Andbank Corporate Review April 2017 by Andbank

GLOBAL OUTLOOK ECONOMY & FINANCIAL MARKETS

ANDBANK CORPORATE REVIEW April 2017 Why is the failure to overhaul US health insurance bad news for equity markets?

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Contents Executive Summary

Country Pages USA

Europe

China

India

Japan

Brazil

Mexico

Argentina

Equity Markets Fundamental Assessment

Short-term Assessment. Risk-off shift probability

Technical Analysis. Main indices

Fixed Income Markets Fixed Income, Core Countries

Fixed Income, European Peripherals

Fixed Income, Corporate Bonds

Fixed Income, Emerging Markets

Commodities Energy (Oil)

Precious (Gold)

Forex

Summary Table of Expected Financial Markets Performance

Monthly Asset & Currency Allocation Proposal

19 2

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Executive Summary Global – Disintegration of the “Reflation Trade”. China started 2016 with the same fears that were present in 2015, with Chinese stocks crashing, copper viewed as poor loan collateral, and the first developer bankruptcies. This led to a vast fiscal and monetary stimulus by the Chinese authorities, channeled through the state-owned companies. This resulted in a strong rally in commodities globally, which was transmitted into the international inflation indices, making China the largest exporter of inflation worldwide. Once these stimuli have been withdrawn in China, we are wondering what will drive the global reflation trade that we have been enjoying since the second half of 2016. USA - The political setback suffered by Trump on March 24, after Congress’ refusal to approve Trump's health law, forces us to be more cautious about the reform agenda, and thus, the equity market. The outcome of the last FOMC showed a largely unchanged outlook for policy. Europe - March ECB meeting brought better price and growth prospects and some self-contained less dovish views. In a nutshell, sentiment remained upbeat, inflation rose again (February readings) and the Netherlands held general elections with a market friendly result. Having said all this, it still remains to be seen whether this path is sustainable, given some external dynamics that we envisage could moderate clearly in the second half of the year. China - Vast stimulus measures were approved in early 2016 and Chinese growth was once again stimulated. China’s growth will continue to slow down structurally, but policymakers still have policy levers to cushion a deep deceleration in activity. The pursuit of social stability will continue to be the main driver of China’s policymaking. India - Prime Minister Modi’s political party (BJP) was the clear winner in the elections held in five states, putting Modi's BJP in pole position to regain power (with larger majorities!) in the 2019 national elections, and legitimating Modi to continue (even accelerate) federal policies and credible pro-business measures. This also signals political stability, which will encourage the record flow of foreign direct investment seen in 2016 to continue at a good pace. Brazil - Fiscal numbers don’t add up. Since changing the primary surplus target is not an option, the gap will likely be covered by expense freezing and tax increases, in a clear sign of the government’s commitment with the control of the public finances. Mexico - Banxico will announce a new hike in its monetary policy rate on March 29th. Analysts expect the central bank ate to close 2017 between 7 and 7.25 percent. It seems like Trump’s aggressive rhetoric against Mexico has diminished as the diplomatic team of both countries have started to work.

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

USA:

APRIL 2017

A bumpy road ahead after the political setback?

Do you feel dizzy? Monetary conditions are clearly accommodative while fiscal policy is neutral

Growth in the US could keep pace but the structural shape is now vulnerable

Politics & Reforms The political setback suffered by Trump on March 24, after Congress’ refusal to approve Trump's health law, forces us to be more cautious about the reform agenda, which is likely to be slower than expected. Despite our cautiousness, the impact on markets may prove to be limited because many of the pending reforms, especially those aimed at deregulating key aspects of the economy, may eventually receive the support of the obstructionists within the Republican party. Our own view is that there is a decent chance that a smaller package will get through on corporate tax, but in 1Q18 at the earliest. We doubt that anything will get done on infrastructure. Fed, don’t press the accelerator… yet Despite a strong hawkish shift in Fed rhetoric in recent weeks, the outcome of the last meeting showed a largely unchanged outlook for policy, with median rate forecasts essentially being identical to the December meeting. After a strong hawkish push in recent weeks, the last meeting came across as relatively dovish. The Fed is responding to solid economic data and robust financial markets, but is not reacting strongly to rising confidence surveys or fiscal policy expectations. We continue to expect two hikes in 2017, but evidence has emerged for a third rate hike this year. Macro front While markets are betting heavily on stronger GDP growth and fixed income risk assets are priced for perfection, we caution investors to be mindful of potential downside surprises. We believe economic growth and inflation in particular may be tamer than expected, which could generate substantial headwinds if the Fed is considering three interest rates hikes in 2017. Admittedly, there are some signs of strength: (1) After bottoming out in negative territory last November, US industrial production momentum is steadily accelerating towards an above-trend peak this summer, with manufacturing rising in the past few months and the rebound in energy mining picking up steam. (2) Leading indicators point to continued strength, with Markit PMI New Orders picking up solidly, while regional manufacturing surveys have jumped sharply higher. (3) Utilities have been depressed by unseasonably warm winter weather, but a reversal is likely in the months ahead, adding fuel to the increasing momentum. (4) Demand growth appears solid, with a rise in investment offsetting some softness in goods consumption. (5) An improving labor market continues to drive rising household income and ultimately we expect a reacceleration in consumer goods spending. But we have also seen some signs of weakness: (1) Real retail sales have been disappointing for the past few months, contracting in January before a modest rebound in February. (2) Auto sales have also come down from a peak in December. (3) Building permits have weakened recently, although new home sales remain firm. Inflation The consumer price index (CPI) rose by 0.12% (MoM) in February and the year-on-year rate accelerated two tenths to 2.7%. Core CPI increased by 0.21% (MoM) in February, although the year-on-year rate nonetheless decelerated one tenth to 2.2%. In the medium term, we still see some modest upside for inflation, but we do not view the recent strength as the beginning of a sharp acceleration. Key macro projections CPI 2017 expected at 2.2%. GDP growth 2.3%. Unemployment at 4.7%. Financial Markets: (Very capable of shrugging off bad news) Equities (S&P): NEUTRAL. Fundamental Target: 2,233. Exit point at 2,456. We expect choppy market conditions ahead as investor expectations for stock market friendly legislation could be dampened in the short term. We are a bit more concerned about the possibility of a near-term pullback in US equities. If this does occur, we would view it as a temporary event and would be watching for the S&P 500 P/E to fall to ~16.6x (or 2,100 for the S&P) Bonds: CAUTIOUS. UST10 target 2.75%. Fed tightening will marginally pressure 10-year Treasury rates this year. In the absence of further inflation, it is difficult to see yields on the 10-year bond pushing much beyond our target of 2.75%. Foreign investors searching for yield have little alternative as the UST offers the highest yield among the developed debt markets. Furthermore, Treasury securities remain the most attractive safe-haven assets, which should keep the long end of the yield curve well bid since political risk in Europe, including a hard Brexit, has led to many non-US investors seeking safety. Credit: CDX IG: NEUTRAL (Target 70). Credit: CDX HY: NEUTRAL (Target 340).

