244bps. However, with Bund yields having fallen to the tightest levels since November 2016, we believe

this trend should reverse as the ECB ends its bond purchase program. Also, relatively appealing yields offered by US Treasuries could result in waning demand for Bunds. Hence, we are Cautious on German Bunds.

Exhibit 39: 10-year Sovereign Bond Yield Movement

Source: Bloomberg

BUDGET PROPOSALS WEIGH ON ITALIAN AND FRENCH BONDS With the political uncertainty surrounding Italy’s proposed budget for 2019, the risk premiums of the benchmark 10-year Italian bond had surpassed the 300bps mark compared to other federal bonds in October 2018. In a bid to address the rising turmoil, the Italian government has recently reached a conciliatory budget plan after the EU Commission found a serious breach of the Stability and the Growth Pact. Hence, we assume a favourable scenario, with the spread over Bunds shrinking, albeit to a limited extent. Notably, contagion effects are also expected to remain limited across European government bonds owing to the ECB’s still (albeit diminishing) accommodative stance.

A similar situation emerged in France with the government having outlined a budget overshooting the EU’s limit of 3.0% of GDP for 2019 to around 3.2%. The resulting French government bond sell-off led to a wider gap over the safe haven Bunds up to 46bps, near a 1.5year high.

Exhibit 40: 10-year Sovereign Bond Yield Movement

Source: Bloomberg

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PORTUGUESE BONDS OUTSHINE Amongst the European peripheries, Portuguese bonds have outperformed with the 10-year bond yield tightening 19bps to 1.71% in 2018, at a 6-month low, as the economy churned out its longest expansion since the European debt crisis of 2012 while its fiscal deficit narrowed. The lower borrowing costs also enabled Portugal to pay back the remaining €4.7bn of bailout loans to the IMF, eliminating its debt to the Fund after a series of early repayments. Going forward, Portuguese bonds are expected to further gain as the ECB plans to reinvest its proceeds from maturing bonds back into markets for several years to anchor borrowing costs.

BREXIT TO INFLUENCE GILTS The uncertainty over the Brexit deal favoured Gilts in the latter half of 2018. While PM Theresa May sought approval from the cabinet on the proposed Brexit deal, the increased likelihood of it being rejected by the House of Commons compelled her to defer the vote until January 2019 and step up for re-negotiations with the EU. In the case of an absence of any concrete outcome, it will result in a major defeat for the government. The market’s nervousness is evident from the gap between 2- and 10-year bond yields, which narrowed to 49bps, the lowest since July 2018, reflecting the risks of no deal. 30-year debt also marked a significant rally, sparking a flattening of the yield curve. For now, higher liquidity, no default risk and lingering Brexit concerns could favour Gilts. However, there is increased traction for a second Brexit referendum at present. Hence, we expect rate volatility to continue for longer until an evident path is reached on the Brexit deal. In the event of no deal or a disruptive Brexit, higher yields will probably follow as the BOE may raise rates to tame inflation risk emanating from a weaker GBP. Hence, we are Cautious on UK Gilts.

Exhibit 41: 10-year UK Gilt Yield Movement

Source: Bloomberg

EM DEBT SET TO COMEBACK After starting 2018 on a high note, EM’s hard and local currency bonds underperformed during 2Q18 and 3Q18, primarily attributable to idiosyncratic factors (Turkey’s credit-fuelled growth running out of steam and Argentina’s policy paralysis), monetary policy tightening in the US, the stronger US dollar, the US-China trade dispute and rising inflation following a surge in crude oil prices in 3Q18. This, combined with political risks due to elections and slow economic growth concerns, triggered a sell-off in the EM debt.

Turkey and Argentina debt remained in the limelight as the loose monetary policy adopted by Turkey’s central bank under President Erdogan and bloated fiscal deficit in Argentina diminished policy credibility, prompting a sell-off in the sovereign debt. Both countries attempted to improve their respective policies, but the efforts came too late only after sharp currency depreciation and corporate credit spread widening. The Turkish central bank hiked interest rates by 625bps in early September and unveiled a credible fiscal and growth plan. Similarly, Argentine assets felt pressure after the administration failed to deliver a credible fiscal austerity package in June. Officials were forced to draft a new fiscal plan calling for a balanced primary account in 2019, supplemented by $7bn of extra funding and $19bn of near-term support from the IMF. Amongst other EMs, Russian assets were hit hard by US sanctions on Russian oligarchs, although sanctions were eased subsequently. Mexican debt came under severe pressure after incoming President López Obrador cancelled the one-third built new $13bn Mexico City airport in late October, after being rejected in a ‘people poll’ involving merely 1% of Mexico’s population, fuelling concerns over policy uncertainty.

However, EM debt staged a recovery in 4Q18, following easing financial uncertainty in troubled economies and a sharp decline in crude oil prices. Furthermore, the signs of easing monetary policy in the US and a 90-day truce agreed between the US and China to negotiate on trade policy issues provided some relief to bond markets.

EM POSITIONED WELL FOR UPSIDE While 2018 was a period of high volatility with negative returns for EM debt, attractive valuations present a long-term buying opportunity in our view. Although the exact

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timing remains difficult to predict, investors would be more focused on developments around two major macro factors. First, the prospect of more stable or slower pace of interest rate hikes in the US could exert downside pressure on the USD, supporting EM currencies and debt. Second, a possible resolution of trade tension between the world’s two major economies could be supportive for EMs. Meanwhile, many EM countries have strengthened their position against hard currencies by increasing their foreign reserves, reducing debt in hard currency, encouraging domestic consumption and employing more credible monetary policies. We believe EM credits (sovereign and corporate) have already seen their worst, and hence bond yields should grind tighter going forward. With expectations of a relatively weaker USD, EM credit would witness increased interest from institutional investors as inflation is likely to stay under control and provide some respite to monetary policy tightening. Against this backdrop, we are Positive on EM debt.

Exhibit 42: DM vs. EM GDP Growth Projected By The IMF

Source- IMF WEO, October 2018, *Forecasted

We prefer EM debt over DMs due to the attractive yield differential and a faster pace of growth in EMs compared to DMs. Nevertheless, we recommend a well-diversified bond portfolio to mitigate idiosyncratic risks present in EM economies. We favour Russia due to its valuation cushion and the central bank’s well preparedness for potential US sanctions; Brazil as a result of prospects of policy reforms; and China for its moderately loose monetary and fiscal policy amidst trade tensions. We hold our Neutral view on India and Indonesia on account of possible volatility due to upcoming elections in 2019. However, some EMs come with heightened credit risk such as Argentina (due to a possible recession and presidential elections), Turkey (slow economic growth and political uncertainty), Mexico (policy uncertainty and NAFTA (now US MCA) deal) and South Africa (political risk amidst the presidential election).

RUSSIA: WELL PREPARED FOR UNCERTAINTY In line with major EMs, the Russian sovereign benchmark bond yield also felt pressure from the global sell-off during 2018. Sovereign debt came under severe pressure when the US imposed sanctions on Russian oligarchs with its 10-year benchmark yield peaking at 9.2% in September. Overall, it widened by 121bps to close at 8.7%. Moving into 2019, Russian markets should be dominated by the threat of new sanctions from the US, which were due in autumn, but have now been postponed until the first quarter of 2019. The restrictions would hit, but the government seems prepared for the worst as it took some strong measures in the last month of 2018. The Central Bank of Russia (CBR) stopped buying currency to build up buffers (foreign reserves stood at $462bn in November 2018, covering almost 23 months of imports). Despite inflation remaining under control, the CBR raised interest rates by 25bps to 7.75% in December, to shore up the rouble ahead of possible sanctions. With a 15% debt-to-GDP ratio (lowest amongst major economies in the word), fiscal surplus and most US treasury holdings sold-off, the Russian government has positioned itself to endure any pressure from possible sanctions.

Exhibit 43: Russia – Inflation, Yield and Interest Rate

Source: Bloomberg

On the macro front, the central bank expects inflation to hit a peak of 5.5-6% in March-April 2019 mainly due to seasonality, and ease thereafter. Consensus expects inflation to average 4.5%, slightly above the CBR’s 4.0% target. Hence, the central bank might cut rates, but not in the first half of 2019. This combined with a stable economic growth outlook (1.8% rise in 2019 projected by the IMF) and favourable oil prices would put Russia on investors’ watchlist. Both Moody’s (Ba1) and Fitch (BBB-) have a positive rating outlook for the sovereign, which brightens the chances for Moody’s raising its rating to investment grade. Against this

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backdrop, we believe a few negative headlines would make the yield more attractive and allow investors to focus on the country’s improving fundamentals.

CHINA: ECONOMIC REBALANCING CONTINUES Chinese markets were hampered by restrictive monetary tightening, targeting deleveraging in the most risky parts of the financial system, including shadow banking. Additionally, the sharp decline in state-led investment growth and the fall-out from the trade conflict with the US weighed negatively, leading to a weaker growth outlook. Although the trade war had a limited impact on import-export growth, it has certainly dampened business sentiment and financial markets. After escalation during 2018, the trade war has come to a pause as both countries agreed on a temporary truce.

Moving into 2019, Beijing has changed its course in terms of macroeconomic management, with supporting growth becoming its key policy priority. The administration has eased fiscal policy, announcing a wide range of tax cuts, as well as softening its financial deleveraging stance. Furthermore, the government has also tweaked its environmental policies. We believe the government has room to add more stimulus if needed. On the monetary front, the PBoC has reduced the bank Reserve Requirement Ratio (RRR) further to inject liquidity into the banking system. We expect the central bank to cut bank RRRs further, and continue open market operations alongside lending facilities to ease liquidity concerns. Given that inflation remains well contained (below the 3% target), the PBoC may choose to cut rates if the trade war scenario worsens. Besides easing policy measures, the weakening of the Yuan against the US dollar should help ease the effect of trade tensions on the economy. Against this backdrop, we see Chinese sovereign bond yields grinding tighter.

Exhibit 44: China – Inflation and Interest Rate

Source: Bloomberg

BRAZIL: CENTRAL BANK TO HOLD INTEREST RATES Brazilian assets were impacted by a truckers’ strike in mid-2018 and uncertainty regarding the outcome of the Presidential elections, resulting in the 10-year sovereign bond yield spiking above 12%. However, the yield reversed its trend since September as the possibility of far-right candidate Jair Bolsonaro winning increased and ultimately won the election. Moving into 2019, the new government has made market-friendly cabinet appointments. Furthermore, the market’s focus is likely to shift towards the next set of reforms, particularly pensions, which is the key to stabilise a deteriorating domestic debt path. The central bank, in its latest monetary policy meeting in December, held its benchmark interest rate at an all-time low at 6.5% and hinted that it would hold off from raising rates for longer than expected. The relatively high unemployment rate is anticipated to put a lid on wage hikes, allowing policymakers to uphold economic stimulus as the economy recovers. In November, inflation slipped below the bank’s target of below 4.5% in 2018, reinforcing a view that the central bank could take time before tightening. Moreover, the new President has pledged to enact painful reforms in order to reduce the budget deficit and curb debt levels. Meanwhile, most credit rating agencies have cited Brazil’s high level of foreign reserves ($380bn in November 2018) as a positive influence on its sovereign rating. Given the positive economic outlook owing to the potential for economic reforms under the new President, we hold a Positive view on Brazilian debt, particularly hard currency debt. However, the government may face hurdles in passing pension reforms, thereby triggering volatility in markets.

