Q2 2010
PAGE 3
Debt Indigestion
So it seems that the global debt banquet has
progressed onto its next unsavoury course. Only
a year or so after policymakers came to the aid
of the financial sector that had overindulged
during the boom years, investor anxiety has
switched to an unlikely area of financial markets.
Government bonds of developed countries, the
safest asset class in many investors’ minds, are
currently the principal source of discomfort in
financial markets.
CITI Outlook
PAGE 9
The Next Thing to Worry
About: Inflation?
PAGE 10
Capex Interrupted,
Recovery Ahead
PAGE 11
Spotlight on Allocations
The key factor behind this is the disruption
that may be caused as certain governments
tackle their unwieldy debt commitments. These
burdensome levels of government debt are
largely a result of the global economic and
financial crisis. The chart on the next page shows
the Organisation of Economic Co-operation and
Development’s (OECD) estimates of government
net financial liabilities as a percentage of gross
domestic product in the four largest developed
economies – the US, Euro Area, Japan and the UK
– having reached their highest peacetime levels
and forecast to rise higher.
 from cover
>>Debt Indigestion

Concerns not misplaced

It is perhaps surprising that most of the recent market attention has centred on the debt of Euro Area member states since the
OECD forecasts that Euro Area total net government debt will be lower than that of the UK, US and Japan by the end of this year
(see chart). However, this headline view hides the wide disparities among the member states of the Euro Area in terms of their public
sector financial health and the many other factors that determine the ability of governments to honour their debt obligations.

Furthermore, member states of the Euro Area are constrained in their range of policy responses that can be called upon to alleviate
such pressures. For instance, they cannot allow their exchange rate to depreciate or lower interest rates independently in order to
stimulate economic activity as a means of improving government finances. By the very nature of the Euro Area’s current framework,
problems concerning a member country’s fiscal position are likely to come to the fore sooner than similar problems in an economy
with its own currency.

The fiscal situations in the US and Japan are less of an immediate concern, according to Citi analysts. With the US dollar continuing to
act as the world’s reserve currency, there is still plenty of demand for US Treasuries from foreign central banks. In Japan, the bountiful
savings of the household sector provides continuing strong demand for Japanese government bonds, despite the worrisome debt
levels. Even without genuine political will to effectively curtail the trajectory of public debt burdens in Washington and Tokyo, Citi
analysts believe that it may be a number of years before financial markets react with the same level of anxiety as they currently are
reacting to the peripheral Euro Area government finances.

General Government Net Financial Liabilities As A Percentage of GDP

120

100
Percentage of GDP (%)

80

60

40

20
Japan Euro Area United States United Kingdom
0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011F

Source: Organisation of Economic Co-operation and Development Economic Outlook No. 86, November 2009.

Reaching for a cure Corporate bonds have significantly outperformed government

bonds in developed countries since the height of the credit
After weeks of contentious debate, European Union leaders
crisis as risk aversion has abated. Despite the continued profit
agreed that emergency assistance for Greece should jointly
improvements among corporations, Citi analysts believe that
come from Euro Area member states and the International
the performance of investment-grade corporate bonds may be
Monetary Fund if the country’s debt problems intensify. Citi
undermined by the weaker performance of government bonds
analysts warn that some Euro governments may be forced to
going forward. They do see more potential for non-investment
implement very severe austerity measures, which could dent
grade bonds, which offer somewhat higher yields (as measured
economic activity in the Euro Area over the coming years. The
by the Citi High Yield Market Index) relative to US Treasuries of
good news is that other larger member economies, particularly
similar maturities. Likewise, given their more optimistic outlook
Germany, have much sounder government finances and this
for emerging markets in terms of economic activity and fiscal
may help to stabilise the region as a whole.
balances, Citi analysts maintain their favourable outlook for
emerging market bonds (both sovereign and corporate) over
Perspective in the near term the coming year.
Given Citi analysts’ belief that concerns regarding sovereign
debt burdens are already largely baked into current bond
market prices, they see monetary policy expectations as the
main driver of sovereign bond yields over the coming year.
They forecast the first Federal Reserve rate hike to occur
later this year, and the European Central Bank to follow in
early 2011. With the markets increasingly anticipating higher
interest rates, they expect to see a limited sell-off of major
developed government debt over coming months. In Japan,
the continuation of deflation and near-zero interest rates is
likely to see bond yields range bound over the coming year, in
their view.

