investment barometer - bank handlowy · levels among consumers. consumer confidence indices...
TRANSCRIPT
Excellent Earnings Season
Investment Barometer
June 23, 2017
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May saw continued growth in the majority of stock and bond indicesbut the scale of that growth was
unimpressive in many cases. The best performers were definitely indices in emerging Asian countries (+4.4%),
frontier countries, including Argentina, Vietnam and Pakistan (+3.8% for the broad-based MSCI FM index), and in
Japan (+2.4%). By contrast, companies were hit by a strong reduction in prices in Brazil (down by 4.1%) and EM
Europe, including Poland (-2.5% for the broad-based WIG index). The U.S. Treasury bonds and Polish bonds
fared pretty well, with Polish 10Y bonds gaining as much as 2%. HY bonds earned nearly 1%. May was,
however, less successful for commodities, with CRB index losing 1.1% mainly due to a drop in oil prices (-2.7%).
The results of the second round of the presidential elections in France came as no surprise and did not lead to any strong reactions of the financial markets. The geopolitical risk seems to be moving from Europe to Asia, and more specifically to North Korea, which threatens the world more and more often with its nuclear tests. That does not seem, however, to constitute any long-term danger for the global stock exchanges. Investors seem resilient, judging by the fact that the South Korea’s Kospi added a whopping 6.4% in May.
The Q1 2017 results of companies turned out to be a positive surprise as they were the best ones in six years. All the main regions recorded a double-digit growth rate in profits (yoy) (Japan +28%, Europe +23% and the U.S. +14%). High forecasts for full year results are another reason to be optimistic. The stock indices should remain in good condition, unless the figures prove disappointing.
We maintain our neutral view on equities vs. bonds. Given the present risk factors (e.g. the continued uncertainty concerning U.S. economic and trade policy, the still unclear issue of Brexit and the increase in geopolitical risk), the reward-to-risk ratio is currently not conducive to any exposure to equities greater than the investor’s risk profile would indicate.
We still believe that global emerging equity markets are more attractive than the Polish blue chip segment. We also think that small and medium Polish companies should outperform larger ones. Additionally, we are of the opinion that in the medium term, European companies may perform better than U.S. ones in relative terms, mainly owing to better EPS (earnings per share) prospects, a different phase in the economic cycle (also reflected by different central bank policies) and the chance for capital inflows emerging after 2016, which was a poor year in this respect.
We are maintaining a positive outlook on high yield bonds (particularly U.S. ones) and on emerging country debt. In our opinion, these two asset classes continue to exhibit favorable reward-to-risk ratios, mainly owing to high yields, low bankruptcy rates, the improving macroeconomic situation and the still strongly sold-off currencies (in the emerging markets). It is, however, worth noting that the yields we have recently been observing for those bond categories are going further down.
Source: Bloomberg, Citi Handlowy
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92
96
100
104
108
112
116
120
124
128
132
May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17
WIG 20 S&P 500 Eurostoxx 50
Source: Bloomberg, Citi Handlowy
97
98
99
100
101
102
103
104
May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17
Polish bonds U.S. Bonds German bunds
Karol Ciuk, CFA
Investment Advisor
Szymon Zajkowski, CFA
Securities Broker
Bartłomiej Grelewicz
Securities Broker
Paweł Chylewski
Securities Broker
Maciej Pietraszkiewicz
Investment Advisor
Dariusz Zalewski
Securities Broker
Michał Wasilewski
3
Poland – bonds brought some good earnings this time
In May, the prices of the Polish bonds went up again, and by extension, the yields went down. The
yield of the 10Y bonds dropped to a record low since November last year (3.25%), and so did the
yield on the 2Y bonds (1.9%). The small- and mid-sized companies sector on the domestic stock
exchange has been moving sideways, which started between February and March, while mWIG
and sWIG remained basically flat month on month. After the peaks in April, WIG20 saw a
correction of around 4 per cent.
Positive news from the Polish economy had a key
impact on the good performance of the Polish
debt in May, in addition to the overall trends on
the global markets. It started with another
increase in the PMI manufacturing index (up from
53.5 to 54.1 points); the GDP growth rate for Q1
2017 was another positive surprise (4% yoy vs the
expected 3.9%, and the 2.5 per cent growth rate
recorded in Q4 2016), and so was the
unemployment rate which in April dropped to the
deepest low since 1991 (7.7%). Polish bonds also
benefited from inflation, which stabilized at 2%,
and the Monetary Policy Council’s decision to
uphold its dovish stance, including the conviction
that there is no need for interest rate hikes until
the end of 2018. On top of it, the market received
positive reports on budget execution for this year.
The Ministry of Finance announced that after April
the deficit was a mere PLN 0.9bn (vs the planned
10.5bn and 2.3bn after March). In fact, industrial
output and retail sales data, which were worse
than expected, turned out to be the only
disappointments. Production in April went down by
0.6% yoy (consensus at +2.35%), and retail sales
went up by 8.1% yoy (consensus was looking for
8.9%).
The budget execution report is certainly worth
paying special attention to. The deficit of PLN
0.9bn is merely 1.5% of the 59.35bn planned for
the entire year. During the first four months of the
year, budget revenue went up by 36% on a year-
on-year basis, and expenditure went up by 30.6%.
