Release of our 2014 global strategy outlook and 5th edition of our 10 Themes List.

Transcription

1 Portfolio Strategy Comment Tuesday, December 3, 2013, Pre-Market 1 Portfolio Strategy 10 Themes for 2014 Vincent Delisle, CFA - (514) (Scotia Capital Inc. - Canada) vincent.delisle@scotiabank.com Hugo Ste-Marie, CFA - (514) (Scotia Capital Inc. - Canada) hugo.ste-marie@scotiabank.com Event Release of our 2014 global strategy outlook and 5th edition of our 10 Themes List. ScotiaView Analyst Link Implications Accelerating world GDP growth and Fed tapering should drive portfolio returns in We expect (1) improving economic news flow to bolster sentiment and equity flows; (2) the upward normalization in bond yields to continue; (3) monetary divergence to drive country/asset leadership; and (4) asset correlations to mean-revert lower. Recommendation We see U.S. 10-Yr yields heading towards 3.5% with a stronger greenback (C$ near US$0.90). Targets are set at 1,950 (S&P 500) and 14,200 (TSX). We expect equities to outperform bonds by high single digit margin. Global leadership should stay with DM. TSX Strategy. Financials, Discretionary, Technology, and Industrials would be the focus. We reiterate our cautious stance in resources and our preference goes to Energy Services, Chemicals, and Forest Products. S&P 500. Financials, Technology, and Industrials should extend their leadership in the first half of the year. Global Portfolio Strategy Outlook 2014 The 2014 Game Plan As we table our 2014 investment strategy outlook, we believe that most of the themes that helped investors outperform in recent years (Equity OW since 2009; DM over EM and UW Resources since 2011) will play out in the early part of However, considering how overextended some of these trades have become, our focus in coming months will be to identify potential shifts that could trigger a leadership change. For now, our macro thesis and our tactical indicators point to extending the 2013 game plan into Still, asset mix is a dynamic process and investors should be on the look-out for reversals once Fed tapering goes from fear to reality. The Macro View for 2014 World GDP growth picking up and the global economy is entering 2014 with positive momentum and most regions contributing. The last 2 years have been dominated by U.S. macro outperformance (Eurozone recession; China slowdown), but recent signals from the Eurozone and China have been encouraging. Moreover, momentum in the U.K. and Japan is robust. Although the pace of the housing recovery could moderate, the U.S. economy should benefit from sustained employment gains, growing energy benefits, and lower fiscal drag. Broader global growth will help Canada, but GDP growth should lag the U.S. for the third consecutive year. Scotia Economics expects world GDP growth to accelerate to 3.5% in 2014 and 3.6% in 2015 (3.2% in 2012 and 2.9% in 2013). For Reg AC Certification and important disclosures see Appendix A of this report. Analysts employed by non-u.s. affiliates are not registered/qualified as research analysts with FINRA in the U.S.