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

Europe:

APRIL 2017

The EU celebrated its 60th birthday without the UK

The perception of banking risk is minimal

Escenario macro BCE 2016E IPC

PIB real

mar-17 dic-16 sep-16 jun-16 mar-16 dic-15 sep-15 jun-15 mar-15 mar-17 dic-16 sep-16 jun-16 mar-16 dic-15 sep-15 jun-15 mar-15

0,2% 0,2% 0,1% 1,0% 1,1% 1,5% 1,5%

1,7% 1,6% 1,4% 1,7% 1,7% 1,9% 1,9%

2017E 1,7% 1,3% 1,2% 1,3% 1,3% 1,6% 1,7% 1,8% 1,8% 1,8% 1,7% 1,6% 1,7% 1,7% 1,9% 1,8% 2,0% 2,1%

2018E 1,6% 1,5% 1,6% 1,6% 1,6%

2019E 1,6% 1,7%

1,7% 1,6% 1,6% 1,7% 1,8%

1,6% 1,6%

Fuente: BCE

PMI Manufacturero 60 58 56 54 52 50 48 46 44 42

Although low, the growth structure in the Euro area seems more balanced than in the USA EUROPA

ALEMANIA

FRANCIA

ITALIA

ESPAÑA

feb-12 abr-12 jun-12 ago-12 oct-12 dic-12 feb-13 abr-13 jun-13 ago-13 oct-13 dic-13 feb-14 abr-14 jun-14 ago-14 oct-14 dic-14 feb-15 abr-15 jun-15 ago-15 oct-15 dic-15 feb-16 abr-16 jun-16 ago-16 oct-16 dic-16 feb-17

ECB: cautious optimism March meeting brought better price and growth prospects and some self-contained less dovish views. The ECB acknowledged that domestic risks were tilted on the downside and the possibility of using all the instruments within its mandate was withdrawn from the statement. We stick to the tapering scenario, to be openly discussed around midyear, after the French elections. Should the ECB follow the Fed’s path, purchases could be reduced by 2018, and 2019 would then be the time for rates to start rising. Latest wording from ECB members points to the possibility of rising rates ahead of the end of QE; the market is already pricing in a 46% probability of an ECB depo rate hike this year. Exit strategy in the oven? Macro figures: more grounds for surprise growth Sentiment remains upbeat, with the preliminary surveys in March surprising on the upside, both for the industrial and services readings. Strong dynamics: employment on the rise, supportive consumer confidence and industrial production picking up. GDP is expected to settle at around 0.4% QoQ for the rest of the year, but the scope for surprise growth has certainly increased according to resilience in the surveys. Inflation rose again in February driven by the energy component (headline CPI 2% YoY; core CPI 0.9% YoY), with overall CPI likely to have peaked in February. March figures will be affected by the calendar effect. CPI 2017 estimates have been revised upwards to 1.7% YoY for headline inflation, and remain close to 1% YoY for the core inflation figure (wage pressures remain subdued). “Deflation risks have largely disappeared” (Draghi), with inflation expectations having moderated since January, waiting for the confirmation of the oil price trend + Trump’s fiscal measures. Politics: France takes center stage; risks fading? • The Netherlands held general elections on 15th March with a market friendly result: the ultra-right party PVV gaining less support than expected and the ruling party leading the formation of the new Government within a fragmented Parliament, which will require a coalition among four to five different parties. Nexit fears seem to be in the past without any material impact on the French polls from the rise of euro-skepticism in the Netherlands. • France is next (7th May): no changes in the polls, which still suggest that Le Pen would win in the first round, but would be defeated in the second, with Macron leading (60% vs. 40% for Le Pen). Financial markets have priced in this scenario, but are far from envisaging a Le Pen victory. • The UK’s PM, Theresa May, is about to trigger article 50, starting Brexit. A special summit would be called for the end of April or the beginning of May. With French elections around the corner and Germany’s coming after the summer, serious negotiations on the UK’s exit could be delayed until the end of the year. Financial Markets Outlook Equity (STOX 600): NEUTRAL. Fundamental target price at 349. Sell at 383. See page 12 for fundamental parameters. ¡Equities (Ibex): NEUTRAL-POSITIVE. Target 9,800. Sell at 10,780. We are still below the consensus for Sales and EPS forecasts. The particular composition of the index (more than a third of the index are banks) and the new context in the interest rate curve represent a tailwind for the Ibex. Sales growth stable at 4% but we raise margins (from 8.2% to 8.3%) meaning expected EPS growth of 18.1%. New target price at 9801 (from 9716). Exit point at 10780. Earnings season in line with expectations (no need for adjustments). Banks, Repsol and Iberdrola lie behind our upward revision. Government Bonds: NEGATIVE. Sell off at the long-end of the curve last month due to the ECB wording, with political risks receding, and a better macro outlook. We stick to our targets for 2017: 10yr Bund 0.70%, Italy: 2.3%, SP 1.9%, POR 3.3%, IE 1.4%. Short term curves could find support in the liquidity injection from the TLRTO II (>200 bill. €), above expectations. ECB purchases will be reduced from April. More pressure to come on bonds as the year advances with the taper talk intensifying. Credit: Itraxx IG: NEUTRAL (Target 80). Spreads have “slightly” increased since our last committee. With ultra-tight valuations and less supportive technical factors, spreads had wide sooner or later. M&A could be one of the biggest threats to spreads in a near future. Credit: Itraxx HY: NEUTRAL (Target 350). While we have seen some inflows in investment grade, we have also seen large outflows in high yield bonds during the last month mainly due to contagion from US HY flows, after the sliding oil price and supply pressures.

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

China:

APRIL 2017

China has been both the source and the engine for the “Reflation Trade”

It seems that Chinese authorities are effective in dealing with, and controlling, bubbles (at the very least, more effective than Western economies)

Currency manipulator? The PBoC has been working hard to avoid a sharp RMB depreciation (which YTD has stabilized from 6.96 to 6.86 vs the USD)

Background facts 2016 started off with similar concerns to those that rocked markets in the summer of 2015, namely, massive concerns around the banking system and the real estate sector, commodity prices plunging, adverse equity market movements that jeopardize the Chinese economy, etc. China’s decision Vast stimulus measures were approved in early 2016, including liquidity injections by the central bank, tax cuts and a significant increase in fiscal spending (with investment by state-owned companies soaring by 23.5%, while private companies’ barely rose by 2.8%). All this helped to prop up demand and avert a deeper downturn, although it also put debt levels on a less sustainable trajectory. Most of the growth in 2016 came from the very sector that was supposed to trigger the economic collapse, namely the property sector. Sales figures, prices and construction activity all moved higher. With the Chinese real estate sector picking up, commodities hitched a ride too, with oil, copper, steel and coal all bouncing back strongly in the second half of the year. Why did China decide to implement vast stimulus and not to opt for a massive devaluation in a way that would have allowed the many renminbi shorts to make money from the trade? By allowing the RMB to fall only by the interest rate spread between Treasuries and CGB (Chinese Government Bonds), the PBoC ensured that the renminbi’s credibility as a potential reserve currency was not affected. Certainly an important aspect since many central bankers had shifted a portion of their reserves from Treasuries to CGB in the previous five years. In short, instead of collapsing, Chinese growth was once again stimulated. Lessons to be drawn The end of the Reflation Trade? With most of these stimuli being withdrawn (with fiscal stimuli mostly eliminated in the summer and monetary stimulus already scaled back in the winter), it is legitimate to think that the big push in commodities will lack continuity, and with this we will probably see the end of the reflation trade (or a lack of acceleration in prices). China was the key driver of the commodity price rebound, but this is not sustainable. The strength of China’s imports in 2016 does not reflect strong final demand and Chinese inventory-building cannot go on much further at a time of low prices. China as the main exporter of inflation: With growth rebounding (driven by huge stimuli), inflation in the early stages of the value chain (manufacturing) also bounced back, with PPI back in positive territory for the first time since 2011 Long-Term Outlook: China’s growth will continue to slow down structurally, but policymakers still have policy levers to cushion a deep deceleration in activity. The pursuit of social stability will continue to be the main driver of China’s policymaking. Politics: Shortsighted fine-tuning or longer-term bold reforms? There is a consensus on China's relaxation of its reform agenda and the frequent use of stimulus to extinguish the successive fires. Some attribute this to a generational change (Chinese millennials demand higher expectations), but we attribute this to the political agenda (with Xi Jinping fearful of being dispossessed if he undertakes tough reforms). However, just recall how Xi Jinping began his mandate implementing strong reforms in the areas of SOEs (which resulted in a brutal deceleration in contracts and acquisitions of foreign minerals, and the imprisonment of many of the executives of these public corporations). Hopefully, after consolidating his power at the Communist Party’s 19th Congress, Xi Jinping will return to the hard -but healthier- line of reforms. What to expect in the Global Bond Market? Not surprisingly, global bond markets were slow to catch on to the fact that the Chinese government was stimulating its economy. Fears about China persisted and this drove the 10Y UST down from 2.25% to 1.75% in 1Q16. Then came the big surprise of the year -the Brexit vote- which pushed yields even lower (to 1.4% in July). Our concerns are that the global bond market may be slow to once again catch on to the fact that “the reflation trade” is temporary and may be at its end. Financial Markets ¡NEW - Equity (Shanghai): NEUTRAL. New Fundamental price 3,226. ¡NEW - Equity (Shenzhen): ATTRACTIVE. New Fundamental price 1,979. Exit point at 2,177 Bonds: ATTRACTIVE. 10Y bond target 2.9% FX: FAIR VALUE USDCNY fundamental target at 6.75-6.8