Such a low deficit would not have been possible
without the dynamic growth of income from VAT,
CIT and PIT, up by 34%, 15%, and 8%
respectively on a year-on-year basis, and without
a drop in expenditures, probably due to the
continued standstill in investments – financial
expenditures, which include, among other things,
investment projects of the local governments,
went down by 17.7% year on year. Citi economists
are of the opinion that in view of those figures and
the expected distribution of NBP profits (around
PLN 9 billion), the overall deficit for the year might
be more than twice lower than the approx. PLN
Budget deficit this year vs recent years
Source: Ministry of Finance, Citi Handlowy
-20
0
20
40
60
80
100
2013 2014 2015 2016 2017
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60bn originally planned. As a consequence, the
total issue of Polish bonds this year may be lower
accordingly. This, in turn, may have a positive
impact on the quotations of the domestic debt.
By contrast, a change in the rhetoric presented by
the Monetary Policy Council may have the
opposite effect on the bonds. Even though in May
Professor Adam Glapiński, President of the
National Bank of Poland, upheld his view that he
did not see the need for interest rates to be
increased up until the end of 2018, Citi’s base
scenario for that period continues to provide for
four hikes, starting from Q1 next year. This view is
supported by the economic growth and the
situation on the labor market, both of which came
as a positive surprise. Those two factors should
translate into higher inflation paths in NBP’s
projections and a more hawkish language of the
Monetary Policy Council in the second half of the
year. To some extent, this has been affirmed in
the latest statement made by Dr. Łukasz Hardt,
member of the Monetary Policy Council, who
stated that end of 2017 and early 2018 could be a
good time to consider making changes in the
interest rate levels. However, he made it
conditional on NBP’s projections showing that
inflation would remain above 1.5% in the 12-
month horizon. The current market expectations
are somewhere between the MPC declarations
and Citi’s forecasts. Interest rate contracts expect
interest rates to increase by around 41bps, which
is less than two increases of 25bps each over the
next 18 months. Consequently, if the economy
and the labor market keep surprising on the
upside, the July projections of the NBP will
probably see an increased inflation path and that
would probably involve adopting a more hawkish
rhetoric on the part of the MPC. Should this
scenario materialize, there would also be more
pressure on increasinge domestic bond yields.
Back in April, we wrote about the record high
optimism among investment experts. This time,
we are pleased to report record high optimism
levels among consumers. Consumer confidence
indices calculated by the Central Statistical Office
in May have hit an all-time high and for the first
time ended up on the plus side. The current
confidence index rose to 3.1 points, and the
leading one to 0.6 points. This means that, for the
first time since the beginning of the readings in
2000, most Poles turned out to be optimists –
readings below zero indicate a higher share of
negative statements, whereas those above zero
show a higher share of positive statements. Poles’
optimism is probably the result of a higher
economic growth, record low unemployment rate,
growing salaries and the government Family 500+
program. As a rule, such index readings should be
a reason for joy; however, from the perspective of
a stock market investor and in light of historic
data, they can be perceived as a warning sign of
an imminent correction – during the peak of the
Inflows to Investment Funds Against Performance of WIG Index
Source: Chamber of Fund and Asset Management, Citi Handlowy
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-40
-35
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-25
-20
-15
-10
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10 000
20 000
30 000
40 000
50 000
60 000
70 000
Net inflows to equity funds (PLN mln, left axis)
WIG index (points, left axis)
Leading consumer confidence index of the Central Statistical Office (points, right axis)
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2007 bull market the indices also recorded record
high levels.
What is interesting, despite such good consumer
sentiments and the bullish market observed over
the past few months, purely equity funds have
recorded systematic capital outflows for more than
a year. There has not been such a significant
discrepancy between stock exchange sentiments
and performance and capital inflows to mutual
funds in the last decade. The total outflows from
equity funds since mid-2015 amounted to PLN
4.3bn. While it could have been understandable at
the beginning of that period, when the Warsaw
Stock Exchange was during a short-lived strong
downward phase, it seems quite surprising over
the last 12 months. During that period, WIG Index
gained approx. 30% and hit the highest level since
2007. The data about transfers to/ from equity
funds do not, however, fully reflect the reality. This
is because total return funds (along with mixed
funds) have been extremely popular in recent
months, and these funds also invest part of their
principal on the local equity market. Total return
funds have recorded inflows amounting to PLN
4.6bn since mid-2015. It seems to us, however,
that the inflows to purely equity funds should grow
alongside economic prosperity and high rates of
return, which should be an additional factor
supporting the quotations. We uphold what we
wrote in previous months and we still believe that
the SME companies should benefit more from that
phenomenon than the ones with the highest
capitalization.
In conclusion, domestic debt listings are
benefitting from the positive momentum of the
Polish economy. It is likely that the prices will
continue to grow until the second half of the year
(a lot depends on the global situation, though);
after that, the listings may be influenced by the
July inflation projection of the NBP and the
possible change in the MPC’s rhetoric. As for the
stock exchange, we believe that as economic
growth accelerates, it still has a chance to perform
well, but we seek investment opportunities in the
small and medium-sized company sector rather
than among blue chips. We may also be in for
another growing wave, this time fueled by the
inflow of retail capital to equity funds.
6
U.S. Market – In Anticipation of the FED’s Decision
Investors who followed the popular adage “Sell in May and go away” last month may be
disappointed. May did not bring any breakthrough on Wall Street and the long awaited correction is
yet to come. What is more, the major stock exchange indices in the U.S. hit record highs again.