2
EQUITIES
CITI
Outlook

NORTH AMERICA A snapshot of Citi’s global market views

across a select group of asset classes,
US equity market gains likely to be uneven in 2010 regions and currencies over the next six
to twelve months.
US equity market performance faltered early in the first quarter as sovereign credit fears
sparked concern that massive government deficits could weigh on global growth and have Our Market Outlook reflects our
negative profit implications. Economic growth in the US is likely to be sustained, according assessment of each asset class
to Citi analysts, and they project moderate GDP growth of 3.3% in 2010 and 2.9% in 2011. independently of other asset classes. Citi
analysts believe that the global economic
US equity market gains in 2010 are unlikely to be smooth despite the beneficial impact from recovery will continue over 2010, led
the earnings recovery, stabilising unemployment and increasing consumption from positive by Asia and lagged by Europe. This,
wealth effects. We may see US equities making gains during the first half of the year but in their view, should be supportive of
higher corporate profitability and of risky
then encountering a period of softness in the second half as markets increasingly focus on
assets, such as equities and corporate
the challenges likely to be faced by year-end. Overall for the year, Citi analysts forecast US bonds. However, after corporate assets
equities posting positive single-digit returns. Within the US equity market, they do not have a have rallied so strongly in the year
preference for small-, mid- or large-cap stocks and remain evenly balanced between growth since the depth of the financial crisis
and value stocks. in March 2009 largely due to receding
risk aversion, gains are expected to be
With corporate profits recovering, corporate cash positions among S&P 500 companies slower going forward and subject to the
outside the financial sector are at historically high levels relative to the market value of occasional temporary setback. Given
these companies. As such, companies with strong balance sheets may be in a position to Citi’s forecasts of a more robust pace
increase their dividends, a trend that Citi analysts see developing over several years. Indeed, of GDP growth among Asian economies
the first quarter marked the first significant uptick in announced dividend increases for S&P and other emerging markets, financial
markets may over the coming year
500 companies since the fourth quarter of 2007.
continue to reward financial assets
linked to these high growth markets,
EUROPE such as emerging market equities,
emerging market sovereign bonds
Cautious revenue expectations and multinational corporate securities
Citi analysts detect that the market’s expectations for the corporate profit recovery may be with significant revenues sourced from
emerging economies. Rising market
losing some momentum as fewer equity analysts have recently been upgrading their profit
expectations of the initial interest rate
forecasts for companies in the DJ Stoxx 600 index. According to the Institutional Brokers’
hikes in the US and Europe may push
Estimate System (IBES) consensus of equity analysts, revenue growth is forecast to recover government bond yields higher over
from -5% last year to 2% in 2010 and 4% in 2011. Citi analysts believe that there is reason coming months and undermine the total
for more optimism, pointing out that historically, European corporate top-line growth has returns in developed sovereign bond
tracked global nominal GDP growth, which they forecast at 6-7% for 2010 and 2011. While markets. Furthermore, recent upsets
they expect the European economy to lag the world economy, they point out that around among the peripheral Euro Area bond
40% of European corporate revenues are derived from outside Europe. markets highlight the risks associated
with particular sovereign issuers.
In terms of profitability, the European corporate sector appear to have done a better job at
maintaining profit margins throughout the recent recession than they did during the 2000-
2002 downturn. The corporate sector has cut costs aggressively and pricing in general has GLOBAL EQUITIES
been robust. The consensus forecasts of equity analysts is for margins to be back at almost MARKET MARKET
OUTLOOK
peak levels at the end of 2010 and even higher at the end of 2011.
POSITIVE

With stocks in the DJ Stoxx 600 index trading at values around 12-13 times analysts’ forecasts US Neutral
of the coming year’s profits, which is somewhat cheaper than the historical average of 13.9 Europe Neutral
times, there is still potential for corporate results to exceed expectations and drive European Japan Neutral
equities higher. Latin America Positive
Asia Pacific Positive

JAPAN Eastern Europe Positive

Japanese stocks to enjoy cyclical rebound GLOBAL FIXED INCOME

MARKET MARKET
Citi analysts believe that Japanese stocks may enjoy a strong cyclical rally this year, propelled OUTLOOK
by above-trend domestic economic growth and yen weakening since the beginning of the NEGATIVE
year. That said, they are careful to distinguish this type of short-term rally from any longer-
Global Government Negative
term breakout from the range-bound cycles that have characterised Japanese stock market
Global High Grade Corporates Neutral
performance after the bursting of the bubble in the early 1990s.
High Yield Neutral

After exporter stocks in Japan suffered badly throughout the recent recession, we see Emerging Markets Neutral

potential for them to lead the Japanese market rebound if the global economic recovery Asia Neutral
and uptrend in global equity prices remains intact. Japanese exports of autos, electronic
components, auto parts and materials to Asia have been booming. Japan’s total exports were ALTERNATIVE INVESTMENTS
up 40.9% in January 2010 from a year earlier, according to Ministry of Finance data. Exports MARKET MARKET
OUTLOOK
to China were up 79.9%, accounting for 18.8% of all exports.
N/A

Citi analysts view global monetary tightening as the biggest risk to the stock market recovery. Hedge Funds Neutral

However, they note that central banks tend to raise interest rates when the economy is
GLOBAL CURRENCIES
performing well, and that the Tokyo Stock Price Index (TOPIX) of Japanese stocks has tended
CURRENCY OUTLOOK
to rise during global interest rate tightening phases since 1980. Given Japanese corporations’ VS USD
high dependency on exports, it is natural that Japanese stocks rise when the outlook is Euro Negative
improving. Among the longer-term investment themes that may drive performance among
Yen Neutral
Japanese stocks are Asian currency appreciation, global infrastructure investment and
British Pound Negative
environmental technology innovation.
3
EQUITIES

ASIA PACIFIC
Dividends likely to matter in trending markets
The pace of equity market gains is expected to moderate this year, according to Citi analysts who are anticipating total returns in the
range of 9-14% for the MSCI Asia ex-Japan index, which posted a 72.5% return in 2009. They highlight that Asian equity markets have
typically moved in distinct phases: the recovery; the grind; then the parabolic. Citi analysts believe that financial markets have now
passed through the first phase, the recovery, where all the easy returns are made and that markets are now in the grind phase. They
assert that this phase typically lasts for two years and is characterised by slower and lower, but still positive returns.