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

India: Modi’s undisputed victory says much more than the headlines suggest

GDP growth is the highest within the EM category (both in q/q and y/y terms)

Plenty of room for favorable monetary conditions and growth

India enjoys a broad and healthy base for further growth

Politics Prime Minister Modi’s political party (BJP) was the clear winner in the elections held in five states (with the last major victory in the key state of Uttar Pradesh, as it is the most populated and is the key to governance). The BJP won 434 of the 690 seats at stake and obtained an overwhelming 80% of the votes in this key state. Why should this interest them? These elections had been seen as a minireferendum on Modi's reforms, and in particular the painful decision to eliminate high-denomination bills. Modi’s victory suggests that the population has correctly deciphered the goal of these reforms. They see the reforms as: (1) Part of a campaign against corruption; (2) an effort to expand and extend the formal economy; (3) and this should result in an improvement in the "fiscal return" and greater resources within the banking system. Outlook Modi’s undisputed victory says much more than the headlines suggest. First, it puts Modi's BJP in pole position to regain power (and this time with larger majorities!) in the 2019 national elections. Second, it is a mandate for Modi to continue (even accelerate) federal policies and credible pro-business measures (including a rapid roll-out of the GST reform - the most important reform since 1947). Thirdly, it clearly signals political stability, an element that every foreign investor needs when making investment decisions. As we see it, all these factors will encourage the record flow of foreign direct investment seen in 2016 to continue at a good pace. We guess that financial investment will also respond with (probably) intense inflows into India’s markets (equities and bonds), especially having observed net outflows since demonetization took place. The budget signaled a clear commitment to long-term stability. Following the decision to scrap large denomination banknotes, the budget was carefully calibrated in a move to reassure financial markets after the IMF estimated that the demonetization would cut growth by 1pp this fiscal year. The budget shows that India remains wedded to fiscal responsibility. The fiscal prudence of the last budget is reassuring for international investors. Sound financial management and reining in external imbalances means the rupee is unlikely to tank, which in turns increases the attractiveness of other Indian assets. The bad news is that in the short-term, fiscal prudence and Delhi’s commitment to cut the deficit makes it harder to press ahead with a decisive clean-up of India’s state banks (perhaps the biggest obstacle to growth). With a 12% NPL rate in the 27 public banks, investment could remain stalled. Public lenders need an estimated capital injection of US$30-50bn according to local sources, but Delhi’s budget has offered them US$11bn spread over several years. In exchange, Delhi’s budget offered much needed infrastructure spending, trying to “crowd in” private investment (which has been in the doldrums since 2012). All said, the government estimates GDP growth will bounce back to 7% this year even without a revival in private investment. The risks are fading Of course we are aware of the risks, though these seem to be fading as of late: (1) An environment of high commodity prices. (2) Trump and his economic nationalism. (3) Or the fact that Modi will not enjoy a majority in the upper-house until 2019 –which may mean his most ambitious reforms being blocked until 2019. Understanding Modi’s 2017-18 Economic Plan Total budgeted expenditure has been fixed at INR21trn (some $310bn), pegging the fiscal deficit at 3.2% of GDP, although a shade over the original target of 3%, it is tight enough to satisfy the rating agencies. Finance minister Jaitley expects to hit the 3% deficit target in 2018-19, halving the deficit level seen in 2011-12. Rural government investment: 25% increase (to INR 2trn) Infrastructure: 8% increase in railways (to INR 1.3trn), 11% increase in highways (to INR 640bn). Housing loans: INR 200bn and granting “infrastructure” status to affordable housing allowing developers to access cheaper credit. Tax cuts: For urban middle-class and small corporations (which account for 95% of all Indian companies). Financial Markets ¡NEW - Equity (Sensex): ATTRACTIVE. Fundamental price 29,958 (from 29,126). Exit point in 32,953 (from 32,038) Bonds: ATTRACTIVE. 10Y bond target at 5.7% FX: FAIR VALUED

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Japan: BoJ – No tapering in sight BoJ & Financial markets No tapering in sight: A BoJ council member (Takahide Kiuchi) called this month for the institution to start tapering its purchases of JGBs. However, the chance that the central bank will announce any such change in QE is negligible, since many other members insist that the BoJ must stick to its course. Why then has the BoJ cut its purchases? The BoJ’s holdings of Japanese government bonds grew by ¥34trn in 2H16 (much less than the ¥51.4trn seen in 1H16). Some argue that the recent decline in the BoJ’s purchasing activity means that it is implementing de facto tapering. That in not exactly true. In switching last summer from QE to QQE with yield curve control, the BoJ decided to allow the 10-year yield to rise and be fixed around zero, which has meant that the BoJ has acquired fewer assets in the market. This tapering has been implemented to reduce stress in the financial sector and to prompt consolidation among small banks – but don’t expect any further cuts in the BoJ’s purchases. The BoJ’s successes so far: (1) New lending to households jumped 20% in 2016. The increase was primarily driven by homeowners taking out cheap mortgages in order to upgrade, although investors played an important role, buying properties in pursuit of rental yields of 4%. (2) This demand from investors has fed into the broader real estate market, with lending to developers rising 15% in 2016 and prompting construction activity to pick up strongly while allowing some major cities to enjoy a property bull market. (3) Corporate borrowing increased by almost ¥1trn in 4Q16, but outside the property sector little of this has been used to fund investment in domestic capacity. The costs of the BoJ’s QE policy: (1) It has drawn fire from officials in the US administration who have accused Japan of manipulating its currency. (2) Negative rates and QE have depressed returns in Japan’s financial sector. Why should you not expect the “tapering”? All these successes could be legitimately described as “limited achievements” since they are all related to the real estate sector and the stock market. This is nothing more than the reflection of low bond yields forcing institutions and investors to allocate more of their funds to riskier assets (equities) or less liquid ones (real estate), as can be seen in the last GPIF financial report, showing a +8% in investment profits in 4Q16. Our assessment: In general terms, we are in line with those who claim that the BoJ’s policy stance has clearly been a failure. Here are the main reasons for our assessment, and ironically, also the reasons that justify our view of a continued QE: (1) Growth remains lackluster. (2) Underlying inflation is barely in positive territory, and inflation expectations have not budged. (3) The BoJ has no realistic chance of achieving its target of 2% inflation within the foreseeable future and with 2% inflation unachievable, the BoJ will be grateful for any upside in lending and real estate prices. (4) The BoJ remains the only player in the market, and with so little depth in the JGB market, any attempt to taper would lead to a dramatic rise in yields that would threaten to choke off Japan’s fragile recovery. The BoJ therefore has little choice but to stick with QE in what we consider a “policy trap”. Can a trade war with the US be avoided? Abe is neutralizing any accusations that Japan is a currency manipulator: The BoJ has not intervened in the FX market since 2011. Regarding QQE, Abe replies that it is necessary in order to buy time for his Abenomics to take effect. Regarding Trump’s complaints that Japan buys too few USmade cars, Abe can demonstrate that Japan no longer erects barriers against imports of American autos. Abe can point out that Japanese manufacturers have made more than US$400bn in FDI in the US, with Toyota’s president reiterating plans to invest US$10bn in its US plants over the next five years. Abe will probably offer his support for Trump’s US$1trn infrastructure plan, pledging that giant GPIF will buy US infrastructure bonds. To avoid a trade spat, Abe can also offer a promise to ramp up Japan’s defense spending (currently running at a 1% of Japan’s GDP. Talks are that Tokyo can double it over the five-year period beginning 2019. This would amount to a major military program (exactly the sort Trump has demanded) and given the lack of knowledge in some areas (notably in advanced missile systems) there would be plenty of lucrative work for specialist US defense contractors. Such a development could work for both sides. Financial Markets • Equity (Nikkei 225): NEUTRAL-NEGATIVE. Fundamental price 18,599. Bonds: EXPENSIVE (USELESS). 10Y bond target 0%. FX: NEUTRAL. USD-JPY fundamental target at 112.