With the positive macroeconomic environment, hard economic data and the leading indicators, the
U.S. equity market remains strong. However, demanding valuations may give rise for growing
concern. In addition, the Fed will also deal the cards this month. And the investors will probably
hold their breaths on 14 June in anticipation of the U.S. central bank’s decision and the
announcement after the Federal Open Market Committee (FMOC) meeting.
Let us first have look at the U.S. economy. End of
last month, the U.S. Department of Commerce
released the “second” estimate regarding the GDP
growth rate in Q1 2017. Initially, the annualized
increase in real GDP was estimated at a mere 0.7
percent. In the past, the subsequent revision of the
advance estimate was quite often positive in tone
and the data were adjusted “upwards”. So they
were this time. According to the current estimates,
the largest economy of the world increased by
1.2% in the first three months of the current year.
Consumer expenditures provided a nice surprise,
with a growth rate of 0.6%. This figure is of
particular importance, bearing in mind that
consumer expenditures make up for 2/3 of the U.S.
GDP. Inventory investments and corporate
investments were on the other end of the
spectrum, with a slightly disappointing growth rate.
Unfortunately, it is difficult to make any
unambiguous conclusions regarding the condition
of the U.S. economy based on an analysis of the
individual GDP components’ contribution relative to
the overall performance. Citi analysts are of the
view that the U.S. economy should accelerate in
the second quarter of 2017 and the overall GDP
growth rate in 2017 should be 2.1%. The economic
growth forecast for 2018 is as high as 2.6%. But
that forecast may be highly inaccurate because
next year the U.S. economy growth rate will be
heavily influenced by the country’s fiscal policy.
Donald Trump’s administration has been rather
vaque in its communications on that aspect. We
assume that the budget deficit may increase from
the current 3% to 3.7% in 2018; as a consequence,
the GDP next year will gain an additional 0.6p.p.
The latest readings of the ISM index, based on
surveys conducted by business managers, may
give cause for some concern about the largest
economy of the world. ISM is equivalent to the
European PMI index and it remains way above 50
points, which suggests economic growth; however,
as you can see on the chart above, the published
values are getting lower and lower. It is not yet a
serious warning sign but it would probably be a
good idea to take a closer look at this index in the
nearest future.
The U.S. companies showed pretty good growth
rates in earnings during the first three months of
the year. Three fourths of the companies reported
better-than-expected results, and 64 per cent
reported revenues that were better than the market
consensus. The earnings of the S&P 500
companies gained as much as 13.9% on a year-
on-year basis, which is the best result since Q3
2011 when the growth rate stood at 16.7% yoy.
Such positive surprises are obviously a good
reason to continue shopping on Wall Street; but the
fact remains that the shares quoted on the New
Manufacturing ISM Index
Source: Bloomberg, Citi Handlowy
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50
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Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17
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York Stock Exchange are still pretty expensive.
The market expectations regarding the earnings
rate in the second quarter of the year are also quite
positive. Market analysts assume that the earnings
will grow by 6.8% yoy over the next three months
of the year, and the overall growth rate for 2017 will
be 10%. Nevertheless, bearing in mind the
earnings growth rate for the first quarter and the
2017 forecasts, the U.S. market does not really
stand out relative to other developed markets. The
companies listed on the European markets or in
Japan show even better results, and according to
forecasts those positive trends should continue.
The P/E or price-to-book value ratios also show
better performance on other markets, where
instruments are relatively cheaper in terms of
valuation. The U.S. market is losing the battle not
only compared to other developed countries.
Equity instruments listed in the U.S. look pale also
in comparison with emerging markets.
The Federal Open Market Committee (FMOC)
meeting on June 13 and 14 and the Fed’s decision
regarding the interest rate levels will undoubtedly
be the most importants event on the global
financial markets in June. The interest rate hike
seems inevitable because its probability implied by
the futures and forward prices is currently 100%.
The response of the financial markets is obviously
a big unknown, although they remained relatively
calm during the last three moves of the Fed as part
of the current cycle to tighten the monetary policy.
Let’s keep in mind that an increase of the cost of
money by another 25bps would bring fed funds to
between 1.00 and 1.25%. Investors will also give
an attentive ear to the announcement after the
meeting and listen for Janet Yellen’s comments
regarding the possible interest rate increase this
year – Citi analysts are of the view that the interest
rate hike might take place as soon as in
September. The new information on the plan to
reduce the balance sheet of the U.S. central bank
will also be of key importance. The minutes of the
FOMC meeting in May already gave away some
details. The reduction is supposed to take place by
limiting reinvestment of proceeds of maturing
Treasury bonds and mortgage-backed securities
(MBS). What is important, the balance sheet
shrinking will take place gradually, i.e. the portion
of proceeds from maturing bonds to be reinvested
will be getting smaller and smaller over time. As no
specifics and no details regarding the reduction
mechanism have been given yet, it is impossible to
determine its impact on the financial markets.
Hence, the investors will be waiting on any news
on the topic in the announcement after the June
meeting of the Federal Open Market Committee.