Exhibit 45: Brazil – Inflation and Interest Rate

Source: Bloomberg

GCC OUTPERFORMED EMS In 2018, global bond markets experienced one of their worst performances in a decade. Nevertheless, GCC bonds and the sukuk market

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had a reasonably better 2018 with the Bloomberg Barclays GCC USD bond index closing with no loss/gain as compared to a loss of 2.8% on the Bloomberg Barclays EM USD bond index. The performance was largely driven by JP Morgan’s decision to include the sovereign and quasi-government bonds from KSA, UAE, Bahrain, Kuwait and Qatar into its EM bond index (EMBI Index) from January 2019 onwards. Also, the $10bn aid provided by GCC members to Bahrain in order to avoid default risk and a constructive resolution of the Dana Gas default case helped in stabilising investor sentiment.

Exhibit 46: Bloomberg Barclays EM and GCC USD Aggregate Total Return Index

Source: Bloomberg; Rebased as on 1st January 2018

Going into 2019, oil prices are anticipated to be favourable as OPEC and allies may act wisely to reduce any supply glut. This, combined with a weaker US dollar due to possible moderation in the rate hike path by the Fed bodes well for GCC credit growth. Furthermore, consolidation in the corporate space, particularly in the banking and telecom sectors, would create more synergies and improve credit metrics. Interestingly, we may see a trend where issuers start exploring local debt, as the UAE has achieved a milestone by finalising the Federal Debt Law (FDL). Under the new law, the UAE government is likely to establish a Federal Debt Management Office (DMO) and seeks credit ratings. It will start issuing bonds/sukuk and will establish a yield curve for local debt, which would create a benchmark and boost corporate issuance. Moreover, the prolific bond issuer, Saudi Arabia, may look to tap markets further as it seeks to raise about $32bn to fund its budget deficit. With the Syrian conflict heading towards resolution, geopolitical risks may subside to some extent. The Sino-US trade war is anticipated to have an indirect impact if it worsens; with China being the largest oil importer, any slowdown in its economic growth will have a negative impact on oil prices. Having said that, we continue to believe that the regional structural reforms and the push to diversify economies away from oil would remain

supportive for credits and hence we are Positive on GCC sovereign as well as corporate debt in 2019.

Exhibit 47: GCC total sovereign bond issuance size

Source: Bloomberg

US IG CREDITS SPREADS TO GRIND TIGHTER The US corporate bond market suffered a loss during 2018, battered by rising interest rates. After tightening to close to a decade low at 94bps in 2017, the US IG bond OAS widened to 148bps in 2018. Similarly, the HY bond OAS also increased 165 bps to 514 bps. Consequently, the US IG market appears to be trading at compelling valuations owing to a sharp correction in 2018. The declining corporate issuance could also help existing bond yields to grind tighter. Although the base effect of tax reforms would be reflecting in corporate earnings, they are still likely to remain in high single digits. With the yield curve relatively flat and expectations of gradual rate hikes amidst growth concerns, we believe high quality bonds could make more sense in a diversified portfolio. Preference should be given to the companies that had not aggressively added leverage in the low interest rate environment and have a high interest coverage ratio.

Exhibit 48: US IG OAS and HY OAS

Source: Bloomberg

In 2018, the decline in oil prices has played a key role in dragging on the US HY bond performance (refer to exhibit 48) as the energy sector comprises more than 15% of the overall Barclays High Yield Bond Index. Looking ahead, favourable

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oil prices, and continued search for yield should drive HY credits in 2019. However, we are Neutral owing to widening spreads in a late cycle economy.

Exhibit 49: WTI vs. Bloomberg Barclays US HY bond index

Source: Bloomberg

FALLEN ANGEL RISK Over the past few years, companies at the low end of the IG spectrum (BBB rated) have been issuing bonds to fund acquisitions and buyback shares as evident from the chart 50. Such credits have come under pressure as rising interest rates and inflation are pushing up firms’ input costs and squeezing profit margins, thereby increasing leverage.

Exhibit 50: Amount Outstanding in BBB-Rated and HY Corporate Bonds

Source: Bloomberg

Major central banks’ reduction in their balance sheets may leave riskier and more leveraged segments of the market vulnerable. Since the entire BBB-rated spectrum is not at a risk of

downgrades, investors need to be selective, given the aforementioned risks. Hence, we reiterate our view that investors should consider moving up in credit quality as economic growth and corporate earnings moderate.

EU CREDITS: FOCUS ON FINANCIALS In line with the US, the European IG and HY bond OAS also widened during 2018 as yields started widening in anticipation of the likely rise in net supply when the ECB bond buying programme ends. The ECB’s monetary easing seems to be feeding through into money supply growth. Accordingly, inflation is likely to increase but undershoot targets. This backdrop would prove to be supportive for EU credits. Nevertheless, the Euro zone’s economic growth continued to disappoint with the bulk of weakness stemming from a contraction in the auto sector. European Union growth in 2019 is projected to slow to 2.0% from 2.2% in 2018, estimated by the IMF. Although rate hike expectations by the ECB are unlikely until late 2019 at the earliest, the formal ending of the bond purchasing programme could tighten liquidity conditions and result in yield widening as was the case in 2018. The European economy is expected to face a number of political challenges in 2019 with major threats from a disorderly Brexit and US auto tariffs. Hence, we are Neutral with a Negative Tilt on European corporate credits. However, on a positive note, the recovery in the European banking sector provides investment opportunities despite political risks. European bank debt, particularly convertible contingent bonds (cocos), offers mid-to-high single-digit yields and a significant spread pick-up over equally rated non-financial corporate bonds.

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The turbulence in energy markets is expected to continue in 2019 due to fears of the global economic slowdown and rising US oil production. That being said, we believe the upward pressure on oil prices will build up gradually over the course of the year as a result of production cuts implemented by OPEC along with less supply expected from Venezuela, Iran and Libya. OPEC has also indicated that it will not shy away from further cuts to keep the oil market in balance. Moreover, the inability of the Permian drillers to sustain lower crude prices may keep their supply growth in check. Thus, we are Positive on oil and expect Brent crude oil prices to trade between $65 and $75/bbl range in 2019. We prefer gold amongst precious metals due to its safe-haven appeal and our view of a relatively weaker US dollar going forward.

2018: A VOLATILE YEAR FOR OIL MARKETS 2018 was marked by some of the highest prices seen by the global oil market in over four years and some of the largest single-day drops. Brent crude prices rose through most of the year and attained a high of $86/bbl in early October led by fears of supply concerns ahead of US sanctions on Iran. However, in 4Q18, it experienced the steepest decline since late 2014 as global slowdown concerns rattled the markets. Notably, Brent and WTI crude oil prices fell 20% and 25% during the year to settle at $53 and $45 per barrel, respectively.

Exhibit 51: Brent and WTI Price Movement

Source: Bloomberg

FEARS OF OIL SUPPLY GLUT In the first three quarters of 2018, oil prices headed north owing to fears of a supply deficit due to continuous strengthening of global demand and supply concerns from Iran, Venezuela and Libya. To meet the rising global demand, oil producers across the globe increased production levels, mainly led by the US. Oil production in the US surged 20% y/y in 2018 to 11.7 MMbpd due to the relentless growth in US shale. Amidst pressure from US President Donald Trump to keep oil prices low, Russia and Saudi Arabia also increased their production levels by 4.2%y/y and 10.8%y/y to 11.4 MMbpd and 11.0 MMbpd, respectively. The combined production of these top three oil producers now comprises around 40% of total global production. However, worries over a supply glut led by swelling US shale output, Iran sanction waivers given by the US, and rising concerns over weaker oil demand

dragged oil prices lower in the last quarter of 2018.

Exhibit 52: Russia, US and Saudi Arabia Production Levels

Source: Bloomberg

The Energy Information Agency (EIA) forecasts the shale production from seven major shale basins in the US to climb to 8.03 MMbpd for the first time on record in December 2018 and is expected to rise by 0.13 MMbpd in January 2019 amidst infrastructure constraints in the Permian Basin. Moreover, the American Petroleum Institute (API) reported a rise in oil inventories by 3.5 MMbpd to 441.3 MMbpd for the week ended December 14, adding to the concerns of a supply glut. Global demand and supply numbers released by the International Energy Agency (IEA) also verify the widening demand-supply gap.

Exhibit 53: Global Oil Demand vs. Supply

Source: IEA

US BECOMES THE TOP OIL PRODUCER Over the years, the US saw exponential growth in its oil production, surpassing Russia to become the largest oil producer in the world. The US also became a net exporter of oil at the end of the fourth quarter for the first time in 75 years. The unprecedented boom in American oil production

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is the result of thousands of wells pumping from the Permian region of Texas and New Mexico. According to Baker Hughes, the oil rig count rose by 138 to 885 in 2018, the second consecutive year of strong growth. With this, the total number of oil and gas rigs averaged 1,031 in 2018, the highest count since 2014.

Exhibit 54: US Oil Inventories and Rig Counts

Source: Bloomberg

Despite the pipeline constraints in the Permian basin for the past two years, oil production in the basin grew 39% y/y to 3.9 MMbpd in 2018. Furthermore, with three new pipelines expected to become operational in 2H19, the total capacity of the Permian basin is expected to increase by another 2 MMbpd. That being said, if lower oil & gas prices persist, it might discourage US shale drillers to increase production, which will be key to re-balancing in the oil market.

Exhibit 55: Break-Even Cost For US Oil Basins

Source: Bloomberg

OIL DEMAND MAY EASE IN 2019 With the ongoing conflict between the US and China on the trade front and rising geopolitical tensions, global economic growth is likely to slow down in the upcoming year. In China, weaker-than-expected retail sales and industrial production figures have already dampened enthusiasm for growth in oil demand. As a result, OPEC expects its oil demand to fall to 31.44 MMbpd in 2019, 1 MMbpd less than its prediction earlier in November. Despite a 90-day peace between the US and China on trade tariffs, the

key question remains whether both countries could reach an agreement in 1Q19 or not. Hence, we expect oil prices to move north in the latter half of the year if the outcome of trade talks turn out to be positive.

Exhibit 56: IEA and EIA Demand–Supply Forecast

(in MMbpd) 2018 2019 2018 2019

OPEC Supply OECD Demand

IEA NA NA 47.8 48.1

EIA 39.2 38.3 47.7 48.1

Non-OPEC Supply Non-OECD Demand

IEA 60.3 62.3 51.4 52.5

EIA 61.2 63.5 52.4 53.5

Total Supply Total Demand

IEA NA NA 99.2 100.6

EIA 100.4 101.8 100.9 101.6

Source: IEA and EIA

BRENT–WTI SPREAD TO NARROW While the prices for both Brent and WTI have declined, the spread between the two has widened. At present, the spread between WTI and Brent is around $8.0/bbl, from $6.4/bbl in January 2018. The spread widened to double digits during mid-year and towards the end of the year, reflecting pipeline bottlenecks in the Permian region. However, with new pipelines to be operational in the upcoming two years, the infrastructure constraints would be a matter of the past and the spread between Brent and WTI should narrow.