In this type of market environment, stocks paying high dividends could potentially outperform the rest of the market. Citi’s analysis shows
that Asian dividend-focused investment strategies have consistently outperformed investment strategies focusing on companies in the
region with the highest earnings growth. Furthermore, dividend-focused strategies have tended to be more stable than the overall market
over the last 20 years. With overall Asian equity market returns likely to be lower in 2010 than in 2009, Citi analysts believe that dividends
will likely be responsible for a greater share of investors’ total returns on Asian stocks going forward.

Within Asia, we continue to favour the outlook for equities in Hong Kong, Korea and Taiwan; and prefer telecoms, banks and technology
at the sector level.

LATIN AMERICA CEEMEA (Central & Eastern Europe,

Latin American equities to grind higher as earnings
outlook improves
Despite a challenging first quarter for Latin American equities,
with the MSCI Latin America index correcting by over 15% in
January and February, Citi analysts remain constructive on the
region’s equities and expect a new high to be reached in the
second quarter of 2010. While equity market volatility is likely
to be high and further temporary corrections may occur, Latin
American equities are expected to maintain their long-term
rising trend in the second year of what we believe to be a multi-
year bull market.
As is typical of the second year of a bull market, earnings are
expected to grow rapidly but regional stock market prices are
likely to lag, leading to a lower price-to-earnings ratio. The
earnings outlook continues to improve in Latin America and Citi
analysts have recently revised up their regional 2010 earnings-
per-share (EPS) growth forecast to 37% in US dollar terms, while
they forecast a moderate 15% appreciation in the MSCI Latin
America index over the year.
Within the region, Citi analysts maintain their positive
outlook on Brazil and see potential for further upside. They
are also constructive on Mexico based on expectations of
strong economic performance in the US. Meanwhile, Chile’s
outperformance within the region leads them to hold a more
negative outlook. With regard to the North Andean markets,
they are also negative on Peru, while they are neutral in their
outlook for Colombia.
Middle East and Africa)
Economic recovery gathers pace
In the opinion of Citi analysts, recent economic data releases
indicate a continuing improvement in the economic backdrop in
the CEEMEA region, as seen elsewhere in the world. Following
a surge in industrial production and retail sales growth moving
sharply back into positive territory, they have increased their
GDP growth forecasts for the region to 4.4% in 2010 and 4.0%
for 2011. They also expect 33% earnings growth in 2010 for
companies in the MSCI CEEMEA index, which is more or less in
line with their expectations for the emerging markets as a whole,
as represented by the MSCI Emerging Markets Free index. Unlike
other emerging markets, inflation across the region appears
to have stabilised and Citi analysts do not forecast significant
pressure in the near term, except in Turkey. As such, they believe
that the potential for interest rates increases is limited and that
interest rates may even be cut in Russia.
With the MSCI CEEMEA index moving sideways since the
beginning of the year in spite of the improvements to the outlook
for corporate earnings, the regional market consequently
appears to offer relatively better value. At the end of March,
the index was trading at levels less than 10 times the value of
the analysts’ forecasts of next year’s earnings of its underlying
companies, making the region’s stocks appear more attractive
than other emerging markets in this respect. Within CEEMEA,
Citi analysts prefer the outlook for Russian and Turkish stocks,
and believe that South African stocks may underperform the
rest of the region.