According to Citi analysts, the tapering will not start
until December; still, Janet Yellen will try to prepare
market participants for that event and will start
communicating it in advance. Judging by Fed’s
Price earnings ratio and price to book value
for selected markets
Region / Country Price to earnings ratio Price to
book value
U.S. 18.6 2.9
UK 14.8 1,9
Europe (excluding the UK) 16,0 1.8
Japan 14,2 1.3
Asia (excluding Japan) 13,0 1,6
Latin America 13,9 1,7
Source: Citi Research, Citi Handlowy
Balance Sheet of the Fed (US trn)
Source: Bloomberg, Citi Handlowy
2,0
2,5
3,0
3,5
4,0
4,5
5,0
2010 2011 2012 2013 2014 2015 2016 2017
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recent moves, we think that we might count on the
central bank’s prudence when taking future
decisions to tighten the monetary policy. Any
moves to shrink the Fed’s balance sheet too fast
combined with subsequent interest rate hikes could
lead to a strong increase in the U.S. Treasury bond
yields, among other things, and also have a
negative impact on the equity market.
To conclude, we are ahead of another month of
Fed’s probably testing the robustness of the equity
market by continuing to tighten the monetary policy
and raising the interest rates. Investors’ response
to the Fed’s decision this time remains to be seen.
Nevertheless, valuations of equity instruments on
Wall Street continue to be demanding and it seems
that allocation in shares quoted in Europe or on
emerging markets is worth considering when
building your investment portfolio.
9
Good Momentum for Europe
The situation on the European equity markets in May was in line with our expectations and saw a
continuation of increases. The European equity market Stoxx 600 index gained 0.7%. The yields
we saw on the Treasury debt markets remained at the levels recorded at the end of April; as
regards the high-yield corporate debt, we saw clear spread tightening, which helped the market get
rates of return around 0.8% at the end of the month.
Ever since the elections in France, the equities in
Europe have been outperforming the U.S. equities.
The European equity index gained 3.1% since 23
April, compared with 2.7% recorded by S&P 500.
That shows that the decrease of premium for
political risk allows the indices in Europe show their
clear power, which is what we expected. This is
also confirmed by broad-based indicators which
show that nearly 80% of the companies in the
Stoxx 600 index are above the average after 50
sessions, compared with slightly over 50% in the
U.S. (see the chart below). And so we see that the
equity indices enter the phase of “broad-based”
growth, which, on the one hand, is a certain sign of
maturity of the current increases but on the other
hand, proves the relative power of the stock
exchange markets in the Old Continent.
The current growth rate of financial markets takes
places at a time when the macroeconomic data
remain strong. The May flash reading of the PMI
Composite index for the European economy
remained unchanged at 56.8, a long-term
maximum level which it reached in April. A minor
decrease of activity in services (56.2 points) was
offset by an increase in industry (57 points). The
May reading shows an extension of a marked
upward trend of business activity in the eurozone
(see chart on the next page).
The reading also confirms a growing activity in
France and Germany which are the two largest
economies; this supports the latest stance of the
European Central Bank President who stated that
the current recovery is “resilient and broad-based”.
On the other hand, the latest announcement after
the ECB meeting shows that the inflation forecasts
remain toned and the central bank will most
probably remain quite patient until it notices some
pay pressure. Therefore, we are of the opinion that
% share of companies whose quotations are above the average after 50 sessions
Source: Bloomberg, Citi Handlowy
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30%
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60%
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Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17
Stoxx 600 S&P 500
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“exit” from the QE program, if any, should not take
place until next year. With the continuing strong
economic environment in the eurozone, we remain
positive that it is worth holding an exposure to that
geographic region in your portfolio.
This view is also supported by the good first
quarter results of the European companies. 65% of
the companies in the DJStoxx 600 index beat the
market expectations when it comes to earnings
(77% at the sales level); the aggregated EPS
growth reached 23%, which means the best
earnings season since Q3 2010.
The yields on the European bonds remain low.
This is because there are no strong foundations for
inflation growth, especially on the pay side, which
could mean a major increase in the risk of
monetary policy tightening by the ECB. While the
current signals from the central bank show that the
probability of such a move is close to none, we are
still of the opinion that the Treasury bonds and
corporate bonds in the Eurozone are not a good
way of investing capital, and a decision to
discontinue the quantitative easing program may
mean a marked reduction in prices for investors,
especially as regards the lowest interest-bearing
debt instruments in the eurozone.
In conclusion, we are of the opinion that the
European equity market still has some growth
potential, whereas the debt instruments market is
not the most promising place for capital
investments. The growing economic activity of the
eurozone countries proves that this year we should
witness an accelerated economic growth and an
increase in corporate earnings.
Industrial PMI for European Economies
Source: Bloomberg, Citi Handlowy
46
48
50
52
54
56
58
60
Jun-14 Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16 Oct-16 Feb-17
Germany France Italy Eurozone
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Japan – positive business environment
Japan benefits from the global revival. The economy accelerates and foreign investors increase
their exposure on the Japanese equity market again. The demographic structure of the population
remains a considerable problem in a long-term perspective though. According to forecasts, the
population may shrink from the current 127 million to 88 million within the next fifty years.
May was a good month for the holders of equities
in Japan. The Nikkei index beat the upper limit on
the four-month consolidation and went up by 2.4%
m/m. From the technical point of view, this opened
the road to the peaks recorded in July 2015, so
around 20600 points. The index would need to gain
around 5% from the current levels (19682 points)
to reach a new high.
The Japanese equity market attracts investors,
with nearly USD 22 billion flowing in to the
Japanese market since the beginning of the year.
By contrast, the U.S. market attracted USD 13
billion, and the European markets attracted USD
12 billion. Relatively attractive valuations,
especially relative to the expensive U.S. market,
seem to be the main factor pulling the foreign
investors. The table below shows that the price to
forecast earnings ratio (P/E 12M) and the price to
book value (PBV) are reasonable. The low
dividend yield and the high CAPE rate which is
based on the average earnings for the last 10
years remain a disadvantage.