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Brazil:

Inflation is falling like never before, giving plenty of room for the central bank to support the economy

The effects of the last crisis are evident

Fiscal discipline Fiscal numbers don’t add up. The 2017 budget was based on GDP growth of 1.6%, but will be 0.5% or lower. Tax increases are the most likely remedy. Central government’s primary surplus target for 2017 was BRL 139 billion, but the economic team announced a BRL 58.2 billion deficit this week, mainly due to the fact revenues missed expectations (lower than anticipated economic growth). What can be done? Since changing the primary surplus target is not an option, the BRL 44 billion gap (BRL 58bn–BRL 14bn) will likely be covered by expense freezing and tax increases: (1) Discretionary expense cuts: BRL 120 billion, of which BRL 37bn is investments. (2) Non-recurring revenues from judicial trials: BRL 14 billion; (3) Sales of public assets (airports). Inflation is providing serious respite for central bank Both realized and expected inflation (12 months forward) are in sharp decline. 2017 Full Year IPCA (Brazil’s CPI) may end below 4.0%. Reform agenda Social security reform: Special Commission has the majority to approve the bill sent by the government. Votes are expected to take place end of March/early April. Government has made some concessions, pulling back and withdrawing state and municipal civil servants from the reform. They represent around 25% of the deficit (BRL 29 bn), but don’t affect federal results. This concession seeks to shorten the bill approval process. In our view, the social security reform will be approved in the House of Representatives in May-17 and in the Senate in Oct-17. Despite the changes to the original bill, the reform has the potential to reverse the perverse sovereign debt dynamic. Minimum age of 65 for men and women is one of the critical points of the reform. Outsourcing Law (“Lei da terceirização”): A bill from 1988 was voted in the House of Representatives and sent to be sanctioned by the president. The Outsourcing Law allows more flexible structures to hire employees as service providers, offering the chance to improve job market efficiency. The Senate is already working on a new bill, seeking to smooth out the current one. The voting session sent a warning to the government, with defections of part of its supporter base. In our opinion, this structural reform will demand more negotiation and new concessions to consolidate its base. No big political risks ahead, at least in the short term. Recent leaks of Marcelo Odebrecht’s testimonies have hit Dilma-Temer candidature and directly affect major PT leadership. In our view, the political class has little incentive to end president Michel Temer’s mandate early. He has been doing the “dirty work” (structural reforms). The slowness of the TSE process (both in-house and, later on, in the Federal Supreme Court – “STF”) will therefore allow Temer to finish his mandate. Janot sent inquiries on 83 politicians to the STF, based on Odebrecht’s testimonies. Names include five of Temer’s ministers and major leaders in the PT, PSDB and PMDB. Temer is still out of the spotlight, at least directly. In our view, the Car Wash Operation should hit some ministers, leading to their dismissal. However, these dismissals tend to occur gradually, allowing the president to handle the situation without greater damage. Banking sector. The largest Brazilian private banks decided to allocate a larger portion of their billion-dollar profits to shareholders. That means two things – firstly, that banks do not have capitalization problems, but secondly, they still have little appetite to lend. In 2016, Itaú, Bradesco and Santander paid out more than half of their profits as dividends. Our Economic Forecasts GDP 2017: +0.5%: IPCA 2017: 4%. Unemployment: 13% (today at 12.6%). Selic rate at 8.5% Financial Markets: Equities (Ibovespa): NEUTRAL-POSITIVE. Target 66,423. Sell at 73,000. Government Bonds: POSITIVE. We fixed the 10Y Loc bond target at 9.75%. Our target for the 10Y USD denominated government bond remains stable at 5.25%. FX: NEUTRAL. Target at 3.2 (we do not rule out a rate below 3.00). Nominal BRL/USD FX rate has been appreciating in the last few months because (1) Brazil’s fundamentals have been improving both in terms of reforms and the economy. (2) Higher commodity prices have strengthened the terms of trade. (3) Interest rate spreads have been supportive. (4) A sharp cut in the current account deficit also helped move BRL.

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

Mexico:

APRIL 2017

Investors’ upgrade in EM has helped Mexico but we see little room for improvement Central Bank Banxico will announce a new hike in its monetary policy rate on March 29th. The analysts’ forecast are split between a 25bp or a 50bp rise. The most recent surveys show that analysts expect the central bank rate to close 2017 between 7 and 7.25 percent. It is currently at 6.25% Macro front & inflation. CPI keeps rising and is now at 4.86%, well above Banxico’s target of 3% (+/- 1%) due to the knock-on of the FX depreciation that became more evident during the first 15 days of the month. Monthly economic indicators came in above analysts’ forecasts in January Politics & NAFTA negotiations. No concrete information yet NAFTA’s renegotiation has started with a more active participation by Luis Videgaray, the new chancellor. It seems like Trump’s aggressive rhetoric against Mexico has diminished as the diplomatic team of both countries have started to work. While NAFTA has increased bilateral trade with the US by $380bn (from $106bn in 1994 to $482bn today and now accounts for 45% of GDP), we believe that the risk of a disruptive event in the negotiations is low. We would bet on a modernization and renegotiation of the current treaty rather than a break from it. Why? Of course the US has a dominant position in the negotiation. However, Mexico also has a lot to say and this balances their positions in terms of reaching an agreement that satisfies both parties. For example, excluding cars, it is Mexico that carries a trade deficit with the US. That is because the US exports a lot of agricultural products to Mexico -for example- specifically from the Midwest. This means that the US Midwest would be severely harmed if the US takes an aggressive stance resulting in a break from NAFTA, something to be seriously considered since this region is the heartland of Trump's electorate. Mexico has plenty of experience in trade negotiations, having been negotiating the TPP accords in the labor and environmental areas. Mexico also has trade agreements with 45 countries (more than the vast majority of countries), proof of its indisputable experience of negotiating trade deals. Mexico has stated that it is open to negotiating and modernizing NAFTA, but will strongly resist anything that means restrictions on free trade, such as the imposition of tariff barriers. The soft line: We guess that the bulk of the negotiations will refer to the “Rules of Origin”. These are a set of rules that determine if a product is eligible for free trade. One of the main rules is Value Added Content (or Regional Value Content), which in turn is divided into two groups: Product Specific or Wide Regime. The latter contains “De minimis” rules (that stipulate the maximum portion of external materials in one product) and the “Accumulation rule” (that allows imported products to be treated as if they were domestic). These rules are very flexible and the negotiation will probably come from this side. Public Finances The last report for 2016 showed that government efforts were insufficient to achieve a primary balance surplus. The Debt/GDP ratio reached 50.5% at its widest measurement, a level at which rating agencies consider it a reason to downgrade the sovereign note. Financial Markets: ¡NEW Equities (IPC): CAUTIOUS. We have raised the upper band of our trading range for the main Mexican index. The new range is 44,000 49,500, with a central fundamental price of 46,750 (from 46,267). The market could muddle through in the short term, until there is more clarity that NAFTA is not at risk. Recent investors’ upgrade in EM has helped Mexico’s equity market, currently at historical highs (49,250). The risks are clear: (1) Severe trade sanctions by the new U.S. administration, resulting in considerable disruption to NAFTA, featuring +30% tariffs that would lower Mexico’s share of the U.S. import market. (2) In addition, a similarly restrictive immigration policy with a negative toll on workers’ remittances. (3) Uncertainty about the 2018 presidential election related to the outcome of the State of Mexico governor election in June, which would potentially strengthen the position of the anti-reform candidate. Bonds: NEGATIVE. We expect that the M10-T10 spread could fluctuate around 475-525 bp so with a projected 2.75% rate for UST10, the mean expectation for the 10Y Mexican bond stays at around 7.75%. For the US denominated 10Y bond we are expecting a 150-200 spread against the US T-bond, which takes the bond rate to around 4.50%-5.0%. A rating downgrade by one notch is already priced into Mexican bonds. Current spread between M10 and T10 is at 5 year record (500 bp). Short term bond rates will keep rising, linked to US monetary policy normalization, but we don’t expect an up-sloped yield curve due to a low growth scenario. FX: NEGATIVE. Our y/e target remains unchanged at 21.