Exhibit 57: Brent and WTI Spread Movement vs. US Crude Oil Exports

Source: Bloomberg

OPEC CUTS PRODUCTION In their December meeting held in Vienna, OPEC and Russia decided to cut crude output by 1.2 MMbpd effective from January, accounting for more than 1% of global demand. The curbs to be in effect from January are expected to balance the world oil markets in 1H19. According to the agreement, OPEC will be reducing 0.8 MMbpd, while Russia and other producers will be cutting 0.4 MMbpd. Saudi Arabia and Russia will be

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shouldering most of the burden while Iran, Venezuela and Libya will be exempted from the production cuts. Meanwhile, the OPEC report indicated that Iran is facing the biggest decline in oil production by 0.38 MMbpd to 2.95 MMbpd in 2018, due to the sanctions imposed by the US. Similarly, Libya also experienced a production slowdown during the year with the latest development being the declaration of force majeure by the National Oil Company (NOC) on exports from the El Sharara oilfield (capacity – 0.32 MMbpd). Moreover, the Venezuelan oil crisis also does not seem ready to conclude as Fitch stated that Venezuela’s state-owned oil giant PDVSA’s oil production is expected to fall by 31.2% in 2019. Notably, Qatar has declared its decision to leave OPEC in January to focus on its natural gas production.

Despite the announcement of supply cuts by OPEC and Russia, which jointly produce more than 50% of total OPEC and its allies supply, oil prices remained subdued due to uncertainties surrounding the global growth outlook. We expect oil prices to remain volatile in 2019 with Brent crude likely to trade between $65 and $75/bbl as OPEC has indicated that it will not shy away from more supply cuts in 2019, which should provide support to oil prices.

NATURAL GAS: HIGHER PRODUCTION LIMITS UPSIDE Natural gas prices plummeted by 8% during 2018, owing to higher production which was partly offset by increased demand due to cold weather. Interestingly, prices had attained a peak level of $7.13/MMBtu (mn British Thermal Units) in the beginning of 2018, the highest in the past three and half years.

Exhibit 58: Natural Gas Production vs. Prices

Source: Bloomberg

According to the data released by the EIA, US natural gas inventories were 19% lower than the five-year average (2013–2017) at 3.0 tn cubic feet (tcf) as of 11th December due to high demand for

heating and power generation, as the US went through the coldest November in the last four years. Moreover, the deficit of gas in underground storage widened to 0.7 tcf, lower than the average of the last five years.

Conversely, the gas rig count increased by 26 to 198 at the end of 2018, which in turn led to higher US dry natural gas production to 87 Bcf/day, well above 78 Bcf/day recorded in 2017. Natural gas production in the US is expected to reach 90.0 Bcf/day in 2019. The EIA forecasts Henry Hub natural gas spot prices to average $3.11/MMBtu in 2019, down 6 cents from the 2018 average. Therefore, we hold a Neutral stance for Natural gas.

SEVERAL TAILWINDS FOR GOLD IN 2019 Despite the Fed’s aggressive stance and a stronger US dollar, the average gold price remained stable to close the year at $1,282/oz, supported by safe-haven appeal amidst geopolitical tensions. Furthermore, the buying spree from central banks limited the fall in the yellow metal’s price. According to the World Gold Council (WGC), Russia, Turkey and Kazakhstan were the largest buyers of gold throughout the third quarter of 2018. The Russian and Kazakh central banks are expected to continue to accumulate gold to support its currency reserves amidst US sanctions policy. The WGC estimates an increase in demand for gold as China resumes buying it amidst domestic currency depreciation.

Exhibit 59: Central Bank Gold Purchases

Source: WGC

Looking ahead, gold is poised to benefit mainly from expectations of dollar softness, global slowdown concerns and geopolitical tensions. Moreover, political uncertainties in Europe, including Brexit could boost gold prices. The uncertainty over the US and China relationship could also spur demand for gold. We are overweight on gold given its upside potential due to the aforementioned reasons, while factors

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limiting the rise in prices, such as the inflationary environment, remain benign.

Exhibit 60: Gold and Silver Price Movement

Source: Bloomberg

SILVER MAY RIDE GOLD’S COATTAILS Silver posted one of the worst performances amongst the precious metals, with a decline of 8.5% to around $15.5/kg due to a demand-supply imbalance. The ongoing Sino-US trade conflict led to a decrease in industrial demand (accounting for more than 50% of total demand) of silver, resulting in a supply surplus and subsequent fall in prices, particularly in the second half of the year. However, silver prices largely moved in tandem with gold prices throughout the year.

In 2019, the industrial demand for silver may weaken due to moderation in economic growth, particularly in China. Having said that, silver prices are currently trading at low levels and given the shift in consumer buying patterns from gold to silver, primarily for jewelleries and ornaments, it is expected to lend some support to silver prices. Thus, we expect silver prices are likely to follow gold prices on its upward trajectory for the most part of 2019. We thus hold a Positive view on silver.

PLATINUM TO BE IN SUPPLY SURPLUS Falling demand of diesel engines in Europe mainly led to the decline in platinum prices in 2018, as it ended the year 14% lower at $796/oz. The metal is primarily used in catalytic converters for diesel-powered vehicles. Diesel cars accounted for only 36% of new car sales in Europe during 2018, 8% lower than in 2017. This led to platinum prices falling to a 10-year low of $769/oz and trading at the highest discount over gold since exchange trading of platinum began in 1987.

Exhibit 61: Platinum Demand-Supply balance

Source: WPIC, *Forecasted

In its latest report, the World Platinum Investment Council (WPIC) has projected supply growth of platinum to outpace demand in 2019. On the supply side, the production in South Africa and North America is expected to expand despite lower prices due to the weak South African Rand and lower cost of production. We also expect recycling supplies to increase as more old cars will be scrapped due to the diesel-car ban in Europe. That being said, platinum is expected to post a surplus of 455K ounces for 2019. However, it is possible that platinum could be used as a substitute for palladium, which trades historically at a high premium over platinum. This in turn could create some demand for platinum, thereby limiting the downside in prices. Hence, we hold a Neutral view on platinum.

Exhibit 62: Platinum and Palladium Price Movement

Source: Bloomberg

PALLADIUM: RIDING HIGH Palladium is the only precious metal to end the year on a positive note, with the prices advancing 19% to close at $1,261/oz. The price of palladium soared to record highs in mid-December, surpassing gold prices for the first time since October 2002. An overall supply deficit in the global palladium market is the primary reason for the elevated prices in 2018. Palladium is generally used in autocatalysts for gasoline engines. Due to stringent emission regulations in Europe, the demand for palladium has increased exponentially during the past few years. Moreover, the ‘diesel-gate’ scandal in Europe has

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resulted in a shift from diesel to gasoline cars, leading to an increase in the demand for palladium.

Looking ahead, we expect palladium prices to remain range-bound as the palladium market is very small and illiquid, which may have speculative bids holding the prices at a higher level. Moreover, the ongoing trade spat could result in declining auto sales, which in turn could weigh on the demand for the metal. However, the introduction of tougher emission standards in China and Europe may keep demand intact. Palladium prices could also get a boost from a semiconductor boom as markets shift towards semiconductor-driven technologies (IoT, Big Data and AI).

INDUSTRIAL METALS LIKELY TO EXPERIENCE A CHALLENGING YEAR Unlike the last year when metals were in the limelight, most of them closed at their yearly low in 2018, mainly due to the appreciation of the US dollar and the uncertain business environment. Given that China is the world's leading consumer of nonferrous metals, the escalating trade battle between the US and China continues to create distortions in the metals market. Moreover, global growth is expected to maintain its expansion, although at a slower pace, which should keep underpinning the demand for metals. Further, supply concerns, particularly for copper, are likely to support base metals. Therefore, we are Neutral on industrial metals.

COPPER: EASING DEMAND OVERSHADOWS SUPPLY SHORTFALL Copper prices remained volatile during 2018, reaching a four-year high of $7,331/tonne in 1H18, driven by a production shutdown in Chile, the largest producer of copper, and touching a low of $5,759/tonne. Overall, copper prices fell by 17% to $5,949/tonne at the end of 2018.

The copper market recorded a supply deficit of 595,000 tonnes during the first nine months of 2018, vis-à-vis a deficit of 266,000 tonnes in 2017, driven by unplanned shutdowns in Chile, Australia, India and the Philippines, as per the International Copper Study Group (ICSG). It expects the supply deficit to narrow in 2019 to 65,000 tonnes, from 330,000 tonnes forecasted earlier, on account of production capacity additions in China and the Democratic Republic of Congo.

Exhibit 63: Refined Copper Surplus/-Deficit

Source: International Copper Study Group, *Forecasted

On the demand side, the ICSG revised down its growth expectation to 2.7% from 4% earlier for 2018 and expects modest growth of 2.9% in 2019. Growth is likely to be supported by demand from emerging nations, particularly India on account of its focus on urbanisation and infrastructure, along with a faster-than-expected shift to electric vehicles in China.

That being said, other factors such as a relatively wide scrap discount, visible stockpiles in China and slowing Chinese imports could restrain upward movement of copper prices.

ALUMINIUM: LOOMING OVERSUPPLY RISK Aluminium prices surged to a seven-year high of $2,598/tonne in April, following the US sanctions on the largest Russian aluminium producer RUSAL. However, they lost ground and fell by nearly 17% in 2018 due to 10% import tariffs levied by the US, fears of a worsening trade conflict and oversupply concerns.

Exhibit 64: Aluminium and Nickel Prices

Source: Bloomberg

Unlike other metals, the global aluminium market is expected to reach an oversupply zone in 2019, as per CRU group (a business intelligence company focusing on commodities), after nine consecutive years of supply deficits. Global supply growth is expected to increase by 4% in 2019 due to new capacity coming online in China and expansion of aluminium processing plants in Bahrain, despite another 800,000 tonnes/year

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smelting capacity cuts from China. Furthermore, the US has lifted sanctions on RUSAL, effective from January 2019 and this should soften the supply constraints of alumina, the raw material for aluminium. On the other hand, demand is expected to remain modest, growing at 3.7% in 2019. Hence, we hold Neutral view with a Negative Tilt on aluminium prices.

NICKEL: CHINA STEALS THE LUSTRE Nickel prices remained volatile in 2018, rising nearly 17% in the first half of 2018 on strong global demand and a larger-than-expected supply deficit, but later fell 16% to below $11,000/tonne on a softer global growth outlook. However, it remained broadly down from the all-time peak at $48,700/tonne in April 2007. Despite the higher production of 6.4% y/y, the refined nickel deficit increased to 108,300 tonnes in January–September 2018 from 72,800 tonnes in 2017. The supply deficit is expected to narrow to 33,000 tonnes in 2019, driven by higher production from China and Indonesia, as per the International Nickel Study Group (INSG).

Rising demand for stainless steel (representing more than two-thirds of total primary nickel demand), and increasing adoption of electric vehicles are likely to fuel demand for nickel. However, the reduction in subsidies for electric vehicles by many countries, particularly in China, may reduce some of the tailwinds. We hold a Neutral view on nickel prices with considerable price fluctuations likely in 2019.

ZINC: BENEFITTING FROM SUPPLY SHORTFALL Over the past five years, zinc prices have increased over 60% due to a significant decline in inventories. Continuing the trend in 2018, prices reached a new 10-year high of $3,606/tonne in February, but later fell sharply to roughly $2,500/tonne on account of weaker demand, a temporary rise in LME inventories, and a tepid global economic outlook. Going forward, the zinc market is expected to witness a supply deficit, albeit at a lower level. The International Lead and Zinc Study Group (ILZSG) expects the supply deficit to narrow to 72,000 tonnes in 2019 from 322,000 tonnes in 2018. Thus, we hold our Neutral view with a Positive Tilt on zinc.