Nikkei with a marked peak of 2015
Source: Bloomberg, Citi Handlowy
14 000
16 000
18 000
20 000
22 000
Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17
Valuation of the Japanese equity market against the other markets
Japan U.S. UK Europe
(excluding the UK)
EM
P/E (12M) 14.2 18,6 14.8 16,0 12,6
PBV (12M) 1.3 2.9 1,9 1.8 1.5
DY (12M) 2.2 2,0 4,3 3.1 2,7
CAPE 24.5 27.7 16.3 19,7 15,4
Source: Citi Research, Citi Handlowy
12
Good global economic conditions, monetary easing
pursued by the BoJ and the perspective of a
significant increase in corporate earnings continue
to support the current trend. According to Citi
analysts, the companies in the Topix index may
increase their earnings per share by 15.8%. On the
other hand, we see a potential risk in that the
corporate earnings are quite heavily dependent on
the exchange rate. As an export-oriented economy,
Japan is strongly exposed to the local currency
appreciation. It’s been our experience that the yen
exchange rate is highly volatile. Bearing all this in
mind and considering the profit to risk ratio, we
remain neutral about the equity market in Japan.
Citi economists decided to raise the GDP growth
outlook again. They currently assume an
acceleration to 1.7% in 2017. The higher outlook is
largely related to the considerable strength of the
export and industrial output. The global business
revival is clearly beneficial to the export-oriented
Japanese economy. We expect that the export will
go up by 7.4% in 2017 compared to the import
growing by 3.3%. The capital expenditures of
companies may also record a marked increase.
Business sentiments improved which translates
into new investment projects. On the other hand,
Japan continues to have problems with stimulating
internal consumption. Despite a very good situation
on the labor market – with the unemployment rate
at 2.8% – we expect a merely one percent uptick in
consumer expenditures.
The demographics and ageing society remain a
major issue for Japan in the long-term perspective.
According to the latest research by the National
Institute of the Population and Welfare, the
population of Japan may shrink from 127.1 million
to 88.1 million in 2065. By contrast, the working
age population (the workforce aged 15 to 64) may
record an even more drastic drop from the existing
77.3 million to 45.3 million in 2065. Shinzo Abe’s
government is aware of the problem and is
currently taking measures to address it and ease
the demographics’ impact on the economy.
Increasing the participation of women and the
elderly people in the workforce is one of the main
elements of those efforts, and a higher participation
level of those social groups will help mitigate the
adverse consequences of that trend. First of all, the
government takes measure to increase the
availability of child care facilities, so that women
can be more active in the professional world.
Secondly, the government is gradually extending
the official age of retirement in Japan. Currently,
the Japanese can retire at 62; the government
decided to raise that limit to age 65 by 2025.
Concurrently, the government wants to introduce
upper limits on pension payments to encourage the
elderly Japanese to continue working past the
retirement age. We can see, however, that those
measures may prove insufficient and the country
will not be able to avoid the demographics impact
on the individual segments of the economy. The
sectors with a relatively low share of working
women and elderly will in particular suffer from
shortage of workforce. Construction sector and the
transport sectors, to name a few, may have to deal
with problems finding new workers. From the
macroeconomic perspective, Japan has to
immediately improve productivity to mitigate the
adverse effect of the demographics. Therefore,
investments into robotics and automation are a
priority for Japan.
To conclude, the revival in the global economy has
a good influence on the export-oriented economy
of Japan. Citi economists expect that the GDP will
accelerate to 1.7% whereas corporate earnings will
go up by 15.8% in 2017. Strong dependence on
the exchange rate, continued geopolitical tension
on the Korean Peninsula and a visible problem with
the demographic structure of the society remain
risk factors. Bearing in mind the profit to risk ratio,
we remain neutral about that market.
13
Emerging Markets – An Excellent Month, Save for LatAm
In the latest materials we emphasized that a steady and systematic growth of the emerging
markets could soon result in greater volatility. And the recent weeks certainly did. Large
movements of indexes were primarily triggered by political developments. May proved a very
interesting month for the Emerging Markets; all the more because the developments discussed
below did not hamper their further growth. What’s more, arriving at the impressive 2.8%, the
Emerging Markets Index managed to outclass the Developed Markets Indexes again.
Mid-May saw over 30 world leaders coming to
Beijing to discuss the 2013 proposal of the
President of China. It is an infrastructural project
funded by China and estimated to close at
USD 900 billion. The project is to strengthen trade,
especially with the European Union member
states. The idea draws on the ancient Silk Route
and provides for construction of two ways – a
landway (to Europe) and a seaway (via South-
Eastern Asia to Eastern Africa). The project was
called “One Belt, One Road” (OBOR). The
enormous undertaking covers investment initiatives
in harbors in Pakistan or Sri Lanka, creation of a
fast railway in Africa or construction of gas
pipelines in Central Asia, to name a few initiatives.
It is the largest foreign venture ever launched by
one state.