4

NORTH AMERICA
Financial recovery proceeds but remains
incomplete
The US Federal Reserve’s efforts to loosen credit and improve
market functioning have significantly slowed financial headwinds
standing in the way of the economic recovery, prompting the
central bank to raise the discount rate, or the rate that it charges
banks for loans, a quarter point to 0.75%. The Federal Reserve
has also been gradually retreating from some of the special
programs that it instigated during the financial crisis that aimed
to inject liquidity into the financial system and ease credit supply.
At the same time, the financial recovery is still at a vulnerable
stage and Citi analysts believe that more compelling evidence is
required that the economic recovery is self-sustaining before the
central bank embarks on interest rate tightening. Moreover, they
maintain a benign outlook on inflation as substantial economic
slack is likely to balance inflation pressures from strengthening
final demand. In their assessment, the Federal Reserve is likely
to leave the federal funds rate at 0-0.25% through the third
quarter of this year and then possibly raising it in the fourth
quarter to 1.0%.
Within fixed income markets, Citi analysts retain their bullish
bias on high-yield corporate bonds given their forecast for
a sharp decrease in corporate default rates through 2010 to
levels of between 3-4%. Meanwhile, they remain neutral on
investment-grade debt as the expected benefit from improving
fundamentals is likely to be largely offset by the gradual upward
shift in government bond yields in the second half of the year.
EUROPE
Mounting fiscal pressures
Citi analysts have revised down their GDP growth forecasts for
the Euro Area for 2010 and 2011. They now expect economic
activity in the Euro Area to grow by 1.1% in 2010 and by 1.3% in
2011. On the positive side, they estimate that the weakening of
the euro, which resulted from the market concerns about the
public debt of Greece and other member countries, is likely to
provide support to export growth in the near term.
Meanwhile, Greece unveiled an aggressive plan in early March
to raise taxes and cut €4.8 billion in government spending. More
recently, national leaders in the European Union agreed on the
terms of an emergency loan package that could be offered to
financially stretched member states with assistance from the
International Monetary Fund. This aimed to bring stability and
reassurance to Euro Area government bond markets. However,
strong domestic opposition to fiscal containment measures may
mean that uncertainty over Euro Area government finances is
likely to persist for some time.
Given the fragility of the economic recovery in the Euro Area,
Citi analysts expect the European Central Bank to hold interest
rates at 1.0% until the first quarter of 2011. However, they
believe that Euro Area government bonds are likely to post
disappointing total returns over the coming year given their
expectations for higher bond yields and the lingering twin deficit
concerns. They expect modest but positive performances from
European investment-grade corporate bonds as earnings growth
contributes to improving balance sheets.
FIXED INCOME
JAPAN
Japanese government bond yields to remain stable
for now
The Japanese economy is forecasted by Citi analysts to grow
at an above-trend annualised rate of between 1.6-2.4% for
the remainder of this year, powered by a combination of a
continued upward trend in exports, the new support measures
for households (such as the child allowance) and a modest
pickup in business and housing investment. In terms of the
inflation/deflation outlook, the narrowing but still-large degree
of economic slack, coupled with an outright fall in unit labour
costs, may continue to exert strong downward pressure on
inflation in years to come. As such, Citi analysts forecast core
inflation to stay negative and the Bank of Japan to maintain its
0.1% interest rate well into 2011.
The fiscal situation in Japan is becoming more challenging.
While the government kept to its target of around ¥44 trillion
of new Japanese government bond issuance in the initial
2010 budget, Citi analysts tentatively estimate that new bond
issuance in fiscal 2011 could balloon to around ¥55 trillion.
They believe that yen bond markets may remain influenced
more by domestic concerns, such as deflation in 2010 and may
be immune to fiscal concerns besetting other markets. They
forecast a very moderate increase in 10-year government bond
yields to 1.45% by year-end with the economy returning to an
above-trend growth track. However, they warn that government
bond issuance may become more the focus for markets in 2011
and beyond, projecting 10-year government bond yields rising
above 2% in the next 3-4 years.
ASIA PACIFIC
Potential for Asia to continue to outperform
The market prices of investment-grade Asian sovereign and
corporate bonds appear close to fair value and may struggle
over the coming year, in the view of Citi analysts. In contrast,
they believe that high-yield quasi-sovereign, corporate and
financial sector bonds still offer attractive yields against global
peers, although no longer offering compelling value. Given
various noises about regulatory reform affecting the bond
markets and the European Union’s plan to support struggling
Euro member states burdened with debt, Citi analysts expect
Asian bond markets to trade within a range in the near term.
While they do not view the high level of government bond
issuance that will have to be digested by global financial markets
in the coming years as an immediate concern, they do not rule
out the possibility of this topic returning at times later this year
and causing ripples.
Beyond the near-term concerns, the fundamentals of Asian
credits, sovereign and corporate, continue to improve and this
is leading to positive credit rating moves for the region’s issuers.
According to Moody’s Investors Service, the bond rating agency,
positive credit rating actions outnumbered the negatives
for the first time in 20 months in the fourth quarter of 2009.
Additionally, Standard & Poor’s has also revised the outlook
on Indonesian and Indian sovereign bonds and some Korean,
Indonesian and Indian banking sector issuers from “negative” to
“stable”. Overall, Citi analysts continue to see potential for Asian
bonds to post another year of healthy returns.
5
CURRENCIES