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

Argentina:

Technically speaking , Argentina has moved out of recession

APRIL 2017

On track to achieve 3% GDP growth (leveraged with deficit) Latest developments: Economy is finally showing signs of recovery as Q4 2016 confirmed Argentinean economy had 2 consecutive quarters of growth with inflation slowly easing. However, political stress is ramping up as wage negotiations with unions get harsher and mid-term elections (scheduled for October this year) get closer. Tax Amnesty: December 31st 2016 was the main deadline for this program. Results showed a big success with 98bn USD of assets declared by Argentineans (in a 530bn USD economy). 86% of these assets were declared but remain offshore , while 14% stayed locally. Next (and last) deadline is March 31st and estimates indicate that 20bn USD more could be declared. Previous government used monetary issuance to cover fiscal gap (which caused high inflation). After holdouts issue was resolved, current government changed the source of financing and tapped international debt markets to cover fiscal needs until they can implement reforms necessary to recover fiscal balance (gradualism). Two aspects are key for this plan: low leverage (Total Debt to GDP @53.8% and External Debt to GDP @31.7%) and government legitimacy that will be tested in mid-term elections this year. Macro: Economic activity: Argentinean economy grew 0.5% QoQ in Q4 2016. This figure marks the end of a recession that started in Q4 2015. As expected, GDP declined 2.3% in 2016 as a whole. Although public consumption was the main driver of GDP growth in Q3 2016, the external sector took the lead in Q4 with both imports and exports performing well. However, high frequency indicators are showing mixed signs with retail sales rising and industrial production indices falling. In this scenario our target remains at 3% GDP real growth for 2017. Fiscal: After last month’s cabinet reshuffle in which Nicolas Dujovne took over as Minister of Treasury, the government has confirmed the 2017 goal of a 4.2% primary deficit. However, next year’s targets were revised upwards from 1.8% to 3.2% in 2018 and 0.3% to 2.2% in 2019. They also introduced quarterly targets and will publish monthly information about the fiscal accounts. Although these changes are not good news as it delays fiscal consolidation, they are more reasonable considering the path of the adjustments made to date. Primary deficit for 2016 was 4.6% in line with the government’s target. Inflation: Official CPI accelerated in February to 2.5% (from 1.3% in January). However, the government’s target for this year remains in the 12-17 range after the central bank left the policy rate unchanged at 24.75% as inflation expectations increased following the last reading. Considering that this is an electoral year and the stickiness of core inflation, we think the target will not be met and expect inflation to close 2017 at 20%. Financial Markets: FX: ARS ended 2016 with depreciation of 23% for the year. Major USD inflows from debt issuance, the tax amnesty and better conditions for foreign investors to invest locally, made depreciation much lower than inflation. However, due to a slower rate of reduction in the policy rate coupled with better USD inflows (tax amnesty and debt issuances) and prospects of a record harvest expected, we are reducing our year-end exchange rate target for 2017 to 18 (from 18.5), which would represent 13% depreciation for the year). Fixed Income: Current 10Y Govt Bond in USD (Global 2026) is trading at 6.55% YTM. Considering the latest developments and the outlook for 10Y US Treasuries, we set our target for 2017 at 7.50%. Fixed Income strategy: Short term bonds continue to offer interesting spread despite the fact that their yield has come down considerably. These bonds will add very low volatility and very low repayment risk (Global 22/4/19 @3.1% YTM, Bs.As. Province 14/9/18 @ 3.03% YTM, Bs.As. Prov. 15/6/19 @ 3.73% YTM). Equities: There has been a strong recovery this year for Argentinean ADRs. Some equities still look cheap but will mostly depend on the success Macri achieves with his measures to reestablish macroequilibrium in Argentina. Examples of companies that could benefit from Macri’s policies are YPF, financials (BMA, BFR, GGAL) and utilities (PAM, EDN, TGS).

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Equity Markets GLOBAL EQUITY INDICES - FUNDAMENTAL ASSESSMENT Sales

Net

Andbank's

Sales

Andbank's

EPS

per Share

EPS

Margin Sales growth per Share Net Margin

EPS

Index

2016

2017

USA S&P 500

1.160

119,0

10,3%

10,0%

1.276

10,0%

295

20,4

6,9%

3,7%

306

7,6%

7.325

535,5

7,3%

4,0%

7.618

Mexico IPC GRAL

30.886

2.291,0

7,4%

7,0%

Brazil BOVESPA

51.104

3.900,0

7,6%

5,5%

Japan NIKKEI 225

19.494

995,7

5,1%

China SSE Comp.

2.501

212,7

8,5%

China Shenzhen Comp

821

67,5

8,2%

Hong Kong HANG SENG

12.170

1.807,0

India SENSEX

14.280

1.503,0

379

47,8

Europe STXE 600 Spain IBEX 35

MSCI EM ASIA (MXMS)

INDEX

2017

Growth PE ltm PE ltm CURRENT Fundam. E[Perf] to

2017

Revaloriz

Entry

Exit

Potencial

Fundam

Point

Exit point

2.233

-5,5%

2.009,7

2.456,3

349

-8,5%

313,9

383,7

10.463

9.801

-6,3%

8.820,5

10.780,6

21,19 20,00

48.542

46.756

-3,7%

43.997,7

49.515,0

16,66 16,00

64.984

66.423

2,2%

59.780,6

73.065,2

4,4%

19,01 17,90

18.932

18.599

-1,8%

17.668,7

19.528,6

1,1%

15,15 15,00

3.223

3.226

0,1%

2.903,7

3.548,9

2,8%

29,42 28,50

1.986

1.979

-0,4%

1.781,3

2.177,2

1.818

0,6%

13,38 12,50

24.178

22.720

-6,0%

20.447,9

24.991,9

1.664

10,7%

19,79 18,00

29.740

29.958

0,7%

26.962,2

32.953,8

7,4%

9,92

474

449

-5,3%

404,3

494,1

4,0% 0,7% 3,0% 2,0% 12,4% 3,1% 10,1% 9,6% 3,4% 10,8% 4,2%

2017

2016

2017

PRICE

Price

128

7,2%

19,85 17,50

2.363

13,8%

18,66 15,00

381

8,3%

632

18,1%

19,54 15,50

33.048

7,1%

2.338

2,0%

53.915

7,7%

4.151

6,4%

2,5%

19.981

5,2%

1.039

7,5%

2.689

8,0%

215

8,5%

890

7,8%

14,8%

3,0%

12.535

14,5%

10,5%

11,0%

15.851

10,5%

12,6%

7,5%

407

12,6%

8,75

ANDBANK ESTIMATES

RISK-OFF PROBABILITY: Short-term view Andbank's Global Equity Market Composite Indicator (Breakdown)

