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

Transcription

1 By John Praveen, Chief Investment Strategist of Prudential International Investments Advisers, LLC.* For Market Commentary Interviews Contact: Lisa Villareal, Financial Market Outlook & Strategy: Stocks Supported by Q2 Earnings Surprises, Cheap Valuations & H2 GDP Rebound. Greek Debt Crisis & Contagion Remains a Near-term Wild Card. John Praveen s Global Investment Strategy July 2011 sees global stock markets entering the second half of 2011 supported by several positive fundamentals. These include prospects for a H2 GDP rebound in the U.S. and Japan, easing inflation concerns, Fed leaving the door open for QE3, positive Q2 earnings surprises, and valuations improved to April 2009 levels. However, the Eurozone debt crisis entered a more dangerous phase with contagion spreading from the smaller periphery to Italy and Spain, while the Greek problem defies resolution. We expect the positive fundamentals to help stocks rebound in H However, in the near-term, a delay/failure by European policy makers to act decisively could be a game-changer for global stocks markets and the global economy. Bonds are likely to be supported in the near-term by safe haven demand as the Eurozone debt crisis escalated. Further, potential Q2 GDP disappointments and a pullback in headline inflation are also likely to support bonds. However, in the medium-term, bond yields are likely to rise with the H2 GDP rebound in Japan and the U.S., continued tightening by ECB and Emerging central banks, and improving risk appetite with a resolution of the Eurozone debt crisis, and the U.S. debt ceiling dispute. Asset Allocation: We expect the positive fundamentals to help stocks rebound in H Hence we raised the equity exposure from the earlier neutral allocation. However, the escalation of the European debt crisis and continued rate hikes by Emerging central banks are likely to keep stocks volatile in the near term. Hence, we have raised stocks to only modest overweight and reduced bonds to modest underweight. Among global stock markets, we are Overweight in the Emerging Markets, the U.S. and Japan, and remain Underweight on the U.K. and Eurozone. Among global sectors, we are Overweight on Industrials; Modest Overweight on Materials, Information Technology and Consumer Discretionary; Neutral on Energy, Consumer Staples and Financials; Underweight on Healthcare, Telecomm and Utilities. Among global bond markets, we are Overweight in Japanese bonds, U.S. Treasuries and Eurozone bonds, Neutral in Emerging Market bonds, and Underweight on U.K. Gilts. Market Outlook: Stocks Supported by Q2 Earnings Surprises, Cheap Valuations & H2 GDP Rebound. Greek Debt Crisis & Contagion Remains a Near-term Wild Card. Safe Haven Demand with Deepening Eurozone Debt Crisis Likely to Support Bonds in Near-term Despite Rich Valuations Stocks: Growth Rebound, Solid Q2 Earnings & Cheap Valuations Support Stocks. Eurozone Crisis a Wild Card Global equity markets were on a roller-coaster in June. Stocks continued to fall in the first three weeks of June as U.S. economic data continued to disappoint while the Greek debt crisis deepened. However, stocks recovered in late June as the Greek parliament voted to implement further fiscal austerity measures and optimism rose about a solution for Greek immediate financing needs. In addition, there were growing signs that the Japan supply chain disruptions were easing, fuelling optimism of better growth in H2. Global stock markets enter the second half of 2011 supported by several positive fundamentals: 1) Growth Optimism: The growth concerns/disappointments of Q2 appear to be easing with Japan poised for a V-shaped rebound and the U.S. on track for a modest rebound in Q3. Growth in core Eurozone remains solid offsetting the drag from the periphery. GDP growth in the emerging economies appears to be slowing to a more sustainable pace in response to rate hikes; 2) Inflation Concerns Easing: Inflation concerns in the U.S. and Europe are easing with headline inflation pulling back with the recent decline in food and fuel prices; 3) Fed Policy & QE 3, and ECB Circuit Breaker: The Fed ended QE II in June but is expected to keep rates low and liquidity plentiful by reinvesting principal payments from its securities holdings. While the Fed indicated that it currently has no plans for QE 3, it left the door open for QE 3 if economic weakness persists and deflationary pressures re-emerge. ECB rate tightening is likely to be