2 2 An imminent shift in Federal Reserve (Fed) policy should remain an underpinning of market psychology in 2014, especially in the first half. The start of Fed tapering could trigger volatility as investors let go of infinite easing scenarios. Late 2013 euphoria places the S&P 500 at risk of policy disappointment, but we believe any weakness should be moderate and short-lived since Fed policy is set to remain accommodative. With deflation the main threat in the Eurozone and Japan, the European Central Bank (ECB) and the Bank of Japan (BoJ) should be the most accommodative central banks in 2014, which could lead to further US$ gains. Negligible inflation should provide the Bank of Canada (BoC) ample time to monitor what the Fed does and we expect a dovish BoC in The C$ could revisit US$0.90 in coming months. The shift in Fed policy threatens developing countries with high inflation and current account deficits. India and Brazil are already struggling with domestic challenges. Accelerating world GDP growth could better support commodity sentiment in 2014, but supply issues (WTI, Potash, copper), policy challenges (Fed tapering; stronger US$), and moderate China GDP growth will remain challenging. Moderating geopolitical risks in the Middle East could also narrow the Brent-WTI premium and weigh on the oil complex. The CRB index declined 6.8% in 2013 and Scotia Economics commodity price forecasts point to further weakness in energy, copper, and gold in From an investment strategy standpoint, the key takeaways are as follows: (1) economic news flow should improve in 2014, thus supporting positive equity investor sentiment and equity flows; (2) the upward normalization in bond yields should continue as plans to lower the magnitude of monetary easing are priced in; (3) inflation and monetary divergence could once again play an important role in country/asset leadership; and (4) asset correlations should mean-revert lower. Yields, Earnings, and Targets Normalizing U.S. monetary policy and the return of growth in the Eurozone should translate into a higher trading range for long term bond yields. U.S. 10-Yr yields traded mostly under 2% through mid-2011/mid-2013, but the pattern has evolved in the latter part of The new range could be 2.5%-3.5% in We would position portfolios for rising yields and we expect slopes to steepen in Short-term CDA-US yield differentials should narrow and corporate credit spreads are likely to remain tight as earnings growth picks-up. We expect bond returns of 0% (corporate) to -2% (government) in 2014 and reiterate our Bond underweight recommendation. We expect positive and broader earnings growth in MSCI AC World earnings peaked in 2011 and have rebounded a modest 2.5% in 2013, mainly on U.S. earnings strength. S&P 500 trailing EPS is up 6.1% in 2013 versus +0.2% for the TSX and -8.3% for the MSCI LatAm. S&P 500 profits earned abroad are slated to recover in 2014 with domestic earnings growth extending into its sixth year. TSX earnings estimates bottomed last summer, and a positive, yet fragile trend has emerged in H2/13. A lower C$ should help, but visible upside to TSX earnings could be limited by a challenging commodity price deck. Earnings & Targets. Our 2014 EPS estimates are set at US$117 for the S&P 500 and C$900 for the TSX. We are introducing our 2015 forecasts of US$125 for the S&P 500 and C$950 for the TSX. Our 2014 price targets are 1,950 for the S&P 500 (15.6X on 2015 EPS forecast) and 14,200 (14.9X on 2015 EPS forecast). For LatAm, our 2014 targets are set at 56,000 (Bovespa), 45,000 (Bolsa), and 4,100 (Ipsa). In local currency terms, we expect equity returns of 6%-9% in 2014 and do not foresee such extreme divergence as witnessed in However, the S&P 500 should retain leadership within the Americas in US$ terms.

3 3 Exhibit 1 - Scotiabank Strategy Forecasts Forecasts E 2014E 2015E Equity S&P/TSX 11,955 12,434 13,400 14,200 EPS S&P 500 1,258 1,426 1,800 1,950 EPS Mexico Bolsa 37,078 43,706 42,200 45,000 Brazil Bovespa 56,754 60,952 51,300 56,000 Chile IPSA 4,178 4,301 3,760 4,100 Interest Rates BoC 1.00% 1.00% 1.00% 1.00% 1.25% CA 10-Yr 1.94% 1.80% 2.45% 3.15% 3.95% Fed Funds 0.25% 0.25% 0.25% 0.25% 0.50% US 10-Yr 1.88% 1.76% 2.55% 3.40% 4.20% Mexico Overnight 4.50% 4.50% 3.50% 4.00% 5.00% Selic Rate 11.00% 7.25% 10.00% 10.75% 11.50% Currencies & Commodities (Yearly Average) CAD-USD EUR-USD USD-YEN USD-MXN USD-BRL WTI Natural Gas Copper Gold 1,573 1,669 1,410 1,270 1,375 GDP U.S. 1.8% 2.8% 1.6% 2.5% 3.0% Canada 2.5% 2.8% 1.7% 2.2% 2.5% China 9.3% 2.8% 7.7% 7.3% 7.0% Mexico 4.0% 2.8% 1.3% 3.3% 3.7% Brazil 2.7% 2.8% 2.3% 2.8% 3.4% Chile 5.8% 2.8% 4.4% 4.4% 4.7% Colombia 6.6% 2.8% 4.2% 4.8% 4.5% Peru 6.9% 6.3% 5.1% 5.4% 5.6% Source: Scotiabank GBM Portfolio Strategy & Scotia Economics estimates, Bloomberg, CPMS, S&P.

