By John Praveen, Chief Investment Strategist of Prudential International Investments Advisers, LLC.*

Transcription

1 October - November 2012 By John Praveen, Chief Investment Strategist of Prudential International Investments Advisers, LLC.* Global Investment Strategy: Maintain Equity Overweight as Q3 Stock Market Rally Likely to Continue in Q4 with Interest Rate Cuts, Liquidity Tailwinds & Eurozone Stabilization. However, Markets Volatile with Uncertainties/Challenges from 4 Es (Eurozone, Earnings, Economies & Elections). Maintain Bonds at Neutral as Yields Likely to be Range-bound with Easing Risk Aversion Offset by Weak Growth Outlook & Central Bank Bond Purchases John Praveen s Global Investment Strategy October-November 2012 retains a modest overweight on equities as the Q3 stock market rally is likely to continue into 2012 year-end, supported by the stimulus injected already injected in Q3 by the Fed (QE3), ECB (OMT) and the BoJ, and several other central banks likely to undertake easing measures in Q4. Further equity valuations are still supportive. However, markets are likely to be volatile with uncertainties/challenges from Eurozone (lingering uncertainty in Spain and Greece), Earnings (risk of disappointments), Economies (weak growth outlook), and Elections (implications for U.S. fiscal cliff). However, some of these issues are likely to be resolved in the near-term, fuelling a relief rally. The ECB s bond buying plan is likely to be activated for Spain and Greece is likely to get a reprieve. Further, once the U.S. elections are over on November 6th, a deal on fiscal cliff is likely to be struck which is likely to lead to a small fiscal drag and prevent the U.S. economy plunging over the cliff. Our Asset Allocation strategy retains a neutral stance on bonds as yields are likely to remain range-bound, caught between improving risk appetite versus weak growth outlook and central bank bond purchase programs. Bonds are likely to enjoy less safe haven appeal with improving risk appetite as the Eurozone tail risks have declined with the ECB s OMT plan providing the dysfunctional Eurozone bond markets with an effective backstop. Further, bond yields have fallen to low levels in major bond markets and are likely to rise further with a sustained decrease in risk aversion. However, the Fed s QE3, the ECB s unlimited bond buying plan, the BoJ s increased asset purchases are all likely to support bonds. Further the global growth outlook remains weak with the U.S. limping at a below-trend pace, while Japan and Eurozone are struggling. Weak growth outlook and asset purchase programs by the ECB, the Fed, the BoJ and the BoE are all likely to support bonds. Among global stock markets, we remain Overweight in Emerging Markets; Remain Modest Overweight on Eurozone: Raise U.S. to Modest Overweight; Reduce U.K. to Neutral; Remain Underweight on Japan. Among global bond markets we remain Overweight in Eurozone & U.K. bonds; Remain Neutral on U.S. Treasuries; and Remain Underweight in Japanese JGBs. Among global sectors, we are Overweight on Industrials & Consumer Discretionary; Modest Overweight on Materials, Financials & Information Technology; Neutral on Energy and Healthcare; and Underweight on Consumer Staples, Telecoms & Utilities Investment Strategy: Maintain Modest Overweight in Stocks as Interest Rate & Liquidity Tailwinds, Eurozone Stabilization & Valuation Support Likely to Fuel Further Gains in Q4. Stocks However Face Uncertainties/Challenges from 4 Es (Earnings, Economies, Eurozone & Elections). Maintain Bond Exposure at Neutral as Yields Range-bound with Easing Risk Aversion Offset by Weak Growth Outlook & Central Bank Bond Purchases Asset Allocation: Stocks, Bonds & Cash Stocks Maintain Modest Overweight: Global stock markets enjoyed a solid rally in Q3 with the Developed Markets (MSCI World) index gaining 6.1% (in US$) during Q3, while Emerging Markets rose 7%. Year to date in 2012, the Developed Markets are up 10.9% while the Emerging Markets have gained 9.4%. Looking ahead to 2012 year-end, stock markets are likely to post further gains, supported by interest rate and liquidity tailwinds. During Q3, central banks injected fresh stimulus with the Fed launching an open-ended QE3, the ECB s proposing an unlimited bond-buying program (OMT), Japan increasing its asset purchases, easing measures in Brazil, *Prudential International Investments Advisers, LLC. (PIIA) is a business of Prudential Financial, Inc., (PFI), which is not affiliated in any manner with Prudential plc, a company headquartered in the United Kingdom. For Informational Use Only. Not Intended As Investment Advice. See Disclosures on the last page for important information. Page 1