The project is in its initial phase – computations
show that it may benefit even up to 65 states. It is
beyond any doubt that the second top world
economy will benefit most from it. China wants to
stimulate the recently snail-paced world trade and
become the top beneficiary of this project. It is
further emphasized that the initiative of President
Xi Jinping also serves as a stepping stone for top
Chinese businesses to expand on the global
markets and gain in significance on the world
markets. Many market watchers accentuate that
the assumptions of the “One Belt, One Road”
project are very ambitious and demanding. At the
same time, they suggest that the majority of the
project initiatives are predestined for success, to
say the least. Should it be the case, the center of
the world economy could shift a bit in the very long
term. This will depend, however, to a large degree
on the followers of President Xi – the project is
enormous and its implementation will necessitate
the collaboration of many states also with the
future authorities of China.
Another event that had a serious impact on the
emerging markets last week was the continued
corruption affair in Brazil. We have repeatedly
described the political developments in the largest
economy of South America. Let us only recall that
in August 2016, Dilma Rousseff was impeached
and removed from office due to a far-reaching
Index of shares in Brazil (Bovespa) versus MSCI EM index in 2017
Source: Bloomberg, Citi Handlowy
850
900
950
1000
1050
60 000
62 000
64 000
66 000
68 000
70 000
Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17
Bovespa (left axis) MSCI Emerging Markets (right axis)
14
corruption affair involving top Brazilian companies.
Michel Temer, a darling of financial markets, took
over the reins. Since Temer assumed power, his
promises to fight the bloated social welfare
programs and to support prospective sectors of the
economy made the Brazilian real and the stock
exchange in Sao Paulo respond pretty well, even
vis-a-vis the other emerging markets that
experienced significant gains. On May 18,
investors saw yet again how risky it is to invest
capital in non-developed markets. On that day, the
Brazilian press revealed the existence of
recordings which could allegedly prove that Temer
had accepted bribes and paid a businessman for
keeping his mouth shut. Naturally, the accusations
immediately raised concerns that another president
would soon be impeached, which in turn caused an
immediate sell-off of Brazilian assets. The stock
exchange in Sao Paulo even suspended its
quotations for a while (a procedure applicable
when the main index drops by over 10%); the
Brazilian real also lost approx. 7%. At the moment,
we are not aware of any other consequences of
that development. Markets have calmed down and
public prosecutors are investigating the case. The
President declares that he will not resign from
office. Political watchers in Brazil expect the
president to remain in office until the next election,
which is to be held next year. Still, his political
power has been tarnished. Temer himself is of
significance for investors. Among the key reforms
endorsed by him were changes to the pension
system. Since increasing costs of the system in the
coming years may hamper the economy, the
determination to enforce changes is high. Without
curbing the public pension expenses, Brazil will
become a considerably less attractive place for
investing capital. Hence, the case will remain a hot
potato in the coming months. The turbulence in
Brazil may bring some positive outcomes for the
Emerging Markets, though – looking at the flows on
the Brazilian stock market, it turns out that in the
week after May 19 the market took in USD 760
million, which was the best result over the last 5
years. One can clearly notice that the investors’
propensity to buy on the Emerging Markets, which
continue to be priced below the developed ones, is
high. An additional price cut, caused by the political
situation, only encouraged the investors with higher
risk appetite. The main Brazilian index lost 4.4% in
May. However, this might not be the end of the
high volatility on that market.
In our analyses of the economic situation in China,
we have been frequently emphasizing that the
individual segments of that economy are very
uneven inside. Debt ratio is the most disturbing
ratio in the long term. As at 2016 yearend, the debt
of the entire economy reached 260% of the annual
GDP. Still in 2008, it stood at a “healthy” 160%.
The debt risk was also noticed by one of the 3 top
rating agencies, Moody’s. Towards the end of May,
it downgraded China (investment rating) for the first
time since 1989. The Aa3 rating to-date (the fourth
top rating among the 21 listed by Moody’s) was
replaced with A1 (one notch lower). These ratings
prove a very high assessment of the capacity to
repay debt all the time. In their report, Moody’s
named the doubts about the debt reduction in the
situation where the past economic growth numbers
prove hard to deliver as the main reason for
downgrading. As we have accentuated many times
in our materials, specially the debt of Chinese local
governments and public companies is reaching
more and more disturbing figures. Downgrading
showed more what investors should be focusing on
in the coming years than stirred rapid response
from the financial markets. The mere fact that the
external debt accounts for 12% of the annual GDP
of China causes that the downgrading does not
have such serious consequences as in the case of
the states indebting themselves abroad.
The last month showed once more that when
investors want to earn on dynamic emerging
markets, they need to accept extra risk. Despite
constant changes, political instability and less
stable financial systems remain the drivers of
higher pricing discounts in the Emerging Markets.
We are of the opinion that despite their volatility, a
portion of the most active investing portfolio should
be still invested in the emerging markets. The bear
market experienced by the Emerging Markets for
many years continues to reverse and May showed
that those markets kept their strength with their
assets being strongly capitalized.
15
Commodity Markets – OPEC Extends Production Cuts
Despite relative volatility during the month, for investors, May closed with the CRB Commodity
Index being 1% below that in April. Commodity quotes were much impacted by the USD
deceleration, which traditionally favors appreciation of commodities. This effect was offset,
nonetheless, by the tightening of the monetary policy in China, which affected the demand of the
key player on most commodity markets, among other factors.
Crude oil
In the first week of May, crude oil continued to
observe the price reduction from April, whereby the
quotes of WTI futures reached USD 43.77 per oil
barrel. The drops were fueled by e.g. new data on
the reserves accumulated by the United States of
America which proved above analysts’
expectations. Stopping of the reduction overlapped
with the second round of the presidential elections
in France, the results of which turned out to be
favorable for the investors on most financial
markets, due to a lower political risk. Reignited
interest in risky assets was among the factors
which caused crude oil to soar above USD 50 per
barrel once more in the short term.