4 4 Asset Mix & Equity Strategy We expect equities to outperform bonds in 2014 and global equity leadership should stay with developed markets (DM), especially in the first half of the year as investors digest consecutive rounds of Fed tapering. The DM group is still carrying relative advantages on earnings revisions and monetary policy, but valuations favor emerging markets (EM P/E discount versus DM stands at 28%; widest discount since 2005). Within DM, we would favor EAFE over the S&P 500 and would position Canada as market weight (MW). Emerging markets have been struggling since mid-2011 and the MSCI EM has underperformed the MSCI DM by 25% in As we table our year ahead forecasts, we will be looking for a potential reversal favoring EM next year, but for now, we reiterate our EM UW call. China and South Korea appear better positioned, and our LatAm rank order would be Brazil, Chile, Mexico, Colombia, and Peru. Our sector bias entering 2014 remains predicated on a cyclicals over interest sensitive bias. Financials, Discretionary, Technology, and Industrials would be the focus on the TSX. Our cautious stance in resources is extended to the start of 2014 and our preference goes to Energy Services, Chemicals, and Forest Products. In the U.S., we believe Large Caps will outperform in 2014 with Financials, Technology, and Industrials extending their leadership in the first half of the year. Exhibit 2 - Scotiabank GBM Recommended Asset Mix December 2013 Asset Mix Benchmark Recommended Equities 60% 63% Canada (TSX) 5% 5% U.S. (S&P 500) 22% 24% MSCI EAFE 18% 22% (1. Europe, 2. Japan, 3. Australia) Far East ex-japan 10% 9% LatAm 5% 3% Change From Last Bonds 40% 32% Government 30% 18% Corporate 10% 14% Cash (91-D Tbills) 0% 5% Source: Scotiabank GBM Portfolio Strategy estimate. Exhibit 3 - TSX Sector Strategy December 2013 Exhibit 4 U.S. Sector Strategy- December 2013 As at Nov. 29, 2013 SQoRE Sector Recommendation SQoRE Sector Recommendation Energy Large UW Discretionary Large OW Services Small OW Staples Small OW Integrated Small UW Health Care Small OW E&P Large UW Financials Small OW Pipelines Large UW Banks Large OW Materials Small UW Div. Financials Small UW Chemicals Small OW Insurance Large OW Metals & Mining Small UW REITs Small OW Precious Metals Large UW Technology Large OW Paper & Forest Large OW Telecoms Small OW Industrials Neutral Utilities Small UW Capital Goods Transportation Small UW Small OW Financials Health Care Technology Industrials Discretionary Materials Staples Energy Telecom Underweight -0.5% -1.0% -1.0% -1.0% 0.0% Overweight 1.0% 1.0% 1.0% 2.0% Utilities -1.5% Source: Scotiabank GBM Portfolio Strategy estimate. -2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% Source: Scotiabank GBM Portfolio Strategy estimate.

5 10 Themes for Stick With Equities in 2014, but Curb Your Enthusiasm. Although the S&P 500 is overbought and Fed tapering could eventually spoil sentiment, we believe equities appear best positioned to outperform in To be sure, positive equity drivers remain in place: jobless claims are low and declining, monetary policy remains accommodative (even with tapering), and yield curves are steepening. Moreover, the other competing asset class (bonds) is more vulnerable to the shifting macro environment and funds flow. Still, equity return expectations for the upcoming year should be more modest as P/E expansion moderates. Investors should view equity pullbacks as buying opportunities. 2. Fed Will Taper and Stay Dovish. Markets have been driven by U.S. monetary policy scenarios in H2/13 and the Fed is not about to win any communications award. While Yellen and Bernanke talk about the need to extend accommodative policy, other Fed members point to tapering being on the table. So which is it? Dovish, tapering, more easing? In our opinion, the disconnect lies between what dovish may really mean to the Fed. Dovish may not exclude tapering, but rather highlight that the Fed will remain cautious by reducing asset purchase gradually and wait before raising the benchmark rate. Separating the initial tapering from fully eliminating QE and/or raising rates could drive the Fed s communication strategy in Bonds and commodities appear set for a shift in Fed policy: 10-Yr Yields are up 30 bp from their early October lows of 2.50% and gold is slipping. Late 2013 S&P 500 euphoria appears at risk of policy disappointment, but any weakness should be moderate since Fed policy is set to remain accommodative for a long time. 3. Play the Wedge in Policy. Monetary divergence between developed markets (DM easing) and emerging markets (EM mostly hawkish) played a key role in global equity leadership in 2013, and we expect the same dynamics to play out in The Fed and the Bank of England (BoE) could be the first developed central banks to unwind aggressive easing policies, while the ECB and the BoJ should be the most accommodative central banks in 2014, which could lead to US$ gains. Negligible inflation should provide the Bank of Canada (BoC) ample time to monitor what the Fed does and we expect a dovish BoC in The shift in U.S. monetary policy threatens developing countries with high inflation and current account deficits. 4. The Revenge of Main Street. The good news entering 2014 is that the global economy and corporate profits appear headed for their best year since Unemployment rates should improve in Europe while U.S. monthly payroll gains should accelerate. As the pace of macro good news picks up, however, financial markets will have to deal with reduced easing in the U.S. (higher yields), and the run-up in valuations could moderate. Since 2009, Wall Street (all-time highs on S&P 500) has materially outpaced Main Street (consumer confidence still 24% below 47-yr average) could mark a reversal favoring Main Street. 5. Bubble Talk Is Premature. Amidst the emerging bubble talk, the level of equity bullishness has indeed recovered sharply since 2011, but we are not seeing exuberant levels of sentiment. Valuations are telling a similar story. P/E multiples have expanded since 2009, but current levels are not overly expensive. Admittedly, global equities bottomed five years ago and the S&P 500 is trading at all-time highs. Hence, expectations for the year ahead should reflect this situation. 6. Cyclical & Growth Bias for 2014, Interest Sensitives to Lag. Recovering global manufacturing momentum and Fed tapering talk have pushed both bond yields and the US$ higher since May, sending cyclicals and interest sensitive sectors in opposite directions. On both sides of the border, Utilities, Telecoms, Real Estate, and Pipelines broadly underperformed Financials, Industrials, and Discretionary in the last seven months. Moreover, our SQoRE S&P Growth list beat our SQoRE S&P Value list by over 200bp in 2013 with most of the outperformance coming after the May bond yield wake-up call. We expect this trend to continue in Asset/sector correlations should mean-revert lower and we expect a widening performance gap linked to the shift in Fed policy. 7. Rising TSX Earnings and Falling Loonie. TSX earnings growth fell short of expectations for a second year in a row in 2013 as commodity prices weakened. Despite muted 2014 commodity price forecasts, we believe TSX 2014 EPS could move up. In our view, increased production in energy (+9.1% MBOE per day/share in 2014) and mining could offset a weak pricing environment. Moreover, C$ weakness could provide earnings support later in the year. We are forecasting TSX EPS of C$900 in 2014, up C$833 from 2013, which would mark the first calendar year improvement in earnings since