Buy signals Positive Bias Neutral Negative Bias Sell signals FINAL VALUATION

Current

Month

1 4 3 7 7 -3,4

1 3 7 3 8 -3,2

Andbank’s Global Equity Market Composite Indicator Preliminary assessment of the level of stress in markets

previous current

-5

-10 Market is Overbought

Area of Neutrality Sell bias

Buy bias

+10 Market is Oversold

Andbank GEM Composite Indictor: WE REMAIN IN AN AREA OF NEUTRALITY WITH A SELL BIAS. Our broad index has moved from a -3.4 level last month to -3.2 (in a -10/+10 range), settling in an area that suggests that the market is moderately overbought (although not significantly stressed). We therefore conclude that: a) The market is expensive although in terms of flows and managers’ positioning the movements have been gradual rather than violent. b) Admittedly, the likelihood of a sudden risk-off shift has been reduced after the slight correction seen in the S&P500 in March. There is still room for the market to go deeper into the “overbought” area. Positioning: Macro discretionary hedge funds (rolling equity beta to the S&P500) became rather cautious, reducing their risk appetite due to two reasons (FOMC meeting and Dutch election result). Once both risk events are no longer in place, it would be appropriate to monitor whether institutional investors change their minds about adding risk in the forthcoming weeks. Conversely, retail investors are calling the shots as they continued to deploy their excess cash levels in passive equity funds last month. JP Morgan’s option skew monitor on the S&P500 peaked after many months demanding more calls than puts. The Citi Macro Risk Index (a measure of risk aversion) suggests that investors are quite relaxed and risk aversion is not intense at all. Sentiment indicators: Investors continue to be complacent but the aforementioned events tempered the euphoric levels in equity market surveys. If this had not been the case, our broad index might have slipped into the clearly overbought area.

TECHNICAL ANALISYS: Trending scenario. Supports & Resistances o o o o o o o

S&P: SIDEWAYS-BULLISH. Supports 1&3 month at 2280/2245. Resistance 1&3 month at 2450 STOXX600: SIDEWAYS-BULLISH. Supports 1&3 month 359/351. Resistance 1&3 month at 387 IBEX: SIDEWAYS-BULLISH. Supports 1&3 month at 9623/9135. Resistance 1&3 month at 10476/10631 €/$: SIDEWAYS. Supports 1&3 month at 1.04/1.035. Resistance 1&3 month at 1.09 Oil: SIDEWAYS. Supports 1&3 month at 42.2. Resistance 1&3 month at 56.5 Gold: SIDEWAYS. Supports 1&3 month at 1180/1122. Resistance 1&3 months at 1303 US Treasury: SIDEWAYS-BEARISH. Supports 1&3 month at 2.33/2.11. Resist. 1&3 months at 2.65

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Fixed Income – Core Country Bonds: UST 10Y BOND: Floor 1.95%, Ceiling 3-3.25%. New Target 2.75% 1. Swap spread: Swap rate rose slightly in March to 2.35% (from 2.32% last month). The 10Y Treasury yield down-ticked to 2.40% (from 2.45%). The swap spread therefore rose to -5 bps (from -15bps last month). For this spread to normalize towards the +25bp area, with our CPI expectations (reflected in the swap rate) anchored in the 2.20% area, the 10Y UST yield would have to move towards 1.95%. 2. Slope: The slope of the US yield curve fell to 133bp (from 123bp). With the short end normalizing towards 1.25% (today at 1.28%), to reach the 10Y average slope (of 175bp), the 10Y UST yield could go to 3.0%. 3. Real yield: A good entry point in the 10Y UST could be when the real yield hits 1%. Given our CPI forecast of 22.25%, the UST yield would have to rise to 3-3.25% to become a “BUY”.

BUND 10Y BOND: Ceiling 0.90%. Fundamental target 0.70% 1. Swap Spread: Swap rates rose sharply to 0.81% (from 0.67% last month), while the Bund yield did its part, rising to 0.42% (from 0.26%). The swap spread therefore down-ticked to 39 bps (from 41bps). For the swap spread to normalize towards the 30-40bp area, with our CPI expectations (reflected in the swap rate) anchored in the 1.25% area, the Bund yield would have to move towards 0.90% (entry point). 2. Slope: The slope of the EUR curve fell to 114bps (from 118). If the short end “normalizes” in the -0.25% area (today at -0.72%), to reach the 10Y average slope (122bp), the Bund yield would have to go to 0.97%.

Fixed Income – Peripheral Bonds

(10Y yield targets)

Spain: 1.90% Italy: 2.30% Portugal: 3.30% Ireland: 1.40% Greece: 7.50%

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Fixed Income – EM Govies. Why so calm? The known negative factors: 1. A strong dollar has been synonymous with "bad news" for emerging markets in the past (think of 1997). 2. Higher interest rates/yields in the US did not help in the past (think of the Taper Tantrum of 2013). 3. The prospects for greater protectionism smell of something "toxic" to emerging mercantilist countries. The not-so-known positive factors: 1. After a prudent reconstruction, the majority of EMs now have better external balance situations (India, Brazil, etc.), which makes them less dependent on external financing in dollars. 2. In past episodes, emerging markets generally had overvalued currencies. Today however, most are undervalued (MEX, TRY, RUB...), which means that the risk of capital flight is lower. 3. If the EMs are now more synchronized with the developed economies, emerging assets should hold up well in a monetary tightening environment in the USA. Furthermore, a marginal tightening in EMs (caused by higher yields) may even be useful in containing any risk of overheating. 4. EM firms now increasingly rely on the debt market and less on their domestic financial systems. In 1997, bank loans in USD accounted for 65% of domestic debt in USD. Today, USD bank loans represents 54%. Therefore, banks in EMs are not so exposed to USD volatility.

Our Rule of Thumb: To date, our rule of thumb for EM bonds has been “buy” when the following two conditions are met: 1. The US Treasury bond is cheap or at fair value. 2. Real yields in EM bonds are 150bp above the real yield of the UST bond.

Do real yields in EM bonds provide sufficient spread? A good entry point in EM bonds has been when EM real yields are 150bp above the real yield of the UST, when this is at fair value. Hence, and assuming that the first condition is met, we should only buy those EM bonds with a real yield at 2.5% (See the bonds in green in the table).

CPI (y/y)

10 Year

Yield

Last

Yield

Govies

reading

Real

7,00% 6,68% 4,71% 3,25% 4,12% 2,61% 2,22% 2,08% 1,09%

3,83% 3,02% 3,30% 0,80% 3,21% 1,42% 0,52% 1,96% -0,03%

3,17%

-1,00%

3,66%

-1,00%

1,41%

-0,50%

2,45%

-0,75%

10,64% Russian Federation 7,89% 10,08% 7,01% 6,67% 6,16%

Indonesia India EM ASIA

Philippines China Malaysia Thailand Singapore South Korea

EME

Taiwan Turkey

Brazil LATAM

Is the UST cheap or at fair value? Historically, a good entry point in the 10Y UST has been when real yields are 1.75%. Given the “new normal” of ZIRPs, a good entry point in the 10Y UST bond could be when the real yield is 1%. Given our 2017 target for US CPI of 2-2.25%, a theoretical fair value (entry point) should be with nominal yields at 3-3.25%. Therefore the first condition is not met.