Another growth booster were the decisions to
curtail oil production made by the OPEC countries
and selected non-OPEC manufacturers. Before the
meeting on May 25, the market consensus, which
so far had assumed an agreement extension by
another 6 months (by 2017 yearend), started to
shift towards 9 months. This was due to the
statement made by the Saudi Arabian Minister of
Energy, who mentioned that a longer applicability
period of output cuts would be a wise decision and
the other agreement members seemed to shore it
up.
These announcements were confirmed. Reduced
output cuts will apply until the end of March 2018,
while Libya and Nigeria continue to be exceptions
here as exempt from cuts. It is worth noting that in
April and in March, the OPEC countries outdid their
obligations, while the manufacturers from outside
the cartel still did not reach the assumed outputs
(Russia is most behind when one thinks about
quantities). Since the potential impact of the
signatories' decisions on the physical commodity
market will only become known in the coming
quarters, Citi’s short-term forecast remains
unchanged and assumes around USD 50 per
barrel with the situation to improve step by step in
Q3 and Q4 2017.
Actual output cut by OPEC and non-OPEC countries vis-a-vis the agreed cuts (thousand barrels per
day)
Source: Bloomberg, Citi Handlowy
0
500
1000
1500
January February March April
OPEC agreed cuts for OPEC countriesnon-OPEC countries agreed cuts for non-OPEC countries
16
Gold
At the beginning of May, this noble ore lost value
just like most other commodities did. However, it
started to gain after the election winning by
Emmanuel Macron. This was a reverse reaction
from the one expected in the case when the
market risk falls. The investors who hoped that
gold would depreciate were surprised to see it rise
after the results in France were announced. It
turned out that due to unambiguous pre-election
polls, gold fell in value still before the mere election
day.
The weakening USD which is used to settle the ore
was another factor to affect gold quotes in May.
USD depreciation against EUR and other
currencies of the emerging markets (e.g. China
which is the largest off-taker of physical gold)
helped make up about a half of the pre-election
losses. Reduction in USD price was driven by the
risk of Donald Trump’s impeachment amid the
accusations about the pressure exerted on the
former FBI Chief. Despite the indirect impact via
USD, a new political threat impacted gold directly
as well. This is because of the safe asset
mechanism which applies whenever market risk
rises.
The gold prices could continue to go up should the
above factors (USD deceleration, new political risk)
sustain – this is not our base scenario
nonetheless. Since IR futures in the U.S. estimate
the probability of the interest rate increase by the
American FED in June at 100%, the decision is
discounted and it should not affect the gold quotes.
To round up the commodity market standing, for
crude oil – despite the positive outcome of the
negotiations between the signatories of the
agreement to limit oil production cuts, we expect
that the prices will respond positively only in the
coming quarters. In the meantime, extension of the
existing cuts should help keep the levels close to
USD 50 per barrel. For gold, the recent weakening
of USD and the fall in trust in President Trump
seem to exhaust their potential to support gold
quotes any more. Should no new surprising
political developments occur, the commodity
stabilization around the present levels would seem
a probable scenario.
17
Rates of return and ratios for selected indices (as at 31 May 2017)
Equities Value May YTD Year P/E P/E
(12M) Dividend
yield
WIG 60092,1 -2,5% 16,1% 31,1% 17,5 12,6 2,4%
WIG20TR 3868,4 -3,8% 17,4% 29,7% 17,7 12,2 2,2%
mWIG40 4798,7 -1,2% 13,8% 37,7% 14,9 14,5 3,0%
sWIG80 16220,6 -0,5% 13,8% 18,7% 19,7 11,5 2,1%
S&P 500 2411,8 1,2% 7,7% 15,0% 21,4 18,6 2,0%
Eurostoxx 50 3554,6 -0,1% 8,0% 16,0% 19,9 15,1 3,5%
Stoxx 600 390,0 0,7% 7,9% 12,2% 25,6 16,0 3,3%
Topix 1568,4 2,4% 3,3% 13,7% 16.5 14,2 2,0%
Hang Seng 25660,7 4,2% 16,6% 23,3% 14,3 12,7 3,2%
MSCI World 1911,7 1,8% 9,2% 14,2% 21,5 17,3 2,4%
MSCI Emerging Markets 1005,3 2,8% 16,6% 24,5% 15,3 12,7 2,4%
MSCI EM LatAm 2532,3 -2,6% 8,2% 24,2% 18,2 13,9 2,8%
MSCI EM Asia 505,5 4,4% 20,7% 26,5% 15,4 13,0 2,1%
MSCI EM Europe 307,6 -1,8% 3,6% 14,6% 9,2 8,0 3,7%
MSCI Frontier Markets 561,5 3,8% 12,4% 10,5% 14,4 11,7 3,9%
Raw materials
Brent Crude Oil 50,3 -2,7% -11,5% 1,2%
Copper 258,0 -0,6% 3,0% 23,1%
Gold 1272,0 0,3% 10,4% 4,7%
Silver 17,3 0,7% 8,8% 8,3%
TR/Jefferies Commodity Index 179,8 -1,1% -6,6% -3,4%
Bonds
Duration