6 8. Lower Energy Costs to offset Higher Yields. Oil prices have retreated 16% since early September, taking U.S. gasoline prices down to their lowest levels since early Still, Brent remains high and the premium over WTI could mean-revert lower in coming months under a definitive deal with Iran. Declining energy costs would be welcomed news for the world economy in 2014 and could offset the strains of rising bond yields. Energy expenditures represented 9% of the U.S. GDP in 2011 and are set to decline to 8.4% in 2013 and 7.9% in 2014 (43-year average of 8.6%). The ongoing U.S. Energy revolution (higher production, low natural gas) could step into overdrive next year should moderating geopolitical issues relieve consumers at the pump. 9. Look Who s Back: Retail Equity Flows Form Strong Tailwind. Among the biggest 2013 surprises was the long awaited return of U.S. retail investors into equities after an uninterrupted exodus from 2007 to According to the Investment Company Institute (ICI), equity mutual funds have recorded inflows total US$174B since the start of 2013, and the industry is set to surpass its average. In contrast, bond mutual fund redemptions have intensified (US$55B YTD) as rising yields inflicted rare losses to fixed income investments. Positive equity inflows should act as tailwind for equities in 2014 and could push valuations higher could also provide for another surprise if institutional investors follow suite. Years of underperformance by private equity, hedge funds, and other alternative investments could make many players reconsider their decade-low public equities positions. 10. U.S. Large Caps > Small Caps. U.S. small caps outperformed large caps by 11% in 2013, but we expect Large Caps to lead next year. Small caps are trading at loftier multiples (20x forward earnings) and the premium over Large Caps stands at the very high-end of the 25-year range. Moreover, we expect companies generating a larger portion of their revenues/earnings abroad to benefit the most from broadening world GDP growth. Historically, a faster pick-up in earnings generated abroad has supported U.S. large cap leadership. 6

7 7 Appendix A: Important Disclosures Company Ticker Disclosures (see legend below)* The following analysts certify that (1) the views expressed in this report in connection with securities or issuers they analyze accurately reflect their personal views and (2) no part of their compensation was, is, or will be directly or indirectly, related to the specific recommendations or views expressed by them in this report Vincent Delisle, and Hugo Ste-Marie This research report was prepared by employees of Scotia Capital Inc. and/or its affiliates who have the title of Analyst. All pricing of securities in reports is based on the closing price of the securities principal marketplace on the night before the publication date, unless otherwise explicitly stated. All Equity Research Analysts report to the Head of Equity Research. The Head of Equity Research reports to the Managing Director, Head of Institutional Equity Sales, Trading and Research, who is not and does not report to the Head of the Investment Banking Department. Scotiabank, Global Banking and Markets has policies that are reasonably designed to prevent or control the sharing of material non-public information across internal information barriers, such as between Investment Banking and Research. The compensation of the research analyst who prepared this report is based on several factors, including but not limited to, the overall profitability of Scotiabank, Global Banking and Markets and the revenues generated from its various departments, including investment banking. Furthermore, the research analyst s compensation is charged as an expense to various Scotiabank, Global Banking and Markets departments, including investment banking. Research Analysts may not receive compensation from the companies they cover Non-U.S. analysts may not be associated persons of Scotia Capital (USA) Inc. and therefore may not be subject to FINRA Rule 2711 restrictions on communications with subject company, public appearances and trading securities held by the analysts. For Scotiabank, Global Banking and Markets Research analyst standards and disclosure policies, please visit gbm.scotiabank.com/disclosures. Scotiabank, Global Banking and Markets Research, 40 King Street West, 33rd Floor, Toronto, Ontario, M5H 1H1. * Legend