2 India and other emerging economies. Several other central banks likely to follow up by undertake easing measures during Q4. Further, Eurozone policy makers continue to take steady steps to reduce tail risks and resolve the debt crisis. In addition, equity valuations are still supportive. However, stocks face risks/challenges from the 4 Es: 1) Eurozone - Lingering uncertainty with question marks over Spain (will it ask for a bail-out? and when?) & Greece (will Eurozone give more money & time?); 2) Earnings - Risk of disappointments; 3) Economies - poor growth outlook; and 4) Elections in USA and implications for Fiscal Cliff, and in China forthcoming leadership change. These risks are likely to keep markets volatile. Consequently, we keep stocks at a modest overweight. However, some of these issues are likely to be resolved in the near-term, fuelling a relief rally. The ECB s bond buying plan is likely to be activated for Spain and Greece is likely to get a reprieve. Further, once the U.S. elections are over on November 6th, a deal on fiscal cliff is likely to be struck which is likely to lead to a small fiscal drag and prevent the U.S. economy plunging over the cliff. Bonds Remain Neutral: Global bond yields are likely to remain range-bound, caught between improving risk appetite versus weak growth outlook and central bank bond purchase programs. Bonds are likely to enjoy less safe haven appeal with improving risk appetite as the Eurozone tail risks have declined with the ECB s OMT plan providing the dysfunctional Eurozone bond markets with an effective backstop. Further, bond yields have fallen to low levels in major bond markets and are likely to rise further with a sustained decrease in risk aversion. However, the Fed s QE3, the ECB s unlimited bond buying plan, the BoJ s increased asset purchases are all likely to support bonds. Further the global growth outlook remains weak with the U.S. limping at a below-trend pace, while Japan and Eurozone are struggling. Weak growth outlook and asset purchase programs by the ECB, the Fed, the BoJ and the BoE are all likely to support bonds. Hence we remain Neutral on Bonds. Cash- Remain Underweight on decline in risk aversion with central bank bond purchase programs. Investment Strategy within Markets: Among Global Equity Markets: Overweight: Emerging Markets: Risk aversion eased as ECB s unlimited bond buying plan reduced Eurozone tail risks. Fed s QE3 and other central banks easing measures provide liquidity and interest rate tailwinds. EM valuations remain attractive despite strong Q3 gains. Modest Overweight: Eurozone & USA 1) Eurozone: ECB s bond purchase program reduces Eurozone tail risks. Valuations are attractive despite recent gains. However, Eurozone GDP expected to contract in Q3 after Q2 decline; 2) U.S.: Fed s QE3 underpins stocks. Modest Q3 GDP rebound. Relief rally likely if agreement reached on fiscal cliff after November elections. Neutral: UK Downgrade to neutral with GDP growth expected to contract in Q3 after Q2 decline. Earnings outlook is also weak. BoE likely to expand asset purchases in November. Underweight: Japan: GDP growth stalls in Q3 after weak Q2. Earnings outlook expected to be revised lower on slower global growth and strong yen. Fresh BoJ asset purchases a positive. Global Bonds Global Sectors Currencies Modest Overweight Eurozone Bonds, U.K. Gilts & Emg Mkt Bonds Neutral: U.S. Treasuries Underweight: Japan JGBs Overweight: Industrials & Consumer Discretionary Modest Overweight: Materials, Financials & Information Technology Neutral: Energy & Healthcare Underweight: Consumer Staples, Telecoms & Utilities Overweight: Euro, EM Currencies; Neutral: Sterling, Yen; Underweight: U.S. Dollar The U.S. Dollar is likely to weaken against the euro, but remain range-bound against the yen. The euro is likely to remain firm as the ECB s OMT plan is activated (for Spain) once all the prerequisites in place, easing extreme negative For Informational Use Only. Not Intended As Investment Advice. Page 2

3 scenarios for the euro. Greece likely to get further reprieve. The sterling is likely to strengthen further given the improvement in risk aversion due to the European crisis. The yen is likely to remain range-bound with depressed inflation offset by easing risk aversion and additional QE by the BoJ. EM currencies are likely to post gains with easing risk aversion while GDP growth is expected to recover in H2 after slowing down in H1. Global Equity Strategy Emerging Markets (EM): In September, the U.S. Fed launched an open-ended QE3, ECB unveiled an unlimited bond buying plan, BoJ expanded its asset purchase program and BoE is likely to announce fresh QE. Further rate cuts and easing measures are likely in China, India and several other emerging economies. These liquidity and interest rate tail winds have eased risk aversion significantly which is likely to keep EM stocks in an uptrend. Despite outperforming EM stocks in Q3, EM stock valuations remain attractive and still trade at a discount to