U.S. Treasuries (>1 rok) 384,3 0,7% 2,1% 0,0% 6,3 German Treasuries (>1 rok) 418,9 -0,1% -0,8% -0,8% 7,4 U.S. Corporate (Inv. Grade) 273,6 1,4% 3,9% 4,2% 8,3 U.S. Corporate (High Yield) 264,1 1,0% 4,3% 12,0% 3,6 EUR Corporate (High Yield) 178,7 0,8% 3,2% 8,0% 3,3 Polish Treasuries (1-3 lat) 324,7 0,4% 1,4% 1,7% 1,9 Polish Treasuries (3-5 lat) 365,5 1,0% 2,5% 1,8% 3,9 Polish Treasuries (5-7 lat) 262,6 1,4% 3,6% 2,1% 5,2 Polish Treasuries (7-10 lat) 432,8 1,6% 5,2% 2,4% 7,6 Polish Treasuries (>10 lat) 336,3 2,2% 6,0% 4,6% 9,0
Currencies
USD/PLN 3,72 -4,1% -11,2% -5,6%
EUR/PLN 4,18 -1,1% -5,1% -4,6%
CHF/PLN 3,85 -1,3% -6,4% -3,0%
EUR/USD 1,12 3,2% 6,9% 1,0%
EUR/CHF 1,09 0,4% 1,5% -1,7%
USD/JPY 110,78 -0,6% -5,3% 0,0%
Source: Bloomberg
18
Macroeconomic forecasts
GDP growth (%) 2016 2017 2018 Poland 2,7 3,7 3,2 United States 1,6 2,1 2,6 Eurozone 1,7 2,0 1,9 China 6,7 6,6 6,5 Developing countries 3,9 4,4 4,8 Developed countries 1,6 2,0 2,2
Inflation (%) 2016 2017 2018 Poland -0,6 2,0 2,4 United States 1,1 1,7 1,9 Eurozone 0,2 1,6 1,4 China 2,0 2,0 2,2 Developing countries 4,3 4,0 3,6 Developed countries 0,7 1,6 1,7
Source: Citi Research
Currency forecasts (end of period)
Currency pairs Q2 17 Q3 17 Q4 17
USD/PLN 3,77 3,81 3,85
EUR/PLN 4,25 4,21 4,17
CHF/PLN 3,89 3,89 3,89
GBP/PLN 5,01 4,95 4,89
Source: Citi Research
19
Glossary of Terms
Polish Shares denote shares traded on the Warsaw Stock Exchange (WSE) and included in the WIG index
U.S. Treasuries bonds issued by the government of the United States of America; figures used for the Bloomberg/EFFAS US
Government Bond Index > 1Yr TR, measuring performance of U.S. Treasuries whose maturity exceeds 1
(one) year
Citi Research A Citi entity responsible for conducting economic and market analyses and research, including that
concerning individual asset classes (shares, bonds, commodities) as well as individual financial instruments
or their groups
Div. Yield the amount of dividend per share over the share’s market price. The higher the dividend yield, the higher the
yield earned by the shareholder on the invested capital
Long Term a term of more than 6 (six) months
Duration a modified term of a bond, measuring the bond’s sensitivity to fluctuations in market interest rates. It
provides information on changes to be expected in the yield on bonds in the event of a 1 (one) p.p. change
in the interest rates
Short Term a term of up to 3 (three) months
Copper figures based on the spot price per 1 (one) ton of copper, as quoted on the London Metal Exchange
German Treasuries
(Bunds)
bonds issued by the government of the Federal Republic of Germany; figures used for the
Bloomberg/EFFAS Germany Government Bond Index > 1Yr TR, measuring performance of German
treasury bonds whose maturity exceeds 1 (one) year
P/E (12M), leading P/E a projected price/earnings ratio providing information on the price to be paid per one unit of 2016 projected
earnings per share, measured as the ratio of the current share price and the earnings projected by analysts
(consensus) for a specified period (12M)
P/E (price/earnings),
trailing P/E
the historic price/earnings ratio providing information on the number of monetary units to be paid per one
monetary unit of earnings per share for the preceding 12 (twelve) months, measured as the ratio of the
current share price and earnings per share for the preceding 12 (twelve) months
Polish Treasuries bonds issued by the State Treasury; figures based on the Bloomberg/EFFAS Polish Government Bond Index for the corresponding term (>1 year, 1–3 years, 3–5 years, over 10 years)
Brent Crude Oil figures based on an active futures contract for a barrel of Brent Crude, as quoted on the Intercontinental
Exchange with its registered office in London
Silver figures based on the spot price per 1 (one) ounce of silver
Medium Term a term of 3 (three) to 6 (six) months
U.S. Corporate (High
Yield)
bonds issued by US corporations which have been assigned a speculative grade by one of the recognized
rating agencies; figures based on the iBoxx $ Liquid High Yield Index measuring performance of highly liquid
US corporate bonds with the speculative grade
U.S. Corporate (Inv.
Grade)
bonds issued by U.S. corporations which have been assigned an investment grade by one of the recognized
rating agencies; figures based on the iBoxx $ Liquid Investment Grade Index measuring performance of
highly liquid U.S. investment grade corporate bonds
YTD (Year To Date) a financial instrument’s price trends for the period starting 1 January of the current year and ending today
YTM (Yield to Maturity) the yield that would be realized on an investment in bonds on the assumption that the bond is held to
maturity and that the coupon payments received are reinvested following YTM
Gold figures based on the spot price per 1 (one) ounce of gold
23
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