Exhibit 65: Ever So Falling Inventories And Price Correlation

Source: Bloomberg

COFFEE: BUMPER HARVEST FLOODS THE MARKET A bumper harvest in Brazil and Vietnam, the world’s 1st and 2nd largest coffee producers, pushed coffee prices to a near five-year low in 2018. The significant depreciation in the Brazilian Real (BRL) has encouraged more exports, thereby flooding the international coffee market and resulting in lower prices. However, some reversal in the BRL later in the year and speculative trading pared losses to 25% to 108 cents/lb.

Brazil’s harvest of coffee beans is expected to hit the market with 63mn bags in 2018–19, as per the United States Department of Agriculture (USDA). However, unpredictable weather patterns, particularly drought forecasts, may significantly vary the production estimate.

We anticipate Brazil’s coffee exports to accelerate in 2019. However, low prices would encourage farmers to shift to other crops. Therefore, we hold a Neutral view with a Negative Tilt on coffee prices for 2019.

Exhibit 66: Volatile Sugar And Coffee Price Movements

Source: Bloomberg

SOYABEAN: CAUGHT IN THE US–CHINA SPAT Soybean prices started the year on a strong note rising nearly 12% as unfavourable weather led to low crop yields in Argentina. However, the rally turned out to be short-lived as the US–China trade conflict effectively closed the biggest soybean market to US suppliers. In all, prices fell 9% to

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$8.4/bushal at 2018-end. Low prices and current trade uncertainty have resulted in lower acreage in the US. As a result, US soybean production is expected to fall by nearly 13% y/y to 111 mn tonnes in 2019, as per the USDA.

On the other side, Brazil’s soybean exports increased by around 10 mn tonnes during January–October 2018, as China (the world’s largest soybean consumer) realigned its soybean imports. Brazil’s soybean production is expected to increase to 121 mn tonnes in 2019, effectively making it the largest soybean producer in the world, as per the USDA. The recent pledges of more US soybean imports by China amidst the 90-day truce have brought some respite to the market. However, the impact of these pledges, even if it materialises will remain low. We expect prices to remain range bound, with a Negative Tilt, in 2019 as the market adjusts itself to the new trade realities.

SUGAR PRICE READY TO RALLY Sugar prices remained weak in 2018, reaching a 10-year low of around 11 cents/lb in August due to oversupply concerns led by high production in India and Thailand, the 2nd and 4th largest sugar

producers, respectively. However, prices received temporary respite as a result of high ethanol demand in Brazil and uncertainty over Indian sugar exports. Ultimately, prices ended the year 11% lower at 12.6cents/lb as sliding oil prices led to a fall in demand for biofuel in Brazil.

Exhibit 67: Sugar Premium/Discount Over Ethanol

Source: FGA, * Forecasted

Going forward, the sugar market is expected to swing to a deficit of 2 mn tonnes, ending the two-year-long oversupply. This is due to severe weather forecast in Brazil and prevailing crop diseases in India, which would lead to low production in 2019. Hence, we expect the potential supply deficit to drive prices higher in 2019.

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The USD may weaken as the Fed gradually begins to slow the pace of monetary tightening. The downside risk of the recent increase in the fiscal and current account deficits may become more visible in the face of moderating US economic growth. Thus, we are Cautious on USD. However, we are Neutral with a Positive Tilt on the EUR driven by rate differentials and of course the weakening of the USD. We hold a Cautious stance on the GBP amidst Brexit uncertainty. We are Positive on the JPY as the country's depressed financial sector may warrant higher yields, which remains in focus for the BOJ. We are Neutral with a Positive Tilt on EM currencies as it is likely to benefit from a benign USD in 2019.

USD: ON A SOFTENING MODE The greenback defied market expectations that it would remain weak in 2018. At the start of 2018, markets were of the opinion that a quiet first year in office for President Donald Trump in 2017, which saw a decent recovery in global growth and weakness in the USD, would persist in 2018. Synchronised global growth was expected and a risk-on theme largely dominated investment ideas. However, things have changed too quickly and too fast as US foreign trade policy started to become aggressive in line with the theme of “America First” propagated by President Trump during the election campaign. As the year progressed, the US started targeting China and imposed tariffs on almost half of Chinese goods entering into the US by the end of the year. This, along with the Fed’s aggressive monetary policy led to massive sell-off pressure across EMs and stronger demand for the USD.

Exhibit 68: Decent Correlation of Rates and Dollar Index

Source: Bloomberg

The risk of contagion stemmed from some of the weaker emerging market countries, further undermining sentiment and seeking safety in the USD. In the face of risk-off sentiment, markets downplayed the downside risks posed by the burgeoning fiscal and current account deficits on the USD. The US has embarked on its fiscal stimulus programme of $1.5tn through tax cuts and additional $300bn in federal spending. This, coupled with huge refinancing needs for maturing bills and corporate repatriation encouraged by tax reforms, led to inflows of dollars into the US, leaving fewer dollars available elsewhere in the world. As a result, the USD has become expensive in relation to major currencies, including the hard

ones. Looking into 2019, the USD looks likely to reverse its course as the country is in the late cycle of expansion and interest rates are approaching closer to the neutral rate. US economic growth is expected to moderate as fiscal stimulus eventually fades in 2H19, and we do not expect any fresh large fiscal stimulus to come in order to prevent the economy from slowing back to a long-term trend of around 2.0% growth. The Democrats now have control in the House and they may not favour any sizeable fresh fiscal stimulus from which the Republicans could reap benefits in the 2020 Presidential elections. However, on the trade front, both parties support an aggressive stance against China, although the US and China have agreed to suspend any additional tariffs on each other during the ongoing 90-day negotiations. Any favourable trade deal with China could reignite risk appetite and put pressure on the USD as investors search for value, particularly in EMs.

Exhibit 69: US Twin Deficits

Source: Bloomberg

We also believe that the US twin deficit (fiscal and current accounts) concerns would resurface in a more convincing manner, this time in the wake of slower growth and the resulting burden on the government’s public finances.

We are of the view that the USD is expensive following the strong rally in 2018 and the collapse of EM currencies. The Fed has become cautious with regard to its monetary policy outlook and looks set to end its rate hike cycle by somewhere in 2020, as reflected in its median estimates. The central bank has lowered its estimates for where the neutral rate sits in the range of 3.0–3.25% instead of 3.25–3.50%

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earlier. The Fed expects two rate hikes in 2019 instead of three earlier. However, markets are sceptical of any hikes in 2019. The slowdown in US growth and the possible end of the Fed’s policy normalisation are likely to keep the yield curve flat, led by longer maturities. Therefore, yields are expected to remain lower and a less favourable interest rate differential is likely to put pressure on the USD. Therefore, we are Cautious on USD.

EUR: SOFTENING IN USD COULD SUPPORT EUR The EUR weakened against the USD last year due to a myriad of adverse developments. The Eurozone’s economic growth lost its momentum in the second half, growing at 0.2% q/q in 3Q18 as compared to 0.4% q/q each in the first two quarters. Inflation remained subdued and the ECB was forced to delay its initial target for ending the quantitative easing by three months to December. Italy continued to steal the limelight since its general election held in March, worrying investors. While the country managed to form a coalition government after three months of negotiation, it dominated the headlines for quite some time due to the standoff against the EU over the budget deficit target for 2019, which eventually got resolved. The risks associated with Brexit, an uncertain political situation in Germany, trade disputes and a broad-based slowdown in the regional economy continued to put pressure on the EUR.

The central bank has slightly revised down its growth projections for 2018 and 2019 while stating that the risk to the outlook is moving to the downside due to persistent uncertainties related to geopolitical factors, the threat of protectionism, vulnerabilities of emerging markets and market volatility. The ECB now expects the Euro zone’s real annual GDP growth of 1.9% and 1.7% in 2018 and 2019, respectively compared with 2.0% and 1.8% projected in September. The growth is anticipated to be driven by favourable financing conditions, ongoing wage growth supporting private consumption and some fiscal spending. While France and Italy are expected to increase their fiscal stimulus, the latter has limited headroom due to its high debt level (130% of GDP), the highest amongst Eurozone members. Forecasts for headline inflation have been revised marginally down to 1.6% for 2019 from 1.7% estimated earlier at the September meeting, owing to the assumption of

weaker oil prices. Notably, core inflation is expected to be benign at 1.4% in 2019.

Anaemic growth in the Eurozone may argue for a weaker EUR in 2019, but we do not share this view. We believe that the EUR may gradually regain some strength as the Fed turns increasingly dovish. Once markets become more convinced about the Fed’s stance over the next few months, the greenback may eventually start displaying its weakness. The favourable interest rates in the US have made the dollar expensive. As per OECD estimates, the purchasing power parity of the EURUSD pair has averaged around 1.29 over the last 10 years. However, the fact that the current actual exchange rate of 1.14 is significantly below 1.29 is owing to the USD interest rate advantage, which has been rising in recent years.

Exhibit 70: EURUSD Exchange Rate Movement

Source: Bloomberg

Going forward, with limited Fed support, the re-rating of the USD looks imminent and its valuation may not be sustained in our view. On the other hand, the ECB has started normalising policy with the winding down of its quantitative easing programme in December 2018.

Yet, the ECB will remain accommodative as it reinvests the principal amount from maturing securities purchased under the Asset Purchase Programme (APP). The central bank intends to continue with the reinvestment strategy for an extended period even after its first rate hike, which is expected only after the summer of 2019. Therefore, the recovery in the EUR is likely to come from the weakness in the USD. Thus, we are Neutral with a Positive Tilt on the EUR. The key risks to our view would be the EU parliamentary elections in May 2019, where the support for populist parties is rising. Further, the ongoing Italian political risks and a likely sovereign downgrade in the first half of the year by either Fitch or S&P will be negative for the EUR.

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GBP: BREXIT UNCERTAINTY MASKS ITS UPSIDE POTENTIAL In 2018, the GBP witnessed a prolonged period of accentuated volatility as the UK continued to scramble in finding a smooth way of leaving the single market. After a protracted negotiation between the UK and the EU, a proposal for Brexit withdrawal agreement was eventually presented in November 2018. The GBP reacted positively but failed to sustain its gains as the draft brought political division in parliament. This was owing to the controversial ‘backstop’ deal that allows maintaining a soft border between Northern Ireland and the Republic of Ireland post the start of Brexit on 29th March. Of course, the opposition was against the withdrawal agreement. Several members from the ruling Conservative Party also did not support the draft deal with Brexit Minster Dominic Raab resigning from his key post. The ruling party even initiated a no confidence vote on PM Theresa May, although she survived the motion in Parliament. The Brexit draft deal, which was supposed to be tabled for the vote in Parliament on December 12th, was deferred to mid-January 2019.