modest. Further, with the Eurozone debt crisis spreading beyond the periphery, the ECB may be forced to step in as a circuit-breaker and reintroduce bond purchases to stabilize markets as it did very successfully in May 2010; 4) Solid Earnings: The Q2 earnings season has kicked-off in mid-july with U.S. companies expected to post positive earnings surprises while European earnings are improving. The earnings outlook in H2 remains solid with strong revenue growth from healthy nominal GDP growth and still good margins; *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 5) Attractive Valuations: Equity valuation continued to improve with a combination of stock price declines and strong earnings results. Developed and emerging market P/E multiples are currently at levels last seen in April However, stocks are likely to remain under pressure with contagion spreading to the big bond markets of Italy and Spain, the Greek problem defying resolution, and Portuguese and Irish debt being downgraded to junk status. The Eurozone debt crisis entered a more dangerous phase with contagion spreading from the small economies of Greece, Ireland and Portugal to the much bigger Italy and Spain. Meanwhile, the Greek crisis drags on with a destabilizing dispute continuing between the Eurozone finance ministers and the ECB about private sector contribution to a second bailout for Greece. In addition, another negative for stocks is the continued interest rate tightening by emerging central banks, especially in China, India and Brazil, with inflation remaining stubbornly elevated. Bottom-line: We expect the positive fundamentals to help stocks rebound in H However, in the near-term, a delay/failure by European policy makers to act decisively could be a game-changer for global stocks markets and the global economy. Bonds: Near Term Support From Eurozone Crisis Safe Haven Demand. H2 GDP Rebound to Pressure Yields in Medium-term Global government bond yields were mixed in June as yields fell on concerns about slower global growth and increased risk aversion with the Greek debt crisis deepening. Yields rose in late June as risk appetite improved with the Greek government approving the austerity plan paving the way for a second bailout. Bonds are likely to remain supported in the near-term by safe haven demand as the Eurozone debt crisis entered a more dangerous phase with contagion spreading to Italy and Spain, the Greek problem defying resolution, and a downgrade of Portuguese and Irish debt to junk status. Further, potential Q2 GDP disappointments in the U.S. and Japan, and a pullback in headline inflation are also likely to support bonds. However, in the medium-term, bond yields are likely to rise with an expected H2 GDP rebound in Japan and the U.S., continued tightening by ECB and Emerging central banks, and improving risk appetite with a resolution of the Eurozone debt crisis, and a settlement in the U.S. debt ceiling dispute. The outlook for JGBs remains relatively favorable. JGBs are likely to remain supported by continued easing measures by the BoJ which remains cautious on its GDP growth outlook due to both domestic as well as external risk factors. GDP is also expected to decline around -3% in Q2 due to the impact of the earthquake before reconstruction spending leads to a strong rebound in H2. However, inflation has edged up modestly over the past few months. Further, with yields remaining low, there is little scope for them to fall significantly further. In the near-term, U.S. Treasuries are likely to be supported by the potential Q2 GDP growth disappointment and safe haven demand with deepening Eurozone debt crisis. However, in the medium-term, the expected U.S. GDP rebound is expected to put upward pressure on yields. Further, nominal yields are very low and real yields are negative and have little room to decline further. Nevertheless, the Fed left rates on hold in June, and is likely to remain on extended hold, while Chairman Bernanke left the door open for further quantitative easing, QE 3. The possibility of QE 3, is likely to cap Treasury yields. The outlook for Eurozone bonds is modestly positive. In the near-term, core Eurozone bonds have increased safe haven support as the Eurozone debt crisis escalated with contagion spreading from the small peripheral economies to the big bond markets of Italy and Spain. Further, Eurozone GDP growth is expected to moderate in Q2 to around 2.5% pace after 3.4% growth in Q1. While inflation remains above ECB target, it is expected to ease