Projected change in Yield

10 Year

Mexico Colombia Peru

0,90%

0,00%

1,19%

-0,50%

1,70%

-0,50%

0,12%

0,00%

1,12%

-0,50%

10,13% 4,60%

0,51%

0,00%

3,29%

-1,00%

4,69% 4,89% 5,20% 3,27%

5,39%

-1,00%

2,12%

-0,75%

1,47%

-0,50%

2,89%

-0,75%

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Commodities – Energy (Oil, WTI) Fundamental target at $45. Buy at $30. Sell at $55. Short term drivers for oil prices point to flat/lower prices. (-) Hedge funds have trimmed their bullish position in crude oil by the largest amount since OPEC announced its output cut in November. Hedge funds cut their combined net long position by a cumulative total of 230M barrels in the last 3 weeks from a peak of 951M. Even after the reduction, the overall long position was still among the highest ever. (-) Surprising cut in Saudi oil price: Saudi Arabia cut the price of some of its April oil sales to Asia, trying to lure buyers towards its lighter and less sulfurous crude at a time when others are rushing to the region from the Americas and Africa. (-) Pioneer sees oil at $40 if OPEC fails to expand cuts (chairman of Pioneer Natural Resources). He said US shale producers are keeping an eye on H2 to see if OPEC and non-OPEC members extend their agreement, which lasts through June. “Production in the Permian basin could surge to 8-10M bpd over the next decade from 2.3M now”. (-) Lack of compliance by some nations is causing friction within the oil producers group: While Saudi Arabia has cut more than planned, Russia has only fulfilled about a third of its commitment. (=) Sources within OPEC increasingly favor extending its output-cut agreement past its June deadline. Russia and other non-OPEC members will need to remain part of the initiative. Russia (which is the largest of the 11 outside producers working with OPEC) has not publicly said whether it supports extending the supply cut. (-) Iran crude oil exports hit 3M bpd in the last month. They have more than doubled since sanctions ended. (-) Libya’s ports prepare to resume crude shipments: Libya's major oil ports of Es Sider and Ras Lanuf are resuming operations and preparing to export crude after a two-week halt in shipments due to military clashes. Output reached about 700K bpd in February before the clashes, from about 260K in August last year. (+/-) Most offshore oil explorers are in "wait and see" mode, waiting for clearer price signals before committing to new projects. This is creating an uncertain outlook for companies that rely on offshore drilling. Shell makes big bet on deep-water drilling: Royal Dutch Shell is trying to reinvent the deep-water drilling business by trying to prove it can take highly efficient technology and processes and deploy them in deep-sea production. It wants to make new deep-water projects cheaper and faster, especially in Brazil. (-) Rising exports make the US a factor in the global market: Outbound oil shipments surpassed 1.2M bpd (vs 500k until recently) since the lifting of the export ban in 2015, and filling the gap in world markets created by OPEC cutbacks. The US has become more integrated into the world oil market and may now have some authority as a swing producer. Structural drivers for oil point to low prices in the long run... (+) IEA sees oil investment revival but also stronger rise in demand: The agency doubled forecasts for production growth outside OPEC next year as US shale producers emerge "leaner and fitter" from the downturn. It forecasts non-OPEC supply will expand by 3.3M bpd in the period from 2016 to 2022. In the meantime, the IEA considers that global oil consumption will keep growing for the foreseeable future despite tougher legislation. The agency's new forecast is for oil demand to expand by 7.4M bpd (from 96.6M bpd to 104M bpd) in the period from 2016 to 2022, leaving OPEC members with a theoretical capacity to increase output by 4.1M bpd simply to adjust to the new demand. (-) Alternative energies picking up the baton: Producers must bear in mind that the value of their reserves is no longer dictated by the price of oil and the quantity of their reserves, but rather by the amount of time for which they can pump before alternative energies render oil obsolete. In order to delay this deadline as long as possible, it is in producers’ interests to keep the oil price low as long as possible (keeping the opportunity cost of alternative energy sources as high as possible). (-) Growing environmental problems will gradually tighten legislation and production levels: Producers are aware that the value of their reserves depends on the amount of time they can pump at current levels before tougher environmentinspired regulation comes in. For example, Saudi Arabia has between 60 to 70 years of proven oil reserves at current output, but with mounting concern about climate change and growing environmental problems that will likely continue to put big pressure on the market for fossil fuels over the coming decades, Riyadh’s most serious risk is of sitting on a big chunk of “stranded reserves” that it can no longer extract and sell. Saudi Arabia (and the other producers) therefore has a powerful incentive to monetize as much of its reserves as soon as possible by pumping as much oil as it can (if only to fund the construction of a less oil-dependent economy). (-) The re-entry of Iran is a game changer equivalent to a structural change in the global energy market. Iran insists that it must be allowed to step up its output from 3.6m to 4m bbl/day. This would imply that Saudi Arabia (the world’s largest producer) would have to take the most, if not all, of the proposed cuts in its own output, but this is somewhat incompatible with the condition imposed by the Saudis of not losing market share under the agreement. (-) OPEC’s producers are no longer able to fix prices: There are good reasons to believe that any deal reached from now on involving the freezing of production would prove ineffective. Back in the 1970s or the early 2000s, the exporters’ cartel agreed to cut output and the approach worked well since it was easy to defend market share as the principal competition was among oil producers (in particular between Opec and non-Opec producers). That is not the case today. Today’s biggest threat to any conventional oil producer comes from non-conventional producers and alternative energy sources. Energy cut from conventional oil will easily be offset by a quick increase in shale oil production, which means that Opec producers are no longer able to fix prices. (-) Global imbalance of supply over demand runs at 1mn bbl/day: Even if the proposed output cuts are confirmed, this deal will not be a game-changer for the international oil market. The global oil market’s imbalance of supply over demand continues to run at 1m bbl/day according to Opec itself. Opec’s proposed production cut will therefore be insufficient to reverse the oil glut. (-) Shale producers to raise output heavily at $60 in oil price: The IEA said that an oil price of $60 would be enough for many US shale companies to restart stalled production.

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Commodities â&#x20AC;&#x201C; Precious (Gold) Fundamental price US$ 1,050/oz. Buy at US$ 900/oz. Sell above US$1,200. Negative drivers: 1. Gold in real terms. In real terms, the gold price (calculated as the current nominal price of 1255, divided by the US Implicit Price Deflator-Domestic, as a proxy for the global deflator, and currently at 1.1233) rose to $1,117 (from $1090 last month). Nevertheless, in real terms gold continues to trade well above its 20-year average of $786. Given the global deflator (now at 1.1233), for the gold price to stay near its historical average in real terms, the nominal price (or equilibrium price) must remain near US$883. 2. Gold in terms of Silver (Preference for Store of Value over Productive Assets): This ratio has ticked up to 68.97x (from 68.12x last month) and remains well above both its 20-year average of 61.15, suggesting that Gold is expensive (in terms of silver). For this ratio to reach its long term average level, assuming that silver is well priced, then the Gold price should go to $1,113 oz. 3. Gold in terms of Oil (Gold / Oil): This ratio rose to 25.96x (from 23.27x last month) and still remains well above its 20-year average of 14.66. Considering our fundamental long-term target for oil of US$45pbl (our central target), the price of gold must approach US$660 for this ratio to remain near its LT average level. 4. Gold in terms of the DJI (Dow Jones / Gold): This ratio has moved to 16.49x (from 16.56x last month), still below its LT average of 20.33x. Given our target price for the DJI of $20,000, the price of gold must approach US$984 for this ratio to remain near its LT average. 5. Gold in terms of the S&P (Gold / S&P500 index): This ratio has remained stable at 0.532x (from 0.533x last month), but is still above its LT average of 0.5825x. Given our target price for the S&P of $2,233 the price of gold must approach US$1,300 for this ratio to remain near its LT average. 6. Speculative Positioning: CFTC - CEI 100oz Active Future non-commercial contracts: longs remained stable at 219.7k (from 219.6k). Shorts rose to 103.46k (from 95.9k) => Thus, the net position decreased to +116k (from +123k). Speculators still remain long in gold, although less intensively. 7. Financial liberalization in China. Higher â&#x20AC;&#x153;quotasâ&#x20AC;? each month in the QFII are widening the investment alternatives for Chinese investors (historically focused on gold). 8. Central bank gold buying. Gold stocks at central banks are still considerably higher than 2008 levels. Positive drivers: 1. Negative yields still make gold attractive. The disadvantage of gold relative to fixed income instruments (gold does not offer a coupon) is now neutralized, with negative yields in a large number of global bonds, although the importance of this factor is diminishing as yields continue to rise. 2. Relative size of gold: The total value of gold in the world is circa US$6.9tn, a fairly small percentage (3.2%) of the total size of the financial cash markets (212tn). The daily volume traded on the LBMA and other gold marketplaces is around US$173bn (just 0.08% of the total in the financial markets).