PM Theresa May still has some time to discuss with the EU amendments to the draft deal. However, the likelihood of getting the draft amended looks quite challenging as EU officials are opposing further concessions. If the EU’s stance prevails, a no-deal Brexit or second referendum looks highly possible as it would be difficult for the British Parliament to approve the existing draft deal before the end of March 2019. In such a scenario, the economic outlook would further worsen and the GBP might take a fresh hit. As a result, we are Cautious on the GBP. That being said, the market is anticipating a Brexit deal to occur at the last moment. In such a case, the GBP would regain its strength, even though monetary policy might not turn supportive for the GBP. This is because a potentially resurgent GBP should itself help to contain (to some extent) inflation, which is currently above the 2% target and on a declining trend. Gradual interest hikes over the next 2-3 years appear possible as rising wage growth due to the tight labour market could underpin domestic inflationary pressure. However, the next interest rate hike is unlikely to take place until after the March Brexit, which has become a key determinant of the monetary policy stance for the BOE.

Exhibit 71: GBP vs. USD

Source: Bloomberg

JPY: AILING BANKING SECTOR QUESTIONS OVER BOJ’S UBIQUITOUS EASING POLICY The Japanese Yen (JPY) closed with a modest gain of 2.6% against the USD last year, as the safe-haven currency benefitted from the ongoing trade conflict between the US and China. The JPY started gaining traction since July, when the BOJ signalled the start of the normalisation process through allowing a higher deviation from its 10yr yield target. The BOJ now allows the 10yr yield to move up to 0.2% as compared to around 0% previously. The central bank has expressed its concerns about low interest rates and their adverse effects on the banking sector, where margins have been under pressure while endangering the stability of the sector.

Exhibit 72: USDJPY and EURJPY Exchange Rates

Source: Bloomberg

As a result, we think that the BOJ may not prefer to keep rates at near zero for so long through its ongoing quantitative easing programme that began in 2013. Therefore, we are of the view that yields may gradually move upward, which would lead to the strengthening of the JPY. Thus, the JPY should appreciate against the USD in 2019.

We acknowledge that the Japanese economy is grappling with headwinds from the trade war as the US still intends to impose import tariffs on the EU and Japanese car makers. The weakening demand in China, the largest trading partner of Japan, has also clouded the growth outlook. Japan’s economy contracted 0.2% in 3Q18 for the

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first time since 4Q16. In December 2018, the country revised down its GDP growth forecasts for this fiscal year (ending in March 2019) to 0.9% from the previous projections of 1.5%. For fiscal 2020, growth is expected at 1.3% as compared to 1.5% forecasted earlier. Corporate capex growth is projected to slow down to 2.7% in FY20 from 3.6% in FY19. More importantly, from the currency perspective, Japan now expects inflation of about 1.1% in FY19, well below its previous forecast of 1.5%. Such disappointing inflation has already forced the BOJ to completely refrain from specifying a timeframe for reaching its inflation target. In our view, this should not imply that the BOJ would necessarily maintain its expansionary monetary policy. The BOJ has been increasingly raising its voice with regard to the side effect of protracted quantitative easing on the banking sector since late 2017, which we had highlighted in our annual outlook for 2018. The stealth tapering has become more pronounced in 2018, with the BOJ buying fewer bonds than its target of JPY80tn per year. Thus, we see decent headroom for the JPY to appreciate against other developed market currencies, including the USD and the EUR.

Exhibit 73: BOJ’s Stealth Tapering Intensifies in 2018

Source: Bloomberg, BOJ

CAD: CAUTIOUS MONETARY POLICY TONE AMIDST BENIGN OIL PRICES The Canadian dollar (CAD) turned out to be one of the underperforming currencies within the G-10 space.

Exhibit 74: G-10 Currencies (2018 y/y)

Source: Bloomberg

After having experienced strong growth in 2017, economic activity has slowed in 2018 due to uncertainties over the trade relationship with the US and the sharp fall in oil prices. As such, Canada has reached an agreement with the US on the revised version of the North America Free Trade Agreement (NAFTA) in September and the NAFTA risk has been eliminated, for now. The US is a key trading partner of Canada as over two-thirds of the goods are being shipped every year to the US. Oil and natural gas contributes about 10% to Canadian GDP and the US is the primary importer of Canadian oil. The lower oil prices, particularly the Canadian oil benchmark (Western Canadian Select), which have nosedived more than the Brent and WTI oil prices over the last three months, are expected to influence the monetary policy decision of the central bank, the Bank of Canada (BOC).

After five rate increases since July 2017, the BOC’s rate hike trajectory looks likely to be more gradual in 2019 as inflation is anticipated to come down within its goal of 2% due to lower oil prices and relatively weak domestic demand. While inflation inched up to 2.4% in October, the central bank kept its benchmark rate unchanged at 1.75% in December, given that the risk to the economic growth outlook has skewed to the downside. The Conference Board of Canada expects GDP growth of 1.9% in 2019, from an anticipated 2.1% in 2018 (2017:+3.0%). Consequently, the BOC has now become more data-dependant and the possibility of a rate hike looks remote until at least the spring. That being said, the BOC is still far from reaching its neutral rate of 2.5% to 3.5%. As a result, we have a Neutral view on the CAD.

EM CURRENCIES TO BENEFIT FROM IMPROVING EXTERNAL FINANCIAL POSITION AND A WEAKER USD Emerging market currencies eventually succumbed to the pressure from the relentless surge in the USD and several other idiosyncratic factors in 2018. Amongst EMs, the Argentine Peso and the Turkish Lira plunged, although the latter stabilised to a large extent towards the last quarter of the year. The capital flight from emerging market economies intensified as the Fed continued to increase interest rates, compelling investors to take advantage of higher yields in the US. Further, the sharp rise in oil until October made EMs more vulnerable, exacerbating the sell-off in regional assets and leading to the weakness

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in currencies. Meanwhile, faced with capital outflows, many emerging market policy makers have opted to hike rates, resulting in tighter domestic financial conditions.

Exhibit 75: EMs Currencies vs. USD (2018 y/y)

Source: Bloomberg

Furthermore, most EM markets faced political uncertainties amidst leadership changes, making them vulnerable to contagion risk at the time of volatility in global markets.

Exhibit 76: EMs Current Account Deficit

Source: Bloomberg

Going forward, we see little impetus for further USD strength considering its high valuation. The performance of EM currencies remains stable since the start of September 2018. We believe that EMs should maintain the ongoing gradual recovery with the likely normalisation of the monetary policy by the ECB and even the BOJ towards the latter half of 2019. A favourable oil price environment, expectations of a weaker USD and tempting valuations may lure foreign capital inflows.

Exhibit 77: EMs Foreign Reserves

Source: Bloomberg

We believe that EMs have already seen their worst and should start benefitting from the aforementioned factors with inflation likely to stay under control. The external position of EMs has improved in recent years. However, amongst others, ongoing China-US trade talks remain crucial for the asset class and any positive outcome could drive risk appetite boosting demand for EM assets. Therefore, we are Neutral with a Positive Tilt on EM currencies.

INR: ELECTION UNCERTAINTY UNDERWHELMS POSITIVE ECONOMIC OUTLOOK The Indian Rupee (INR) has been one of the worst performing currencies in Asia, depreciating 9.2% in 2018 against the USD. The INR mirrored the sell-off in EM assets caused by elevated US-China trade policy risks, higher oil prices, the Fed’s tighter monetary policy and concerns about liquidity in the domestic non-banking financial sector (NBFC). The rift between the RBI and the government, which led to the abrupt resignation of Reserve Bank of India (RBI) Governor Mr. Urjit Patel, has raised questions over the central bank’s independence. Furthermore, the increasing current account deficit had been a concern due to the sharp upswing in oil prices, despite India’s external position remaining much better than its peers. Forex exchange reserves of $400bn at the end of September 2018 cover imports of 8 to 9 months. With the recent sharp correction in oil prices and expectations that they would remain relatively lower in 2019, India’s external position looks more favourable. On the fiscal front, we believe the government may deliver on its commitment to meet fiscal deficit for FY19 (3.3% of GDP), yet we see some risk for its FY20 fiscal deficit target of 3.0%. This is because the government may come up with a more populist budget ahead of the general elections in May 2019, following the recent upset in some state elections.

While the domestic economic outlook remains positive, we do not see much upside potential in the INRUSD pair as the RBI looks likely to take a dovish stance. This is due to benign inflation, with the central bank downgrading its inflation forecast for FY20. Consumer inflation grew by just 2.3%y/y in November 2018, the lowest in 17 months, from an upwardly revised 3.4% in October. This was primarily attributable to lower food prices. As a result, we believe that the RBI might drop its ‘calibrated tightening’ stance while

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switching to a neutral outlook. Recently, the RBI cut its Statutory Liquidity Ratio (SLR) by 25bps to 19.5%, thus releasing more liquidity into the banking system, which has been under pressure due to defaults taking place in the NBFC’s sector. Given the upcoming general elections in March -April 2019, the ruling government has been taking efforts to address the liquidity problem faced by the NBFC sector. As a result, the government along with the central bank is anticipated to keep yields lower to support liquidity. In our view, this may keep INR upside potential in check. We are Neutral on the INR amidst the growing challenges faced by the ruling party for a comprehensive victory and the implication resulting from the likely populist budget in the second half of the year.

CNY: SLOWING GROWTH WARRANTS MORE LIQUIDITY The Chinese Yuan (CNY) is on its second wave of depreciation since the devaluation in August 2015, depreciating 5.7% in 2018 against the USD amidst the escalating trade war and economic slowdown. We believe that the upside potential on the CNY looks somewhat limited in 2019 due to the modest growth outlook. GDP growth moderated from 6.7%y/y in 2Q18 to 6.5%y/y in 3Q18 as the country continued to move from debt-funded investment to a consumption-led growth model. China’s debt levels remained elevated in the non-financial sector.

While China has embarked on a deleveraging path since early 2017, efforts became less effective in 2018. This is because bankruptcies rose amidst the ongoing trade disputes with the US, somewhat restricting Chinese monetary policy. The potential slowdown in the Chinese economy and volatile financial markets are likely to keep the CNY under pressure. The central bank may keep infusing liquidity as inflation remains benign. We expect the ongoing truce and softening rhetoric on tariffs between the US and China to keep the USDCNY pair below the important 7.0 mark in the near term. However, if they do not find common ground on tariffs, the pair could move beyond the 7.0 level. Thus, we are Cautious on CNY.

BRL: FIXING PENSION LIABILITIES WILL BE THE KEY CATALYST FOR BRL The Brazilian Real (BRL) had a roller-coaster ride in 2018, depreciating 17.2% against the USD amidst tightening external financing conditions, emerging market contagion and domestic factors

including the truckers strike and recently concluded elections. However, market sentiment remains upbeat since Jair Bolsonaro was elected as President. Brazil’s fiscal health has deteriorated due to large pension liabilities as it amounts to nearly one-third of the government’s expenditure. However, President Bolsonaro aims to speed up privatisations, implement pension reforms and shore up confidence in the economy. Investors continue to take cues from the political arena over the pension reforms, which is a key measure to address the nation’s widening fiscal deficit. Notably, Brazil displayed a weak economic recovery post-recession in 2016, with growth of 1.0% in 2017. Following muted growth of 0.2% each in 1Q18 and 2Q18, the economy grew 0.8% in 3Q18. The government expects the economy to expand at 1.2% in 2018 and 2.4% in 2019, which remains weak in comparison with the growth expectations in other EMs.

Looking ahead, we expect the economy to gradually recover, supported by favourable interest rates. The BRL has somewhat stabilised below 4 against the USD, partly due to the reduction of political uncertainty. The upside from here would largely depend on the actions from the new President to address the country’s high budget deficit and rising debt levels. Thus, we are Neutral with a Positive Tilt on BRL.