in coming months with the correction in oil prices. However, the ECB raised rates in July and is expected to raise rates again in Q4. Yields also remain depressed on both a real and nominal basis. The outlook for U.K. Gilts remains negative. Inflation remains one of the biggest negatives for U.K. gilts, with the highest inflation rate among the major economies at 4.2%. The improving GDP growth outlook is also a negative for U.K. yields with GDP expected to rise 2% QoQ annualized in Q2 after 1.9% in Q1. Further, while the BoE was on hold in July as expected, inflationary pressures suggest that the BoE will raise rates before the U.S. and Japan. The outlook for Emerging Market bonds is neutral. In the near-term, continued rate hikes and elevated inflation are negatives. The elevated inflation has prompted EM central banks to tighten monetary policy, possibly resulting in slower GDP growth in coming quarters. Nevertheless, even if growth slows, it is still expected to be strong relative to developed markets. Further, developed market growth is expected to improve later in the year. Hence, there should be some decrease in risk aversion, narrowing the spread between EM and DM bonds later in the year. However, the deepening of the Eurozone debt crisis is likely to keep risk aversion elevated and is a near-term negative for EM bonds. Developed market growth expected to improve, narrowing the spread between EM and DM bonds. For Informational Use Only. Not Intended As Investment Advice. See Disclosures on the last page for important information. Page 2

3 Investment Strategy: Stocks Supported by Growth Rebound, Solid Q2 Earnings & Cheap Valuations. Raise Stocks to Modest Overweight Asset Allocation: Raise Stocks to Modest Overweight; Reduce Bonds to Modest Underweight; Global Equities: Overweight: U.S., Emerging Markets, Japan; Underweight: U.K. and Eurozone; Global Bonds: Modest Overweight: Japan, U.S., Eurozone: Underweight: U.K.; Global Sectors: Overweight: Industrials Modest Overweight: Materials, Consumer Discretionary, Info Tech; Neutral: Energy, Consumer Staples, Financials; Underweight: Healthcare, Telecomms, Utilities; Currencies: Overweight: EM Currencies; Neutral: Yen & U.S. Dollar; Underweight: Euro & Sterling. ASSET ALLOCATION: Stocks vs. Bonds Stocks Raise to Modest Overweight: Global stock markets enter the second half of 2011 supported by several positive fundamentals with prospects for a H2 GDP rebound, easing inflation concerns, Fed leaving the door open for QE 3, Positive Q2 earnings surprises, and valuations improved to April 2009 levels. However, the escalation of the European debt crisis and continued EM rate hikes are likely to keep stocks volatile in the near term. Hence only raised stocks to modest overweight. Bonds - Reduce to Modest Underweight: Bonds are likely to remain supported in the near-term by Eurozone crisis safe haven demand and potential Q2 GDP disappointments in th U.S. and Japan. However, in the medium-term, bond yields are likely to rise with an expected H2 GDP rebound in Japan and the U.S., and improving risk appetite with a resolution of the Eurozone debt crisis and U.S. debt ceiling dispute. CURRENCIES Overweight: EM Currencies; Neutral: Yen & U.S. Dollar; Underweight: Euro & Sterling The U.S. Dollar is expected to strengthen against the euro and pound but trade range bound against the yen. The escalation of the Eurozone sovereign debt crisis is a big negative for the euro. Elevated inflation is a negative for the sterling. The yen is likely to remain range bound against the dollar with expectations of a H2 GDP rebound offset by BoJ easing measures. Further gains are expected for EM currencies due to stronger growth and central bank hikes. Commodity currencies are likely to post gains as commodity prices rise with solid global GDP growth leading to continued commodity demand. Global Equity Strategy Emerging Markets (EM): GDP growth in the emerging economies remains solid but is gradually moderating with EM central banks continuing to raise rates to combat inflation. However, China and India appear to be on track for a soft landing easing concerns of a hard landing due to past rate hikes. Inflation still remains elevated prompting further rate hikes. However, further rate hikes are likely to be modest as rates are near the peak. Emerging Markets valuations have improved to the most attractive since April 2009 with EM stock prices falling while earnings remained strong. The earnings outlook remains solid driven by strong domestic demand