EURO YEN BRITISH POUND

Longer term strains on
peripheral Europe debt likely to
continue to undermine euro
The euro experienced a sharp trend
reversal since the beginning of the
year as sovereign debt risks among the
peripheral members of the Euro Area
weighed heavily on the currency. The
late-March agreement between the
member states to provide emergency
bilateral loans with International
Monetary Fund (IMF) assistance to any
euro member country facing funding
difficulties helped to stabilise the
currency. However, Citi analysts foresee
renewed weakening of the euro against
the US dollar later this year as they think
that the harsh, but necessary, measures
among some member countries to
trim government deficits may dent
economic activity in the Euro Area. As
a consequence, the European Central
Bank is likely to keep interest rates on
hold for longer and the growing interest
rate differential with the US is likely to
turn out supportive to the US dollar.
They forecast the euro weakening to
$1.30/€ over the next 6-12 months.
Following broad USD trends
Citi analysts assert that the factors that
have supported the yen over the last
year remain in place and account for
the resilience of the currency during
the recent bout of market nervousness.
They note that the yen has historically
performed well during previous US
economic recovery phases. Unlike the
situation over most of the past 15 years,
the yen is no longer the sole low interest
currency that speculators can use to
borrow funds cheaply as other central
banks maintain their interest rates in
the 0% to 1% range. This is another
yen supportive factor in the opinion
of Citi analysts. They believe that the
persistence of deflation in Japan may
continue to buoy the yen exchange
rate going forward, without impairing
Japanese export competitiveness, and
they forecast the yen remaining at
around ¥90/$ over the next 6-12 months.
Policy and political uncertainty
The UK’s economic fundamentals remain
very challenging: the budget deficit is
high, debt levels are escalating and the
UK still runs a current account deficit.
In addition, political uncertainty remains
high with polls still pointing to a significant
risk of an indecisive election result in May,
which may hinder the political process
needed to resolve these problems. On the
other hand, Citi analysts note that the
pound appears cheap against their long-
term estimates while the likelihood is that
the Bank of England may adopt a more
hawkish monetary policy, which would
improve the attractiveness of the pound.
They forecast the pound at $1.46/£ and
£0.89/€ over the next 6-12 months.

DOLLAR BLOC
Commodity units supported on dips
The Australian dollar (AUD) remains supported by export price gains and expectations of further tightening by the Reserve Bank
of Australia (RBA). Export price gains to Australia have exceeded expectations with coal and ore price hikes this year likely
to be much greater than earlier expectations in the context of a generally strong commodity market. Short rate differentials
to other currencies have also widened significantly following the RBA rate hikes. With economic activity at robust levels,
the RBA is expected to lift the cash rate to 5.25% by year end. That said, Citi analysts caution that risks for AUD at this
point look greater to the downside than of making new highs. They note that gains in the AUD have outpaced both the S&P 500’s
gains and gains in Australian interest rates relative to US, and that the currency remains vulnerable to bad news from China.
Meanwhile, New Zealand’s lower growth profile to Australia and bigger budget/ current account deficits suggest that the
New Zealand dollar (NZD) is likely to lag AUD. In Canada, upside surprises to Canadian economic data and more upside risks
to growth suggest that the Bank of Canada (BOC) could hike rates in June 2010. Citi analysts’ year-end 2010 forecasts currently
stands at USD 0.92/AUD, USD 0.71/NZD and USD 1.00/CAD.

6

ASIA PACIFIC
Asia emerging market currencies likely to continue
to appreciate towards longer-term equilibrium
Asia emerging market currencies are anticipated to strengthen
further against the US dollar over the short and medium
term, backed by expectations for the region to commence
monetary policy tightening ahead of the industrialised world,
and the likely resumption of renminbi (RMB) appreciation late
in the second quarter of the year. Citi analysts believe that
the Chinese authorities are likely to allow RMB appreciation in
order to (1) lessen the pressure on exporters from rising wages
that are contributing to higher inflation; (2) avert the risk of
a protectionist backlash; (3) rebalance the economy towards
domestic consumption; and (4) continue efforts towards
internationalising the Chinese currency.
The Korean won and Indian rupee are likely to outperform their
Asian peers in the medium term, supported by robust growth
and strong capital inflows. The Philippine peso has been one of
the main laggards in the region due to the risks surrounding
the presidential elections on 10 May 2010. Looking ahead, Citi
analysts expect a post election relief rally and for the peso to
join the appreciation trends of other Asia emerging market
currencies as the economic recovery matures towards end-2010.
Citi’s year-end 2010 forecasts (against the USD) for the different
currencies currently stand at: 6.62 (Chinese Renminbi), 7.75
(Hong Kong Dollar), 43.00 (Indian Rupee), 9125 (Indonesian
Rupiah), 3.27 (Malaysian Ringgit), 44.00 (Philippines Peso), 1.37
(Singapore Dollar), 1090 (Korean Won), 31.30 (Taiwan Dollar) and
31.70 (Thai Baht).
CURRENCIES
EMERGING MARKETS
Positive over the short and medium term
The short and medium term outlook for most currencies in
Central & Eastern Europe, Middle East and Africa (CEEMEA)
continue to be positive, assuming that the fiscal strains in the
Euro zone periphery have a limited impact on CEEMEA and
foreign capital continues to flow into the region. Currencies
such as the South African rand (ZAR) and Russian ruble (RUB)
(relative to the USD and EUR basket) are expected to continue
benefiting from commodity prices. ZAR should also benefit from
capital flows associated with the 2010 World Cup, but may soften
longer term as the impact of deteriorating external deficits and
a higher real exchange rate kick in. Improvements in the balance
of payments and the fiscal outlook should foster RUB demand in
the medium term, while economic improvements, reforms and
de-dollarization may lend additional support further out. A near
term risk for the Czech koruna (CZK) is the May election which
could lead to some noise in the FX markets. But, the combination
of rising Czech interest rates and a more coherent political
environment should support CZK later in 2010. In Turkey,
refinancing risks and low expected real interest rates (given
higher expected inflation) could weigh on the lira (TRY) in the
medium term. The outlook for the Israeli shekel (ILS) remains
positive due to Israel’s strong activity growth and balance
of payments position, as well as the likely need to rely on ILS
appreciation as a disinflationary tool.
In Latin America, Citi analysts continue to expect short and
medium term upside to most Latin American currencies versus
the USD. Capital inflows are expected to support the Brazilian
real (BRL) near term but wider current account deficits and
the impact from the upcoming presidential election may
constrain BRL strength further out. In Mexico, a recovery in the
domestic economy, large capital inflows into the local market
and a sustained recovery in foreign direct investment, and
an improved performance of the Mexican oil export price are
positives for the Mexican peso (MXN). But, lower than expected
tourism revenues (the third most important source of USD
revenues) during the current season weighs on the outlook.
Meanwhile, risks to the Chilean peso (CLP) may come from
the use of the stabilisation fund (which requires buying CLP
with USD held abroad) to finance earthquake reconstruction
works. In Colombia, strong performance of current account and
capital account fundamentals may lend near term support to
the peso (COP). Further appreciation may however be limited
by central bank intervention which is likely to occur if the USD/
COP reaches 1900.
7
ALTERNATIVES