DM stocks. EM GDP growth outlook has been revised lower due to knock-on impact from developed economies through trade and capital flows. However, monetary easing by EM central banks is likely to support a GDP recovery. Earnings outlook has been revised lower but still remain supported by domestic demand. Remain Overweight. Eurozone: ECB s aggressive bond-buying plan, the Outright Monetary Transactions (OMT), is designed to provide the dysfunctional Eurozone bond markets with an effective backstop and reduces tail risks from Eurozone. However, in order for the ECB to undertake bond purchases, a country must first participate in the full EFSF/ESM program. Meanwhile uncertainty remains about when and if the OMT will be activated for Spain. Further, Greece has again come under the spot light in recent weeks, asking for more money and time. Eurozone economy continues to struggle under the shadow of the sovereign debt crisis. However, there have been signs of improvement with the commitment of the ECB to a new asset purchase program and approval of the German constitutional court of the ESM program, leading to a narrowing of sovereign spreads. Hence remain Modest Overweight on Eurozone. U.S.: The Fed launched QE3 in September with an open-ended commitment to buy MBS and extended the zero interest rate pledge into This is likely to keep U.S. stocks on track for further gains in coming months. The U.S. economy is expected to post a modest rebound to around 2% in Q3 after a disappointing 1.3% GDP growth in Q2. Markets remain concerned about the risk of the U.S. economy going over a massive fiscal cliff of large spending cuts and tax increases in However, it is likely that deal will be struck after the elections and before year-end leading to a relief rally. Market could also enjoy a post-election relief rally, especially with a Romney win. The Q3 earnings season has kicked off and while U.S. earnings expectations are low, the risk of big earnings shortfall and poor forward earnings guidance poses headwinds for the market, Hence, upgrade to Modest Overweight. U.K.: Downgrade UK to neutral as prospects of additional BoE asset purchase offset by weak economic and earnings outlook. The BoE left monetary policy unchanged at its October meeting, but it is very likely that once the current tranche is completed, the BoE will announce fresh asset purchases in November given the weak U.K. growth outlook. U.K. GDP is expected to contract -1% QoQ annualized in Q3 with consumer spending likely to be mixed in Q3 following earlier declines. The boost from tourist spending from the 2012 London Olympics is expected to fade in late August and September. Further, earnings outlook continue to be revised lower for U.K. stocks given the weak domestic economy and slower global growth. Downgrade to Neutral. Japan: Economy stalling with GDP growth on track to slow further to 0% in Q3 and improve modestly to around 1% in Q4. Japanese Q2 earnings results were weaker than expected and the outlook is likely to be revised further lower. Strong yen remains a negative for Japan s economy and earnings. Stocks are likely to get modest support from the BoJ increasing the size of its asset purchase program in September to 80tn from 70tn and extending the deadline for purchases to end-2013 from end-june Remain Underweight on Japan. Global Bond Strategy Eurozone: The outlook for Eurozone bonds remains positive with supportive fundamentals. The ECB left monetary policy unchanged in October after announcing new unlimited bond buying plan (OMTs) and changes to collateral requirements at their September meeting. The resulting reduction in risk aversion has reduced the safe haven appeal of core Eurozone bonds, putting upward pressure on their yields, while bond yields in the periphery are declining. ECB President Draghi made it clear at the October ECB meeting that while the OMT was a fully effective backstop, it was now up to the Eurozone governments to put all the prerequisites in place for the ECB to commence bond buying. The Eurozone economy continues to struggle and is on track to contract again in Q3 after declining in Q2. Remain Overweight Eurozone Bonds. For Informational Use Only. Not Intended As Investment Advice. Page 3