and solid exports. However, increased risk aversion due to the European debt crisis, and currency appreciation are negatives. Remain Overweight. U.S.: The U.S. economy is on track to post a modest rebound in H2 after a disappointing 2% GDP growth in Q2 with Japan supply chain disruption appearing to be reversing in late Q2/early Q3, while gas prices moderated as crude prices declined. The U.S. Fed left rates unchanged at its June meeting and concluded QE 2 as scheduled at the end of June. The Fed is likely to keep the reinvestment policy in place, thereby keeping its balance sheet steady and preventing premature passive tightening of policy. While the Fed indicated that it currently has no plans for QE 3, it left the door open for fresh quantitative easing if economic weakness persists and deflationary pressures re-emerge. The Q2 earnings season is scheduled to start in the second half of July and U.S. companies are expected to post a solid 14% YoY growth with scope for upside surprises. The escalation of Eurozone debt crisis into a more dangerous phase with contagion from smaller countries to bigger countries is likely to provide relative safe haven support to U.S. stocks. Remain Overweight. Japan: The Japanese economy remains on track for a V-shaped recovery with easing of supply chain disruptions and households increasing purchases of durable goods and reconstruction spending beginning to take effect as reflected in the rebound in industrial production. Current expectations are for a 4.5% rebound in Q3 and around 5.5% in Q4 with risks to the upside. The BoJ continues to keep rates low and has maintained the scale of its asset purchase program in July. Valuations are still relatively expensive on some measures with respect to other markets. Japanese earnings are expected to rebound in H2. Remain Overweight. Eurozone: The Eurozone debt crisis is escalating with the Greek problem defying resolution, Portuguese and Irish debt has been downgraded to junk status, while contagion has spread from the small periphery to the big bond markets of Italy and Spain. Eurozone GDP growth is expected to moderate in Q2 to around 2.5% pace after 3.4% growth in Q1. The ECB hiked rates by 25bps in July and additional rate hikes are likely. However with Eurozone debt crisis spreading beyond the periphery, the ECB may be forced to step in as a circuit-breaker and reintroduce bond purchases to stabilize markets. Eurozone earnings growth is expected to improve in Q2 after the mixed earnings results announced during Q1. Earnings are expected to rise 12.4% during Q2 after rising 9.7% during Q1. Remain Underweight. For Informational Use Only. Not Intended As Investment Advice. See Disclosures on the last page for important information. Page 3

4 U.K.: U.K. GDP growth outlook remains weak while inflation remains well above the BoE s 2% target, leaving the BoE torn between members wanting to keep rates low to support growth and several pushing for rate hikes to combat inflation. Consumer spending appears to be off to a slow start in Q2, while business confidence has weakened recently. GDP is expected to rise 2% in Q2. U.K. headline inflation moderated to 4.2% YoY in June from 4.5% YoY in May. The Bank of England left rates unchanged at 0.5% at the July meeting and the stock of asset purchases fixed at 200bn. The relative earnings outlook and valuations for U.K. stocks are modest positives. Remain Underweight. Global Bond Strategy Emerging Markets: In the near-term, continued rate hikes and elevated inflation, in spite of the recent correction in oil, are negatives. The elevated inflation has prompted EM central banks to tighten monetary policy, possibly resulting in slower GDP growth in coming quarters. Nevertheless, even if growth slows, it is still expected to be strong relative to developed markets. Further, developed market growth is expected to improve later in the year. Hence, there should be some decrease in risk aversion, narrowing the spread between EM and DM bonds later in the year. However, the deepening of the Eurozone debt crisis is likely to keep risk aversion elevated and is a near-term negative for EM bonds. Neutral EM Bonds. Japan: The outlook for JGBs remains relatively favorable. JGBs are likely to remain supported by continued easing measures by the BoJ which remains cautious on its GDP growth outlook due to both domestic as well as external risk factors. GDP is also expected to decline around -3% in Q2 due to the impact of the earthquake before reconstruction spending