MXN: TO STAY VOLATILE AMIDST POLICY UNCERTAINTY The Mexican Peso (MXN) eventually ended the year on a positive note after having experienced significant volatility due to economic measures adopted by the newly elected President Andres Manuel Lopez Obrador (AMLO) and the imposition of import tariffs by the US. US authorities levied 25% and 10% tariffs on the import of steel and aluminium, respectively, in May 2018. The tariffs affected trade flows of about $3bn (1% of Mexican exports to the US). AMLO ran a populist campaign and won the election in July 2018. Market sentiment deteriorated, particularly after AMLO decided to abandon the construction of a new airport in Mexico City, after having completed almost one-third of the project that was partly funded through private creditors. Risk of departure from pro-market policies increased the risk of lower growth and higher inflation, which remained high at 4.7% in November 2018. Inflation is still above the central bank’s target of 3.0% with +/- 1%, which prompted it to hike rates by 25bps to 8.25% in December.


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The central bank has flagged the downside risk to its growth and inflation outlook due to the economic policies adopted by the incumbent government. The increase in minimum wages has also added to inflationary risk. However, the central bank is prepared for more rate hikes to contain inflationary pressure resulting from populist measures, but it may impact the economic growth of the country. The outlook is further clouded by the government’s decision to limit banking fees and tighten regulation on the mining sector. Nevertheless, the 2019 budget presented in mid-December was welcomed by the market as it aims for a primary surplus of 1% of GDP and the fiscal deficit ceiling of 2.5% of GDP. If the government meets these targets, it should be able to sustain its debt-to-GDP ratio at around 46% for the public sector. However, this alone may not be sufficient to regain investor confidence, given the abrupt stance taken with regard to the $13bn new airport project that entails significant risk to bondholders. Unless the government takes more positive economic measures to build the confidence of foreign investors, we expect to see continued volatility in the MXN.

TRY: SUSCEPTIBLE TO WEAK MACROECONOMIC CONDITIONS The Turkish Lira (TRY) was the second worst performing emerging market currency after the Argentine Peso due to a liquidity crisis and policy paralysis. Despite rising inflation, President Erdogan kept pressuring the central bank to lower interest rates, thus raising questions over the central bank’s independence and undermining foreign investor confidence. The doubling of tariffs on steel and aluminium by the US and the imprisonment of the US Pastor in Turkey further added to the feud between the countries, affecting the Lira adversely.

Exhibit 78: Volatility in USDTRY Pair Spikes in 2018

Source: Bloomberg

Given that Turkey is heavily reliant on foreign funding, the collapse of the Lira has a significant

bearing on public and private debt, thus impacting the economy. The country (Ba3/B+/BB) risks further ratings downgrades by Moody’s and Fitch with their outlook being kept on Negative. Economic growth has slowed notably, recording 1.6%y/y in 3Q18 following 5.3%y/y growth in 2Q18. As such, Turkey might continue to face growth pressure in 2019 amidst a large corporate debt pile and tight financial conditions. While the Lira has stabilised to below the 6.0 mark following the central bank’s surprise rate hikes by 625bps to 24% in September, inflationary pressure remains extremely high at 21.6% in November in relation to the central bank’s target of 5%. The Turkish central bank kept rates on hold at its December meeting, but showed its willingness for further tightening if the inflation outlook deteriorates. We believe that markets are yet to be convinced over the central bank’s independence, given President Erdogan’s unorthodox view on the relationship between interest rates and inflation in the past. Thus, we are Cautious on the TRY.

ZAR: ELECTIONS AND REFORMS REMAIN IN FOCUS The South African Rand (ZAR) has been under pressure losing 15.9% in 2018 against the USD. However, since early November, the ZAR started benefitting from the central bank’s decision to hike interest rates and fading dollar strength. Furthermore, investor sentiment towards emerging markets improved due to the sharp correction in oil prices. The economy has also emerged from recession with 2.2%y/y growth in 3Q18 (1Q18: -2.6% and 2Q18: -0.4%), driven by gains in manufacturing, agriculture and the transport sectors. However, the recovery in the economy is very sluggish and the ZAR remains susceptible in the event that global risk-off sentiment increases. Moreover, the economy faces domestic risk in the form of a sovereign rating review and upcoming Presidential elections in May 2019. However, we believe that South Africa may avoid a rating downgrade to junk status by Moody’s (Baa3) due to the improving credibility of the central bank following its recent measures and greater efforts from the current President Cyril Ramaphosa to boost the economy ahead of the elections. S&P and Fitch have already maintained below investment grade ratings on South Africa at BB and BB+, respectively.

In September, the government announced a fiscal

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stimulus programme to revive the economy. However, the country’s high fiscal deficit (projected at 4.2% of GDP for FY18/20) and debt burden limit its potential for a sizeable stimulus. Furthermore, the unemployment rate remains at an elevated level of 27.5% in 3Q18. Fiscal expansion may add to inflationary pressure, but we take comfort from lower oil prices. Inflation rose by 5.2%y/y in November 2018, the highest inflation rate since May 2017, forcing the central bank to hike its benchmark rate by 25bps to 6.75%. This was the first time the central bank took action in almost three years. Furthermore, the bank has hinted at four similar hikes of 25bps through 2020, seemingly strengthening its credibility as a proactive and stable-oriented central bank. Thus, we are Neutral with a Positive Tilt on the ZAR.


SUSTAINABLE INVESTMENT


WHAT IS SUSTAINABLE INVESTING? ‘Sustainable investing’ is an umbrella term for all investment approaches that entail environmental, social and governance (ESG) factors and their impact. Sustainable, Responsible and Impact (SRI) investing includes the consideration of ESG factors while maintaining the objective of generating long-term financial gains and a positive social impact. The adoption of Sustainable Development Goals (SDGs) in 2015 by 194 members/countries of the United Nations provided a massive boost to sustainable investing. There are 17 SDGs including poverty eradication, good health and well-being, quality education, clean energy, sustainable cities, responsible consumption and production, and action on climate changes, which the countries have agreed to achieve by 20301.

Exhibit 79: A brief overview highlighting the difference amongst the key terms used in sustainable ecosystem

Particulars Sustainable investing ESG Impact Investing Corporate Social Responsibility (CSR)

Definition

It is a comprehensive approach which focuses in creating and maximising long term economic, social and environmental value

Include both active and passive investments in companies under ESG framework

Actively seeking to invest in companies that have positive economic, social and/or environmental impact

CSR refers to doing business in ways that benefit, rather than harm society and the environment

Composition A broader term A sub-set of

sustainable investing A sub-set of ESG investing

More often a compliance measure rather than investment approach

Parameters

It is the discipline that considers ESG criteria to make investment decisions

ESG are the criteria used to measure a company’s commitment to CSR

Goes beyond “do no harm” approach and seek to create positive impact, measure and report their impact in a transparent way

CSR includes programs, policies and practices that relate to employees, suppliers, customers and society

Source: Mashreq

GROWING DEMAND FOR SRI Globally, the SRI market was worth approximately $23tn2 in April 2018, with around 50% of the assets being managed in Europe and more than one-third in the United States. In terms of absolute figures, 65% of the total ESG assets under management (AUM) is focused on fixed-income instruments in the form of bonds, whereas AUM of $11bn is invested in ESG Exchange Traded Funds (ETFs). BlackRock and Vanguard, two of the world’s largest asset managers, made their debut in the ESG market offering low-cost ETFs in 2018 with the aim to become a global leader in sustainable investing. Having said that, ESG-themed ETFs are expected to witness increase in fee pressure as well as competition as more global peers tap the market in 2019. Moreover, the surge in sustainable investing entailed noticeable contributions from China, Japan, Australia and New Zealand.

Exhibit 80: ESG and Sustainably Themed Funds Growth Exhibit 81: Europe Leads the ESG market

Source: Bloomberg Source: Bloomberg

1 www.tokyofoundation.org 2 www.jpmorgan.com

0

150

300

450

600

0

400

800

1200

1600

2013 2014 2015 2016 2017

$ bn

$ bn

Number of ESG Funds AUM (RHS)

Europe 53%

US 38%

Canada 5%

AUS/NZ 2%

Japan 2%

http://www.tokyofoundation.org/

http://www.jpmorgan.com/




ESG INDEXES CLOSELY TRACKING BENCHMARKS Despite being a concentrated and themed-based investment, ESG indexes have closely tracked and briefly outperformed the benchmark in 2018. Similar trends have been witnessed at the individual company level as well. A study from Axioma, one of the leading providers of enterprise risk management and regulatory reporting solutions, suggests that companies with better ESG credentials tend to perform better against peers, given the empirical relationship between good governance and profitability.

Exhibit 82: Closely Tracking Benchmark indexes

Source: Bloomberg

KEY TRENDS The following are some of the key market trends with regard to SRI investing:

Strong supply induced better quality of data: With a growing number of investors incorporating ESG into their investment approach, the demand for ESG data has risen. Investors have started to increase their engagement with companies, as shareholders, in order to bolster sustainability reporting, which will meet information requirements. At the regulatory level, market regulators across the globe have started the reporting of non-financial data. For example, more than 80% of S&P 500 companies now report ESG metrics compared with 20% in 2011 as per the leading ESG database company.

Regulation is a key driver of ESG adoption: Tightening regulation is bringing more companies to comply with ESG factors, resulting in more transparency and investment opportunities. For example, French law requires corporates and HNIs to disclose the carbon footprint of their assets. Similar trends have been implemented in other countries such as Canada, Sweden, the US, the UK etc. In terms of adoption, consumer staples and financials are leading the pack, while utilities and real estate are still far behind in implementing ESG factors.

Green Bond Market picking-up: Debt investors and other stakeholders in the fixed income market have noticeably embraced the rise of ESG. The market for green bond has been growing steadily with ~$175bn in new issuance in 2018, representing ~10% increase over 2017. Further, it is expected that new green bond issuances to reach $210-240bn in 2019, as per leading Nordic bank. Banks and supra-nationals are the key issuers in the green bond space, together representing 70% of the total green bond market. Among the non-financials, utilities, transportation and real estate are main issuers. In terms of geography, China, France, and Germany are the leading issuers of the green bonds.

Exhibit 83: Green Bond Issuances Picked-up Exhibit 84: Cumulative green bond issuance by country from 2010 to February 2018


83.93 84.30

89.47 88.54

93.69 92.21

75.00

85.00

95.00

105.00

115.00

Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18MSCI EM ESG Index MSCI EM Index MSCI World ESG Leaders IndexMSCI World Index MSCI USA ESG Leaders Index MSCI USA

4.0 1.2 3.1 11

36.6 42.4

93.4

163

74.6

0.0

45.0

90.0

135.0

180.0

10 11 12 13 14 15 16 17 1H18

$ bn

0

20

40

60

80

$ bn




Sustainable investing in the GCC countries: The GCC countries are set to explore a plethora of opportunities in the sustainable investment space. According to Bloomberg estimates, the GCC could find multiple opportunities stemming from renewable energy, including the reduction of water withdrawal by 11 tn litres and savings in the power sector in the form of 400 bn barrels of oil. This could result in the creation of about 2000 direct jobs and a reduction of the GCC’s per capita carbon footprint by 8% by 2030. The green bond market has started to gain traction in the GCC region with FAB being amongst the early issuer of green bonds. Recently, the Dubai Financial Market (DFM) has updated its Shari’ah standards that focus on sustainability and environmental protection to address the constraints for raising green sukuk. This move should attract a more diversified investor base and may reduce the cost of funding.