COMMODITIES
Volatility likely to heighten on the back of
macroeconomic risks
The global economic recovery continues to provide a supportive
backdrop for commodity prices in 2010 and 2011, but commodity
prices look to have gone a long way already in pricing in the
scenario of robust economic growth and low interest rates.
Going forward, Citi analysts expect less spectacular returns over
the medium term and a more volatile environment for the rest
of 2010 given macroeconomic risks.

Regarding base metals and crude oil, Citi analysts remain

constructive over the medium term based on further recovery
in global demand and higher investor inflows. They favour the
outlook for copper and lead where Chinese demand continues to
account for most of the growth in global demand. Citi analysts
forecast the West Texas Intermediate (WTI) crude oil price to
average US$81.90/bbl in 2010. While they see potential for
prices to trade mainly sideways at around US$80/bbl over the
short term due to weak seasonal demand, they anticipate a lift
in the crude oil price over the medium term.
REAL ESTATE INVESTMENT TRUSTS
The outlook for gold continues to be robust with investment
REIT dividend yields may need to rise to fuel
demand remaining strong. Although Citi analysts believe gold
prices are likely to further consolidate to around US$1,120/oz
additional appetite
over the near term, they see potential for gold prices to surpass Global REITs, represented by the FTSE EPRA/NAREIT Global
their medium term forecast of US$1,150/oz if fiscal concerns REIT total return index, gained 4.0% in the first quarter of 2010
intensify. They also continue to expect silver to outperform in US dollar terms. The index was led by the performance of US
gold as it benefits more from the industrial cycle upswing and REITs, with the FTSE EPRA/NAREIT US total return index up by
forecast silver prices to average US$17.60/oz in 2010. 9.8% in the same period.

In their outlook for 2010, Citi analysts believe that the stock
performance of US REITs may be supported by the economic
recovery at home, the prospects for a bottoming of the
commercial real estate market, increased credit availability, the
maintenance of low interest rates and the possibility of increased
merger and acquisition activity in the sector. They believe that
these themes may have, to some extent, played out ahead of
schedule and may have contributed to the strong year-to-date
performance. That said, they caution that there obviously remain
some high hurdles on the US macro picture relating to lingering
unemployment and monetary and fiscal policy that could weigh
on US REIT performance.

The rise in REIT share prices and the cumulative effect of

dividend reductions made by REIT managements have lowered
the average REIT dividend yield to historically low levels that
compare poorly to other yield-oriented asset classes. The FTSE
EPRA/NAREIT Global REIT index had a dividend yield of 3.8%
at the end of March. Citi analysts believe REIT dividend yields
may need to rise to fuel additional appetite for REIT securities
– either through dividend increases, dividend reinstatements or
declining share prices.