8 8 Definition of Scotiabank, Global Banking and Markets Equity Research Ratings & Risk Rankings We have a four-tiered rating system, with ratings of Focus Stock, Sector Outperform, Sector Perform, and Sector Underperform. Each analyst assigns a rating that is relative to his or her coverage universe or an index identified by the analyst that includes, but is not limited to, stocks covered by the analyst. Our risk ranking system provides transparency as to the underlying financial and operational risk of each stock covered. Statistical and judgmental factors considered are: historical financial results, share price volatility, liquidity of the shares, credit ratings, analyst forecasts, consistency and predictability of earnings, EPS growth, dividends, cash flow from operations, and strength of balance sheet. The Director of Research and the Supervisory Analyst jointly make the final determination of all risk rankings. The rating assigned to each security covered in this report is based on the Scotiabank, Global Banking and Markets research analyst s 12-month view on the security. Analysts may sometimes express to traders, salespeople and certain clients their shorter-term views on these securities that differ from their 12-month view due to several factors, including but not limited to the inherent volatility of the marketplace. Ratings Risk Rankings Focus Stock (FS) The stock represents an analyst s best idea(s); stocks in this category are expected to significantly outperform the average 12-month total return of the analyst s coverage universe or an index identified by the analyst that includes, but is not limited to, stocks covered by the analyst. Sector Outperform (SO) The stock is expected to outperform the average 12-month total return of the analyst s coverage universe or an index identified by the analyst that includes, but is not limited to, stocks covered by the analyst. Sector Perform (SP) The stock is expected to perform approximately in line with the average 12- month total return of the analyst s coverage universe or an index identified by the analyst that includes, but is not limited to, stocks covered by the analyst. Sector Underperform (SU) The stock is expected to underperform the average 12-month total return of the analyst s coverage universe or an index identified by the analyst that includes, but is not limited to, stocks covered by the analyst. Other Ratings Tender Investors are guided to tender to the terms of the takeover offer. Under Review The rating has been temporarily placed under review, until sufficient information has been received and assessed by the analyst. Scotiabank, Global Banking and Markets Equity Research Ratings Distribution* Distribution by Ratings and Equity and Equity-Related Financings* Low Low financial and operational risk, high predictability of financial results, low stock volatility. Medium Moderate financial and operational risk, moderate predictability of financial results, moderate stock volatility. High High financial and/or operational risk, low predictability of financial results, high stock volatility. Speculative Exceptionally high financial and/or operational risk, exceptionally low predictability of financial results, exceptionally high stock volatility. For risk-tolerant investors only. Percentage of companies covered by Scotiabank, Global Banking and Markets Equity Research within each rating category. Percentage of companies within each rating category for which Scotiabank, Global Banking and Markets has undertaken an underwriting liability or has provided advice for a fee within the last 12 months. Source: Scotiabank GBM. For the purposes of the ratings distribution disclosure FINRA requires members who use a ratings system with terms different than buy, hold/neutral and sell, to equate their own ratings into these categories. Our Focus Stock, Sector Outperform, Sector Perform, and Sector Underperform ratings are based on the criteria above, but for this purpose could be equated to strong buy, buy, neutral and sell ratings, respectively.

9 9 General Disclosures This report has been prepared by analysts who are employed by the Research Department of Scotiabank, Global Banking and Markets. Scotiabank, together with Global Banking and Markets, is a marketing name for the global corporate and investment banking and capital markets businesses of The Bank of Nova Scotia and certain of its affiliates in the countries where they operate, including Scotia Capital Inc. All other trademarks are acknowledged as belonging to their respective owners and the display of such trademarks is for informational use only. Scotiabank, Global Banking and Markets Research produces research reports under a single marketing identity referred to as Globally-branded research under U.S. rules. This research is produced on a single global research platform with one set of rules which meet the most stringent standards set by regulators in the various jurisdictions in which the research reports are produced. 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