UAE and Saudi Arabia amongst the key investors in Africa’s renewable sector: Africa’s energy gap presents an opportunity for Gulf investors, particularly Dubai and Saudi Arabia to diversify its economy by investing in energy infrastructure in African region. African nations, primarily Morocco, Kenya, and Rwanda provide huge potential for green energy such as geothermal, hydro, wind and solar. Morocco is currently undergoing solar revolution with ~$24bn investment gap. UAE and Saudi Arabia represent second and fifth largest investing countries in Africa, respectively, after China, and they can leverage its existing relationships in the world’s highest potential energy market.

Exhibit 85: GCC new investment in Sustainable Energy Exhibit 86: Middle East and Africa are underinvested in Renewable Energy, 2017 ($280bn)


KEY RISKS In defiance of growing investor confidence, there are multiple problems with ESG reporting, which must be addressed in order to nurture the sustainable investing marketplace. Investors rely on data reported by companies and the analysis of rating agencies to make informed decisions. Currently, the SRI investing paradigm is plagued with issues such as inconsistent metrics and performance indicators, inadequate rating mechanisms that are also highly subjective and insufficient reporting by companies. For example, a clean-coal mining in China is considered to be green project, which does not fit the definition of sustainable investment as per the European regulation. Therefore, more transparency is being sought to encourage the participation of institutional and private equity investors, among others.

4.2 3.2

10.2 9.2

8.3

13.3

9.0 10.1

0

4

8

12

16

10 11 12 13 14 15 16 17

$ bn

45.2%

14.6% 14.5%

11.2%

4.8%

3.9% 3.6% 2.1%

China Europe USAsia-Pacific Americas IndiaMiddle East & Africa Brazil

Share of global electricity generated by renewable in 2017: 12.1%

Corresponding amount of CO2 emissions avoided: 1.8 gigatonnes

Global Investment in green energy sources since 2004: $2.9tn


CHARTS


Exhibit 87: US-GDP Growth (q/q annualised) Exhibit 88: US-CPI and PPI (y/y change)

Source: Bloomberg, GDP- Gross Domestic Product Source: Bloomberg, CPI- Consumer Price Index, PPI- Producer Price Index

Exhibit 89: US-Unemployment Rate Exhibit 90: US-Avg. Hourly Earnings (y/y change)


Exhibit 91: US-Foreign Exchange Reserve Exhibit 92: US-Current Account Balance & Fiscal Deficit as % of GDP


Exhibit 93: US-Retail Sales (m/m change) Exhibit 94: US-Industrial Output (m/m change)


1.9 1.8 1.8

3 2.8

2.3 2.2

4.2

3.4

0.0

1.1

2.2

3.3

4.4

3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18

%

2.2

2.5

2.0

2.5

3.0

3.5

4.0

Nov-17 Feb-18 May-18 Aug-18 Nov-18

%

CPI PPI

4.1 4.1 4.1 4.1 4.1

3.9

3.8

4

3.9 3.9

3.7 3.7 3.7

3.6

3.8

3.9

4.1

4.2

Nov-17 Jan-18 Mar-18 May-18 Jul-18 Sep-18 Nov-18

%

3.1

2.4

2.6

2.8

3.0

3.2


%

42

42 42

42 41

42 42

41 41 41 41

41 41

39

40

41

42

43

Jun-18 Aug-18 Oct-18 Oct-18 Nov-18 Nov-18 Dec-18

$ bn

-2.3

-3.8 -4

-3.5

-3

-2.5

-2

3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18

%

Current Account Balance % of GDPFiscal Deficit % of GDP

0.2

-0.3

0.1

0.5

0.9

1.3


%

0.61

-0.8

-0.3

0.2

0.7

1.2


%


CHARTS


Exhibit 95: Euro zone-GDP Growth (y/y change) Exhibit 96: Euro zone-CPI and PPI (y/y change)


Exhibit 97: Euro zone-Unemployment Rate Exhibit 98: UK-GDP Growth (y/y change)


Exhibit 99: UK-CPI and PPI (y/y change) Exhibit 100: UK-Unemployment Rate


Exhibit 101: UK-Current Account Balance as % of GDP Exhibit 102: UK-Debt as % of GDP


1.8

2.1 2.1

2.5

2.8 2.7

2.4 2.2

1.6

0.0

0.8

1.6

2.4

3.2

3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18

%

2

4.9

0.0

1.5

3.0

4.5

6.0


%

CPI PPI

8.1

8.0

8.3

8.5

8.8

9.0

Oct-17 Jan-18 Apr-18 Jul-18 Oct-18

%

1.7 1.7

1.8

1.9

2.0

1.6

1.3

1.4

1.5

1.2

1.4

1.7

1.9

2.1

3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18

%

2.3

3.1

2.2

2.5

2.8

3.1

3.4


%

CPI PPI

4.1

3.9

4.1

4.2

4.4

4.5

Oct-17 Dec-17 Feb-18 Apr-18 Jun-18 Aug-18 Oct-18

%

-3.8

-6.0

-5.2

-4.5

-3.7

-3.0

Sep-16 Mar-17 Sep-17 Mar-18 Sep-18

% 87

75

80

85

90

95

2010 2011 2012 2013 2014 2015 2016 2017

%


CHARTS


Exhibit 103: BRICS Nations-GDP Growth (y/y change) Exhibit 104: BRICS Nations-CPI (m/m change)


Exhibit 105: BRICS Nations-PPI (m/m change) Exhibit 106: BRICS key Interest Rates


Exhibit 107: European Equity Indices Exhibit 108: Saudi Arabia, Qatar, Bahrain -GDP Growth (y/y change)


Exhibit 109: GCC Countries-CPI (m/m change) Exhibit 110: GCC Key Interest Rates


0.9

1.9

8.2

6.7

0.7

-3

0

3

6

9

Sep-16 Jan-17 May-17 Sep-17 Jan-18 May-18 Sep-18

%

Brazil Russia IndiaChina South Africa

-0.2

0.5

2.3 2.2

5.2

-0.3

1.8

3.9

6.0


%


4.3

0.9

4.0 5.8

5.1

-1.0

3.5

8.0

12.5

17.0

Nov-17 Jan-18 Apr-18 Jul-18

%


6.50

7.75

6.25

4.35

6.75

4

5

6

7

8

Brazil Russia India China South Africa

%

86.9 82.0

89.5 87.7

75.0

85.0

95.0

105.0

115.0


Europe Germany France UK

1.6

2.5

1.6

-2.0

-0.5

1.0

2.5

4.0

Sep-17 Dec-17 Mar-18 Jun-18 Sep-18

%

Saudi Arabia Qatar Bahrain

2.8

-0.2

0.7

1.3 1.1

0.1

-2

0

2

4

6


%

Saudi Arabia Qatar BahrainUAE Oman Kuwait

2.75 3.00

5.00

3.00 2.75 2.84

0.0

1.5

3.0

4.5

6.0

UAE SaudiArabia

Qatar Kuwait Bahrain Oman

%


TABLES


Key Forecasts

December 2018#

12-month forward estimates

(Bloomberg) Change

S&P 500 Index 2,507 3,119 ▲+24.41% Stoxx Europe 600 Index 338 414 ▲+22.70% FTSE 100 Index 6,728 8,191 ▲+21.75% 10-Year US Treasury (Yield) 2.68% 3.29% ▲+61bps 10-Year UK Gilt (Yield) 1.28% 2.00% ▲+72bps 10-Year German Bund (Yield) 0.24% 0.89% ▲+65bps Brent ($/bbl) 53.2 72.0 ▲+35.41% WTI ($/bbl) 45.4 64.6 ▲+42.33% Gold ($/oz) 1,282 1,260 ▼-1.75% Silver ($/kg) 15.5 15.9 ▲+2.87% GBP/EUR 1.1122 1.1364 ▲+2.17% GBP/USD 1.2754 1.3600 ▲+6.63% EUR/USD 1.1467 1.2000 ▲+4.65% USD/JPY 109.6900 109.0000 ▼-0.63% Source: Bloomberg * As of 31st December 2018

Global Equity Indices

Close# 1 Month

3 Month

YTD Y/Y 10-

Year Avg. PE

BEst PE

Developed Markets Indices S&P 500 Index 2,507 -9.18% -13.97% -6.24% -6.24% 17.81x 15.43x Stoxx Europe 600 Index 338 -5.55% -11.88% -13.24% -13.24% 20.83x 13.15x FTSE 100 Index 6,728 -3.61% -10.41% -12.48% -12.48% 24.05x 11.93x DAX Index 10,559 -6.20% -13.78% -18.26% -18.26% 18.63x 12.16x CAC 40 Index 4,731 -5.46% -13.89% -10.95% -10.95% 18.41x 12.16x Nikkei Index 20,015 -10.45% -17.02% -12.08% -12.08% 20.72x 14.52x ASX 200 Index 5,646 -0.37% -9.04% -6.90% -6.90% 20.23x 14.50x Emerging Markets Indices ex MENA

Hang Seng Index 25,846 -2.49% -6.99% -13.61% -13.61% 12.20x 10.82x Shanghai Composite Index 2,494 -3.64% -11.61% -24.59% -24.59% 16.21x 10.28x Korea Stock Exchange Index 2,041 -2.66% -12.89% -17.28% -17.28% 16.69x 10.28x BSE Sensex 36,068 -0.35% -0.44% 5.91% 5.91% 19.47x 8.68x Taiwan SE Index 9,727 -1.62% -11.62% -8.60% -8.60% 22.86x 12.66x Ibovespa Brasil Index 87,887 -1.81% 10.77% 15.03% 15.03% NA 12.66x Micex Index 2,359 -1.42% -4.72% 11.79% 11.79% 7.64x 5.18x JSE Africa All Share Index 52,737 4.09% -5.33% -11.37% -11.37% 18.80x 12.92x MENA Indices

Abu Dhabi Securities Market Index 4,915 3.04% -0.41% 11.75% 11.75% 13.39x 12.27x Dubai Financial Market Index 2,530 -5.21% -10.77% -24.93% -24.93% 20.38x 7.49x Egyptian Exchange 13,036 -2.13% -10.81% -13.21% -13.21% 51.39x 9.99x Tadawul All Share Index 7,827 1.61% -2.16% 8.31% 8.31% 16.93x 14.82x Qatar Exchange 10,299 -0.63% 4.95% 20.83% 20.83% 12.84x 14.17x Bahrain Bourse 1,337 0.64% -0.10% 0.42% 0.42% 29.22x NA Muscat Securities 4,324 -2.00% -4.84% -15.21% -15.21% 11.85x 7.47x Source: Bloomberg * As of 31st December 2018, NA- Not Available


TABLES


Upcoming Macroeconomic Indicators*

Date of Release

Country/ Region

Indicator Period Bloomberg Survey

Last Impact

03-Jan-19 United States Wards Total Vehicle Sales Dec 17.30m 17.40m Low 04-Jan-19 United States Unemployment Rate Dec 3.70% 3.70% Medium 04-Jan-19 United States Markit US Services PMI Dec F 53.5 53.4 Low 04-Jan-19 Japan Nikkei Japan PMI Mfg Dec F -- 52.4 Low