8
 The Next Thing to Worry About:
Inflation?
The response to China’s monetary
tightening in January indicates that
the market can grow unhappy when
it sees the punchbowl being taken
away. Although the January consumer
price index (CPI) was lower than
expected in China, inflation data in
November and December had produced
surprises in the other direction. Those
surprises, combined with evidence of
mushrooming credit growth at the start
of the year, produced a relatively swift
David Lubin policy response. Since early January, the
Emerging Markets Economist, Chinese authorities have twice raised
Citi Investment Research the yield on 3-month and 1-year central
and Analysis bank bills, taking the 1-year bill yield from
1.76% to 1.92%; have twice increased
the required reserve ratio; and have
also introduced loan quotas and special
reserve requirements for individual
institutions. Although the market
responded calmly to the latest increase
in the reserve requirement, previous
announcements had destabilized asset
prices both in China and globally.
China isn’t the only country where
inflation surprises have emerged. In
Brazil, both consumer and wholesale
price inflation produced negative
surprises in January.
In India, low inflation rates in 2009 have
led to some unpleasant surprises: the
January wholesale price data came in
8.6% above the previous year’s level
and already exceeds the Reserve Bank’s
forecast for the fiscal year-end in March.
In Turkey, headline inflation rocketed to
10.1% in February from a low of 5.1% in
October 2009.
In Mexico, inflationary pressures are
rising not so much because of demand
pressures, but because of the hikes in
VAT, in special taxes on production and
services, in farm prices, and in some
administered and regulated prices.
9
Our view is that monetary policy needs
to be tightened in several countries. Of
course, this process of hiking rates has
already started, notably in Israel, Vietnam
and China, to the extent that this year’s
rise in CB bill yields can be considered a
rate hike. Until now, however, most of the
effort to tighten monetary conditions
has relied on quantitative adjustments
in liquidity conditions through changes
in reserve requirements, other
administrative measures, or currency
appreciation. This is likely to remain
true for some time. The only countries
that we estimate will be cutting rates in
2010 are those in Eastern Europe, whose
monetary policies had to be tightened
pro-cyclically during the crisis in order
to minimize capital flight.
China’s experience with monetary
tightening in early 2010 raises an
important question: how should markets
react when monetary policy tightens?
The evidence from early 2010 doesn’t
bode well: the market’s reaction to
China’s tightening was negative, not just
in China but globally. Yet this reaction
is likely to have been a blip. Indeed, our
view is that, for the most part, markets
will not be destabilized by rising interest
rates in the emerging markets, largely
because the interest rate increases
that we forecast will do little more than
to bring the monetary stance towards
neutrality. And since, in many cases,
our rate forecasts are below what’s
priced into the market, disruptions to
confidence should be minimized.
Capex Interrupted, Recovery Ahead
Michael Geraghty
Global Themes Strategist,
Citi Investment Research
and Analysis
10
In many regions of the world, capex flow
was interrupted by the global financial
crisis and subsequent economic downturn.
In the US, private investment in equipment
as a percentage of GDP dropped to levels
last seen in the 1970s, according to Bureau
of Economic Analysis figures. A similar
decline occurred in Europe according
to Eurostat data. However, a number of
factors suggest a recovery in capex ahead.
Previously, an improving corporate profits
outlook has been positive for investment.
Our expectation is for profits to recover
in all regions in 2010 and 2011, so we
would expect capex to follow. That said,
company managements have usually been
cautious about adding costs or expanding
the business early in a recovery and have
previously begun to loosen purse strings
in the second year of a recovery, once
utilization rates have picked up.
Also, through first quarter 2009,
governments in more than 40 countries
announced stimulus programs totalling
more than US$2 trillion. The bulk of this
impact will likely be felt in 2010 and 2011.
Here are some of the principal areas
where Citi analysts expect growth in
capex spending:
Economic Infrastructure in Asia: US$700
Billion Spending Increments
Capex in Asia will likely focus heavily on
infrastructure. In China, after the kick-
off of the stimulus in November 2008,
transportation infrastructure investment
became the focus of China’s economic
growth. Railway investment is still on the
up-trend while port and road investment
growth is set to slow down significantly, or
even decline, due to overcapacity.
Economic Infrastructure in MENA: US$500
Billion on Hold
It is widely acknowledged that governments
in the Middle East and North Africa (MENA)
region have underinvested in infrastructure
for decades, despite growing populations
and spreading urbanization. While the
value of construction projects under way
in the Gulf region rebounded as the global
credit crunch eased, it remains below peak
levels. Even as oil prices have rebounded,
the percentage of projects on hold in the
Gulf Cooperation Council (GCC) states has
trended upward, with the value of those
projects now more than US$500 billion.
Commercial Infrastructure: Telco Capex
Stagnant at US$250 Billion
Many developing countries are building
infrastructures from scratch, allowing
them to leapfrog to the latest technologies.
However, in many developed economies,
significant expenditures on commercial
infrastructure are being necessitated by
aging networks, over-taxed facilities, and
new demands that are driven, in some
cases, by technological advances.
Telecom carriers were generally proactive
about cutting capex in 2008 to protect
cash flow despite continued digital traffic
growth. This capex under-spending cannot
continue indefinitely. After growing at an
11% compounded annual growth rate in
2005-08, global telecom carrier capex of
US$250 billion in 2010, as forecasted by
Citi analysts, is expected to be 3% below
2008 levels.
Commercial Infrastructure: €1 Trillion for
European Utilities?
In the European electric utility sector,
aging networks and power fleets
increasingly require a marked step up
in replacement/refurbishment spend.
Citi analysts expect the level of capex
spending to ramp up again in 2012–13 to
a peak of nearly €90 billion per annum
given unprecedented investment required
to replace existing infrastructure and meet
new environmental targets. They estimate
that utility capex could amount to €1 trillion
in the decade 2010 to 2020.
Social Infrastructure: A US$125 Billion
Healthcare Plan in China
In China, healthcare expenditures as a
percentage of GDP are significantly lower
than in other developing countries since
many patients do not have insurance
and pay out of their own pockets for
medical expenses. However, this situation
is changing rapidly. The government is
significantly increasing its spending on
healthcare, both as part of an upgrade of
the medical system, as well as its initiative
to boost internal consumption to become
less dependent on growth in the global
economy.