4 U.K.: The outlook for U.K. Gilts remains positive. The U.K. economy remains in recession with GDP on track to contract -1% annualized in Q3 after declining -1.5% in Q2. While the BoE left monetary policy unchanged at its October meeting, leaving the interest rate target at 0.5% and the size of the asset purchase program at 375bn, it is very likely that once the current tranche is completed, the BoE will announce fresh asset purchases in November with U.K. GDP outlook remaining weak. U.K. inflation edged down in August despite upward pressure from the rise in oil and commodity prices. Remain Overweight U.K. Gilts. Emerging Markets: The near-term outlook for Emerging Market bonds has improved recently with the improvement in risk appetite with reduction in Eurozone tail risks and narrowing of Eurozone sovereign credit spreads following European policymakers measures. This has put downward pressure on the spread between EM and DM bond yields. In addition, EM central banks continue to cut rates and ease monetary policy in order to support the slower GDP growth outlook. However, there have been some signs that recent increases in inflation could limit the easing cycle. There are still risks that the EM spread could widen again due to renewed Eurozone uncertainty. While EM GDP growth is stronger than DM growth, concerns about slower EM growth could put also upward pressure on EM spreads. Raise EM Bonds to Overweight. U.S.: The outlook for U.S. Treasuries is neutral. The reduction in Eurozone tails risks following the ECB s aggressive bond-buying plan has recently led to an increase in global risk appetite. Further, by reducing the safe haven demand for U.S. Treasuries, it has put upward pressure on bond yields. Though there has been some consolidation in equity and bond markets, risk appetite is expected to continue to improve, further reducing the safe haven appeal of Treasuries and sending yields higher. Further, while the U.S. is limping at a below-trend pace, the economy is on track to a modest rebound to 1.8% GDP growth in Q3 after a disappointing 1.3% pace in Q2. However, the Fed launched QE 3 in September with a commitment to buy a total of $85bn in assets per month. While these purchases are focused in the MBS sector, it will still impact Treasury yields by providing additional monetary stimulus. Remain Neutral U.S. Treasuries. Japan: The outlook for JGBs remains relatively less favorable. The recent improvement in global risk appetite has reduced the safe haven appeal of Japanese bonds. In addition, JGB yields are very low and even if there is an increase in risk aversion it would be unlikely to send JGB significantly lower if investors are searching for safety. However, JGB yields are supported by weak growth outlook with GDP growth stalling in Q3 after the disappointment in Q2. The BoJ voted unanimously in September to increase the size of its asset purchase program to 80tn from 70tn and extended the deadline for purchases to end-2013 from June Japan s inflation remains negative with August inflation data indicating that moderate deflation is continuing. Remain Underweight JGBs. Global Sector Strategy We are Overweight Industrials & Consumer Discretionary; Modest Overweight in Information Technology, Financials & materials; Neutral in Energy & Healthcare; Underweight in Consumer Staples, Telecoms & Utilities. Consumer Discretionary: U.S. consumer spending in Q3 was stronger than in Q2, with a strong jump in retail sales in September. Japanese consumption spending remains relatively solid due to government subsidies and pent-up demand following the 2011 earthquake. Valuations remain fairly attractive with the sector trading at an attractive P/E ratio. Remain Overweight. Industrials: Easing measures by major central banks are likely to support growth. Capital goods demand is expected to recover in emerging economies in H2 as central banks ease policy and government policies support GDP growth. Recent cost reductions are a positive for the sector. Global sector valuations are attractive. Remain Overweight. Information Technology: Info Tech continues to benefit from ongoing product launches in mobile devices. Meanwhile, the outlook for PC s remains uncertain, which could lead to a disappointing Q4 despite a boost from the launch of Windows 8. The sector trades at a discount to both trailing as well as forward P/E multiples. Remain Modest Overweight. Financials: Sector is likely to benefit from the extension of low rates and additional asset purchases by global central banks. However, the operating environment remains challenging. A housing recovery and signs of growth in consumer demand are a positive for US banks. Earnings growth of 11% is expected for 2012 after staying flat in Remain Modest Overweight. For Informational Use Only. Not Intended As Investment Advice. Page 4