04-Jan-19 Eurozone Markit Eurozone Services PMI Dec F 51.4 51.4 Low

04-Jan-19 Eurozone PPI YoY Nov 4.20% 4.90% High 04-Jan-19 Eurozone CPI Core YoY Dec A 1.00% 1.00% High 08-Jan-19 United States Trade Balance Nov -$51.8b -$55.5b Medium 09-Jan-19 Eurozone Unemployment Rate Nov -- 8.10% Low 11-Jan-19 United States CPI YoY Dec -- 2.20% High

11-Jan-19 United Kingdom Trade Balance Nov -- -£3300m Medium

11-Jan-19 United Kingdom Industrial Production YoY Nov -- -0.80% Medium 11-Jan-19 United Kingdom GDP (MoM) Nov -- 0.10% High 11-Jan-19 Japan Trade Balance BoP Basis Nov P -- -¥321.7b Medium 15-Jan-19 United States PPI Final Demand YoY Dec -- 2.50% High 15-Jan-19 Eurozone Trade Balance SA Nov -- 12.5b Medium 16-Jan-19 United Kingdom CPI YoY Dec -- 2.30% High 16-Jan-19 United Kingdom PPI Output NSA MoM Dec -- 0.20% High 16-Jan-19 Japan PPI YoY Dec -- 2.30% High 18-Jan-19 United States Industrial Production MoM Dec -- 0.60% Medium 18-Jan-19 Japan Natl CPI YoY Dec -- 0.80% High 18-Jan-19 Japan Industrial Production YoY Nov F -- -- Medium 23-Jan-19 Japan Trade Balance Dec -- -¥737.3b Medium 23-Jan-19 Eurozone Consumer Confidence Jan A -- -- Low

24-Jan-19 United States Markit US Manufacturing PMI Jan P -- -- Low

24-Jan-19 Eurozone Markit Eurozone Manufacturing PMI Jan P -- -- Low

30-Jan-19 United States GDP Annualised QoQ 4Q A -- 3.40% High 31-Jan-19 United States Personal Income Dec -- 0.20% Medium 31-Jan-19 United States Personal Spending Dec -- 0.40% Medium 31-Jan-19 United States PCE Core YoY Dec -- 1.90% High 31-Jan-19 Japan Industrial Production YoY Dec P -- -- Medium 31-Jan-19 Eurozone GDP SA YoY 4Q A -- 1.60% High 01-Feb-19 United States Unemployment Rate Jan -- -- Medium

01-Feb-19 United Kingdom Markit UK PMI Manufacturing SA Jan -- -- Low

01-Feb-19 Japan Jobless Rate Dec -- -- Low Source: Bloomberg, *Table covers select economic indicators, #F: First estimate, T: Third estimate, A: Advance


TABLES


Economic events*

Date Critical Events What to watch out for / Anticipated action

Estimated impact

14-Jan-19 Commons will vote on Brexit plan

Theresa May needs to secure 320 votes to get the Brexit deal approved High

23-Jan-19 BoJ interest rate decision Status quo High 24-Jan-19 ECB interest rate decision Status quo High 31-Jan-19 FOMC rate decision Status quo High 07-Feb-19 BOE interest rate decision Status quo High 07-Mar-19 ECB interest rate decision Status quo High 15-Mar-19 BOJ interest rate decision Status quo High 20-Mar-19 FOMC rate decision Status quo High 21-Mar-18 BOE rate decision Status quo High

29-Mar-19 UK to leave European Union Possibility of delay and of an extension to the Article 50 High

10-Apr-19 ECB interest rate decision Status quo High 25-Apr-19 BoJ interest rate decision Status quo High April-May 2019 Indian general elections

Probability of BJP (ruling party) loosing the elections on the rise Medium

01-May-19 FOMC rate decision Status quo High 02-May-19 BOE rate decision 32% probability of a 25bps rate hike High (08-May – 07-Aug)-19

South African general elections

Opinion polls show ANC party leading with 60% of votes Medium

23-26 May-19

EU parliamentary elections - High

06-Jun-19 ECB interest rate decision Status quo High 19-Jun-19 FOMC rate decision Status quo High 20-Jun-19 BOJ interest rate decision Status quo High 20-Jun-19 BOE interest rate decision 32% probability of a rate hike to 1% High 25-Jul-19 ECB interest rate decision Status quo Medium 30-Jul-19 BoJ interest rate decision Status quo Medium 31-Jul-19 FOMC rate decision Status quo High 01-Aug-19 BOE interest rate decision 42% probability of a rate hike to 1% High 12-Sep-19 ECB interest rate decision Status quo High 18-Sep-19 FOMC rate decision Status quo High 19-Sep-19 BOJ interest rate decision Status quo High 19-Sep-19 BOE interest rate decision 40% probability of a rate hike to 1% High

20-Oct-19 Canada Elections Opinion polls show 38% support the Liberals whereas 33% voted for Conservatives

High

24-Oct-19 ECB interest rate decision Status quo High 27-Oct-19 Argentina general elections - Medium 30-Oct-19 FOMC rate decision Status quo High 31-Oct-19 BoJ interest rate decision Status quo High 07-Nov-19 BOE interest rate decision 40% probability of a rate hike to 1% High 12-Dec-19 FOMC rate decision Status quo High 12-Dec-19 ECB interest rate decision 25% probability of a rate hike to -0.3% High 19-Dec-19 BOJ interest rate decision Status quo High

Source: Bloomberg, *Table covers select economic events


TABLES


Corporate Credit Total Returns

Close# 1 Month 3 Month YTD Y/Y

US IG Corp 2892 1.47% -0.18% -2.51% -2.51% US HY Corp 1909 -2.14% -4.53% -2.08% -2.08% EUR IG Corp 244 0.21% -0.62% -1.25% -1.25% EUR HY Corp 305 -0.34% -3.66% -3.82% -3.82% USD EM Index 1069 1.37% -0.18% -2.46% -2.46% USD UAE Liquid Index 119 1.00% 0.69% 0.80% 0.80%

Source: Bloomberg * As of 31st December 2018

Commodity Performance


Brent ($/bbl) 53.17 -9.02% -35.90% -20.43% -20.43% WTI ($/bbl) 45.41 -10.84% -38.01% -24.84% -24.84% Natural Gas ($/MMBtu) 3.188 -30.86% 5.58% -9.95% -9.95% Gold ($/oz) 1282 5.08% 7.69% -1.56% -1.56% Silver ($/kg) 15.5 9.08% 5.73% -8.52% -8.52% Platinum ($/oz) 795.7 -0.31% -2.49% -14.28% -14.28% Aluminium ($/ton) 1,863 -4.83% -9.05% -17.43% -17.43%


G-10 Currencies Performance


EUR/USD 1.1467 1.3% -1.2% -4.5% -4.5% USD/CHF 0.9832 -1.5% 0.2% 0.9% 0.9% USD/JPY 109.690 -3.4% -3.5% -2.7% -2.7% GBP/USD 1.2754 0.0% -2.1% -5.6% -5.6% USD/AUD 1.4188 3.7% 2.5% 10.8% 10.8% USD/NZD 1.4881 2.4% -1.5% 5.6% 5.6% USD/CAD 1.3637 2.6% 5.6% 8.5% 8.5% USD/SEK 8.8533 -2.8% -0.4% 8.2% 8.2% USD/NOK 8.6409 0.3% 6.0% 5.3% 5.3%


EM Currencies Performance


USD/CNY 6.8785 -1.18% 0.14% 5.7% 5.7% USD/INR 69.7675 0.26% -3.76% 9.2% 9.2% USD/TRY 5.2894 1.42% -12.66% 39.3% 39.3% USD/BRL 3.8812 0.36% -4.18% 17.2% 17.2% USD/MXN 19.6504 -3.52% 4.98% 0.0% 0.0% USD/ZAR 14.3467 3.44% 1.45% 15.9% 15.9% USD/RUB 69.3514 3.37% 5.79% 20.2% 20.2%


Glossary

BEst: Bloomberg Estimated Ratio – Consensus estimates from various analysts contributing to Bloomberg;

Credit Spread: The difference in yield between two bonds of similar maturity;

DM: Developed Markets – Group of countries that are most developed in terms of their economy and capital markets;

EM: Emerging Markets – Group of countries that have some characteristics of developed market but do not meet the standards to be developed market;

Duration: A measure of price sensitivity related to an interest rate change;

DXY: Dollar Index – measures the value of USD relative to a basket of foreign currencies;

EPS: Earning Per Share – calculated by dividing the company's net income with its total number of outstanding shares;

FOMC: Federal Open Market Committee – US Fed’s committee which takes key decisions on interest rates and the US’ money supply growth;

HY: High Yield – High return bond with a low credit rating than IG bonds;

IG: Investment Grade – An IG bond has a relatively low risk of default, so low risk with low returns;

Maturity Date: The date on which principal amount of the bond will be paid to the investors;

PE Ratio: Price to Earnings Ratio – measure of the company’s share price with respect to its EPS;

YTM: Yield to Maturity – The total interest rate earned by an investor, who buys and holds the bond until maturity;

YTW: Yield to Worst – The lowest potential yield that investor receives on a bond, that has callable, puttable, exchangeable, or any other features;

Sharpe Ratio: A measure of return earned in excess of the risk-free rate per unit of volatility;

GDP: Gross Domestic Product – The monetary value of all the finished goods and services produced within a country's borders in a specific time period;

IHS Markit Composite PMI: The Purchasing Managers’ Index (PMI) calculated by IHS Markit based on monthly surveys of carefully selected companies representing major and developing economies worldwide;

General Disclaimer

This report was prepared by the Private Banking Unit of Mashreq Bank PSC (“Mashreq”) in the United Arab Emirates (“U.A.E.”). Mashreq is regulated by the Central Bank of the U.A.E. This report is provided for informational purposes and private circulation only and should not be construed as an offer to sell or a solicitation to buy any security or any other financial instrument or adopt any hedging, trading or investment strategy. Prior to investing in any product, we recommend that you consult with a professional financial advisor, taking into consideration investment objectives, financial circumstances and tax implication. While based on information believed to be reliable, we do not guarantee and make no express or implied representation as to the accuracy of this report or complete description of the securities markets or developments referred to in this report. The information, opinions, forecasts (if any), assumptions or estimates contained in this report are as of the date indicated and are subject to change at any time without prior notice. The stated price of any securities mentioned in this report is as of the date indicated and is not a representation that any transaction can be effected at this price. The risks related to investment products described in this report are not all encompassing and investors should refer to the relevant investment offer document for detailed information and applicable terms and conditions. Investment products, including treasury products, are not guaranteed by Mashreq or any of its affiliates or subsidiaries unless stated otherwise and are subject to investment risk, including loss of principal. Investment products are not government insured. Past performance is not an indicator of future performance. US persons (US Citizens; US Green Card Holders; Resident Aliens subject to US income taxes for IRS purposes) are not eligible for any of the investment products introduced by Mashreq unless stated otherwise. This report is for distribution only under such circumstances as may be permitted by applicable law. Neither Mashreq nor its officers, directors or shareholders or other persons shall be liable for any direct, indirect, incidental or other damages including loss of profits arising in any way from the information contained in this report. This report is intended solely for the use by the intended recipients and the contents shall not be reproduced, redistributed or copied in whole or in part for any purpose without Mashreq’s prior express consent.

global asset allocation | 2019 - mashreq bank€¦ · support em assets. we therefore prefer em...

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