ASSET ALLOCATIONS
Below are the active client asset allocations for Asian clients,
which include a bias towards Asian equity. These portfolios
reflect different current market views.
The suggested allocations are intended to be general in nature
and are not to be construed as specific investment advice.
Investors are encouraged to consult with their Relationship
Managers to determine their allocation needs based on their risk
tolerance, suitability and goals.
Active Portfolios - USD ($) Denominated
INCOME
Money Market / Short Term Bonds 23%
Global Government Bonds 33%
Global Corporate Bonds 32%
Global High Yield & Emerging Market Bonds 12%
CONSERVATIVE
Global Government Bonds 27%
Global Corporate Bonds 26%
Global High Yield & Emerging Market Bonds 17%
Balanced 15%
Asia Pacific incl. Japan Equity 10%
Alternatives 5%
BALANCED
Global Government Bonds 6%
Global Corporate Bonds 10%
Global High Yield & Emerging Market Bonds 22%
Balanced 20%
Global Equity 14%
Asia Pacific incl. Japan Equity 18%
Alternatives 10%
GROWTH
Global Corporate Bonds 3%
Global High Yield & Emerging Market Bonds 17%
Balanced 15%
Global Equity 27%
Asia Pacific incl. Japan Equity 23%
Alternatives 15%
ENHANCED
Global High Yield & Emerging Market Bonds 2%
Balanced 10%
Global Equity 42%
Asia Pacific incl. Japan Equity 31%
Alternatives 15%
SPOTLIGHT ON ALLOCATIONS
About the Citi Asset Allocation Process
The Citibank tactical portfolio allocations are based on the
work of the Global Investment Strategy Committee (GISC) and
the Global Portfolio Committee (GPC) of Citi Private Bank. The
membership of both committees is comprised of experienced
investment specialists from across Citi. The GISC deliberates on
the macroeconomic and financial market environment in order
to formulate an outlook across multiple asset classes. The GPC
is responsible for creating strategic model portfolios for Citi
Private Bank and maintaining tactical model portfolios, which
are based on the conclusions of the GISC. The tactical weights
that are applied to the Citibank portfolios are aligned to the
decisions of the GPC.
Allocation to bond & equity markets
• We have maintained our preference for global equities relative to global
bonds.
Although Citi analysts do not forecast a repeat of the robust pace of
appreciation set in global equity markets over the three last quarters of
2009, they nevertheless do expect to see a V-shaped recovery in global
corporate profits, which should see stock markets grind higher over this
year with some bumps along the way. They believe that this impressive
rebound in profits is achievable given the cost discipline of many companies
in their response to the global downturn and the strengthening of the
global economy this year. In contrast, Citi analysts believe that significant
components of the global bond market may struggle this year as market
expectations of eventual interest rate tightening around the world intensify.
In anticipation of interest rate hikes in the US, Euro Area, UK and other
countries, Citi analysts forecast a rise in developed government bond
yields, implying below-average returns in this asset class. Accordingly, they
maintain their preference for global equities over global bonds.
Allocation to regional equity markets
• We have maintained our overweight allocation to emerging market
equities and our neutral allocation to European, US and Japanese equities.
Given the mixed and uncertain outlook for economic activity among some
developed countries and the more robust and resilient recovery exhibited
by emerging economies, Citi analysts therefore have a strong preference
for the outlook of emerging market equities over developed market
equities. From a valuation perspective, they note that certain regional
equity markets, such as the US and Japan, are not trading on particularly
attractive valuations and therefore believe that they may struggle to keep
pace with other regional markets.
Allocation to government and credit markets
• We have maintained an underweight position in government bonds
and a neutral position in investment-grade corporate bonds, high-yield
corporate bonds and emerging market debt.
Citi analysts believe that the bond market volatility linked to European
sovereign credit worthiness concerns may gradually diminish this year
but that developed government bond markets may come under pressure
as expectations of central bank interest rate hikes in the US, Europe and
elsewhere intensify. With corporate bonds having performed very strongly
over the last 12 months to end-March, Citi analysts assert that the yields
on investment-grade corporate bonds may be largely offset by the impact
of rising government bond yields over the coming 6-12 months, resulting
in low total returns in this asset class. However, they continue to believe
that yields among non-investment grade (high-yield) corporate bonds and
emerging market bonds are attractive and that these areas of the bond
market may outperform in the coming year.
11
 Disclaimer
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within Citi Investment Research and Analysis and
Citi Global Markets (CGM) and voting members of
the Global Investment Strategy Committee.
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