5 Materials: Easing measures by global central banks are a positive for commodity prices. Base metals and precious metals are likely to outperform on the recent central bank actions. The US housing market recovery is a positive for construction materials. Valuations have become relatively cheap. However, any return in risk aversion would be a negative. Remain Modest Overweight. Energy: Valuations are attractive following the steep price declines in Q2. The sector remains attractive on both trailing P/E as well as P/B ratios. Weaker global growth is likely to be a drag on oil demand and a negative for the sector. Any increase in risk aversion is also likely to be a negative for the sector. Downgrade to Neutral. Healthcare: Reduction in risk aversion is a negative. While the earnings growth for the sector is unimpressive at just around 3%, the possibility of negative earnings revisions is lesser relative to the cyclical sectors. Valuations remain attractive despite the strong performance for the year and the high dividend yield is a positive. Remain Neutral. Telecomm Services: Sector is likely to underperform with market risk aversion easing. Earnings outlook remains weak while sector valuations are expensive relative to market. Recent large M&A deals have not dampened investment spending with further capital expenditures expected as companies aggressively roll out new technologies. Remain Underweight. Consumer Staples: The recent rise in input prices are a negative for the sector. Weather conditions, especially in the U.S., are likely to keep upward pressure on grain prices. Valuations have become expensive as the sector has outperformed amidst an environment of global uncertainty. Earnings growth is expected to remain modest for 2012, around 6%. Remain Underweight. Utilities: The sector remains unattractive on both a forward as well as trailing price to earnings basis. Earnings growth for 2012 is expected to be strong, but the growth comes after two years of earnings declines for the sector. Dividend yield remains high. Remain Underweight. Investment Strategy Summary: Asset Allocation: Modest Overweight in Stocks; Remain Neutral in Bonds; Remain Underweight in Cash Global Equities: Remain Overweight in Emerging Markets. Remain Modest Overweight on Eurozone; Raise U.S. to Modest Overweight; Downgrade U.K. to Neutral;Remain Underweight on Japan Global Bonds: Remain Overweight Eurozone & U.K. bonds; Remain Neutral U.S. Treasuries; Remain Underweight Japan JGBs Sectors: Overweight: Industrials & Consumer Discretionary; Modest Overweight: Materials, Financials & Information Technology; Neutral: Healthcare & Energy; Underweight: Consumer Staples, Telecoms & Utilities Currencies: Overweight: Euro & EM Currencies; Neutral: Sterling, Yen; Underweight: U.S. Dollar Follow us on Twitter: For more information contact: Lisa Villareal: , lisa.villareal@prudential.com Disclosures: Prudential International Investments Advisers, LLC. (PIIA), a Prudential Financial, Inc. (PFI) company, is an investment adviser registered with the Securities and Exchange Commission of the United States. Pramerica is a trade name used by PFI and its affiliated companies in select countries outside of the United States. PFI, a company incorporated and with its principal place of business in the United States of America is not affiliated in any manner with Prudential plc, a company headquartered in the United Kingdom. The commentary presented is for informational purposes only, and is not intended as investment advice. This material has been prepared by PIIA on the basis of publicly available information, internally developed data and other third party sources believed to be reliable. However, no assurances are provided regarding the reliability of such information. All opinions and views constitute judgments of PIIA as of the date of this writing, and are subject to change at any time without notice. There can be no assurance that any forecast made herein will be realized. Distribution of this information to any person other than the person to whom it was originally delivered and to such person s advisers is unauthorized and no part of this material may be reproduced or distributed further without the written approval of PIIA. These materials are not intended for distribution to, or use by, any person in any jurisdiction where such distribution would be contrary to local law or regulation. The companies, securities, sectors and/or markets referenced herein are included solely for illustrative purposes to highlight the economic trends, conditions, and the investment process, but may or may not be held by accounts actually managed by PIIA. The strategies and asset allocations discussed do not refer to any service or product offered by PIIA or by its affiliates The global asset and strategy allocation models presented are hypothetical allocation models shown for illustrative purposes only, and do not necessarily reflect the management of any actual account. Following the allocation recommendations presented will not necessarily result in profitable investments. Past performance is not an assurance of future results. Nothing herein should be viewed as investment advice to adopt any investment strategy, nor should it be considered an offer to provide investment advisory or other allocation services. The Rock symbol is a service mark of PFI and its related entities, registered in many jurisdictions worldwide. Copyright 2012 For Informational Use Only. Not Intended As Investment Advice. Page 5