GOLD SPECULATIVE POSITIONS

Long Futures Net Futures

Short Futures 16

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Currencies – Fundamental Targets Slight increase this month in investors’ global USD positioning (from US$+14.6bn to US$+18bn today). Despite this recent uptick, positioning in the US dollar still remains far below the US$+28.7bn seen in September 2016, although admittedly it is now in the upper half of the range seen in the last 3-Year Z-score (see the chart). Under this approach, there is still room to build new long positions in the US dollar, although we guess that this will depend on favorable outcomes coming from the US Congress and Senate in the form of the planned bills to be passed. In the absence of these supportive factors, the USD outlook against other currencies would still be neutral.

•

EUR/USD: Fundamental Target (1.00)

In the aftermath of the first French presidential debate, the EUR had a few days of respite, with net short spec positioning in EUR being aggressively trimmed (from US$ -7.67bn to US$ -2.66bn), or cut by 0.5 s.d. (basis of the 3Y Z-score) with respect to last month’s positioning. EUR shorts are now the lowest in nearly 3 years (or the positioning in Euros is now the longest seen in the last three years), reflecting the improvement in the data in Europe. Any further appreciation will set new positioning records in Euros. Given our doubts about the sustainability of the economic jump (considering that the vast fiscal and monetary stimuli in China, which have caused most of the “reflation trade”, have been gradually withdrawn since last summer), if investors’ structural pattern continues and they decide to hold the average exposure of the last three years, the stage is set for further structural falls in the Euro from this level. Our Fundamental Value for EUR/USD remains unchanged at 1.00. Known positives for USD: (1) Rising positive carry on US dollar debt instruments. (2) The Fed has a tightening bias, while most other central banks still have easing bias. (3) Continued improvement in the US trade balance through greater domestic energy production. (4) US$10trn of unfunded positions leveraged with USD. Now that other currencies are signaling their easing stance more clearly, many of these leveraged positions could change their funding currency (asking for € or ¥ loans and buying back $ to repay the loans). Known negatives for USD include: (1) The US president is a clear mercantilist and mercantilists tend to dislike strong currencies. Trump’s desire to relaunch manufacturing in the US cannot happen without a weaker dollar. (2) The US dollar is increasingly overvalued on a PPP against many currencies. (3) Almost everyone remains bullish on the US dollar.

• • • • • • • • • •

7,0

JPY= Target (112); EUR/JPY: Target (112). Still very stressed shorts in JPY’s Z-score. GBP= Target (0.83); EUR/GBP: Target (0.83). Trump trade vs Brexit uncertainty. CHF= Target (0.95); EUR/CHF: Target (0.95). Net shorts, room for longer positions in CHF. MXN= Target (21); EUR/MXN: Target (21) BRL= Target (3.20); EUR/BRL: Target (3.20) ARS= Target (18.5); EUR/ARS: Target (18.5) Mkt Value of Change vs Current RUB: NEUTRAL Ne t positions last we ek Z-score AUD: NEUTRAL-POSITIVE in the curre ncy in the curre ncy 1-yr Max 1-yr Min 1-yr Avg Z-score CAD: NEUTRAL-NEGATIVE Curre ncy (Bn $) (Bn $) (Bn $) (Bn $) (Bn $) 3-yr CNY: Target (6.75-6.80)

Max Min Current

USD vs All USD vs G10 EM EUR JPY GBP CHF BRL MXN RUB AUD CAD

18,09 19,33 1,24 -2,66 -7,50 -8,41 -1,51 0,52 -0,09 0,81 3,46 -1,83

SPECULATIVE POSITION IN THE FX MARKETS (3Yr - Z SCORES. Max, Min & Current in 1Yr)

1,21 1,35 0,14 2,78 0,27 -0,27 -0,39 0,02 0,05 0,07 0,19 -3,42

28,7 28,4 1,2 -2,7 8,6 -3,0 1,4 0,8 -0,1 1,3 4,6 2,3

-6,9 -7,1 -1,7 -19,0 -9,3 -8,4 -3,1 0,0 -2,3 0,1 -1,2 -1,8

-0,25 -0,18 1,07 1,42 -0,68 -1,88 -0,68 0,83 0,49 1,97 1,36 -0,40

12,1 11,7 -0,4 -9,8 1,9 -5,5 -0,5 0,4 -1,3 0,5 1,8 0,5

ANDBANK

3-year Z-Score:

5,0

Current Position - 3 year average position 3-year Standard Deviation

3,0

1,0

Values above +1 suggest positioning may be overbought

-1,0

-3,0

ANDBANK -5,0 USD vs All

USD vs G10

EM vs USD

EUR vs USD

JPY vs USD

GBP vs USD

CHF vs USD

BRL vs USD

MXN vs USD

RUB vs USD

AUD vs USD

CAD vs USD

Values below -1 suggest positioning may be oversold

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Market Outlook â&#x20AC;&#x201C; Fundamental Expected Performance

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Monthly Global Asset & Currency Allocation Proposal

This recommended asset allocation table has been prepared by the Asset Allocation Committee (AAC), made up of the managers of the portfolio management departments and the product managers in each of the jurisdictions in which we operate. Likewise, the distribution of assets within each customer profile reflects the risk control requirements established by regulations.

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

Principal Contributors

Alex Fusté – Chief Global Economist – Asia & Commodities: Equity, Rates, FX +376 881 248 Giuseppe Mazzeo – CIO Andbank USA – U.S. Rates & Equity. +1 786 471 2426 Eduardo Anton – Portf. Manager USA – Credit & Quasi governments. +1 305 702 0601 J.A Cerdan – Equity Strategist Europe – European Equity. +376 874 363 Renzo Nuzzachi, CFA – Product Manager LatAm – Rates & FX. +5982-626-2333 Jonathan Zuloaga – Analyst, Mexico – Macro, bonds & FX. +52 55 53772810 Albert Garrido – Portfolio Manager Andorra – European Equity. +376 874 363 Luis Pinho – CIO Andbank LLA Brazil – Bonds, FX & Equity Brazil. Andrés Davila – Head of Asset Management Panama – Venezuela. +507 2975800 Marian Fernández – Product Manager, Europe – Macro, ECB & Gov. bonds. +34 639 30 43 61 David Tomas – Wealth Management, Spain – Spanish Equity. +34 647 44 10 07 Andrés Pomar – Portf Manager Luxembourg – Volatility & ST Risk Assessment +352 26193925 Carlos Hernández – Product Manager – Technical Analysis. +376 873 381 Alejandro Sabariego – Portfolio Manager Luxembourg – Flow & Positioning. +352 26 19 39 25 Alicia Arriero – Portfolio Manager Spain– European Banks. Credit HG & HY. +34 91 153 41 17

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

APRIL 2017

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APRIL 2017