leads to a strong rebound in H However, inflation has edged up modestly over the past few months. Japanese headline prices rose 0.3% YoY for the second month in May after remaining flat at 0% since the end of Further, with yields remaining low, there is little scope for them to fall significantly further. Modest Overweight JGBs. U.S.: The outlook for U.S. Treasuries is modestly positive. In the near-term, U.S. Treasuries are likely to be supported by a potential Q2 GDP growth disappointment and safe haven demand with the Eurozone debt crisis entering a more dangerous phase with contagion spreading to Italy and Spain. However, in the medium-term, the expected U.S. Q3 GDP rebound is likely to put upward pressure on yields. Further, nominal yields are very low and real yields are negative and have little room to decline further. Nevertheless, the Fed left rates on hold in June and is likely to remain on extended hold. Chairman Bernanke (in July testimony to Congress) left the door open for QE 3 if recent economic weakness may prove more persistent than expected and deflationary risks might re-emerge. The possibility of further Fed quantitative easing, QE 3, is likely to limit the rise in Treasury yields. Upgrade U.S. Treasuries to Modest Overweight. Eurozone: The Eurozone bond outlook is modestly positive. In the near-term, core Eurozone bonds have increased safe haven support as the Eurozone debt crisis escalated with the Greek problem defying resolution, Portuguese and Irish debt has been downgraded to junk status, while contagion spread from the small peripheral economies to the big bond markets of Italy and Spain. Further, Eurozone GDP growth is expected to moderate in Q2 to around 2.5% pace after 3.4% growth in Q1 with appreciating euro, weaker Periphery growth, flat consumer confidence and falling business confidence. While inflation remains elevated, the readings are likely to ease in coming months with the correction in oil prices. However, the ECB raised rates in July and is expected to raise rates again in Q4. However with Eurozone debt crisis spreading beyond the periphery, the ECB may be forced to step in as a circuit-breaker and reintroduce bond purchases to stabilize markets. Yields also remain depressed on both a real and nominal basis. Upgrade to Modest Overweight. U.K.: The outlook for U.K. Gilts remains negative. Inflation remains a big negative for U.K. gilts, with the highest inflation rate among the major economies. U.K. headline inflation remains elevated at 4.2% YoY in June after holding steady at 4.5% in May. Improving GDP growth outlook is also a negative for U.K. yields with GDP expected to rise 2.1% QoQ annualized in Q2 after 1.9% in Q1. Further, while the BoE was on hold in July as expected, inflationary pressures suggest that the BoE will raise rates before the U.S. and Japan. Remain Underweight U.K. Gilts. Global Sector Strategy Our global sector model ranks sectors on a comparative basis using macro factors, valuation, earnings and risk measures. Industrials - Industrial activity in the U.S. and Japan is expected to pick up after slowing down in the past few months. Industrials benefit from exposure to emerging economies. Sector valuations are attractive and benefits from strong earnings momentum. Defense sector is likely to be affected by budgetary cuts in the U.S. and U.K. Upgrade to Overweight. Consumer Discretionary - Consumer confidence in developed economies is mixed. However, EM consumption spending remains solid driven by strong employment and strong wage growth. Earnings forecast remain higher than that of the overall index. The Auto sector appears to be returning to normalcy with easing of the supply side pressures after the Japan earthquake. Modest Overweight. For Informational Use Only. Not Intended As Investment Advice. See Disclosures on the last page for important information. Page 4

5 Information Technology Demand outlook for the sector remains solid driven by corporate spending. Demand for wireless devices has been trending up with shipments from Korea and Taiwan on the rise. Semiconductors which have lagged the overall sector in H1 is likely to pick up in H2 as demand steadily increases. Earnings expected to rise 15% in Modest Overweight. Materials - Commodity prices have declined sharply in the past few months due to global growth concerns. However, continued solid demand from emerging economies and expected H2 rebound in U.S. and Japan is likely to push commodity prices higher. EM rate hikes are a negative. Sector earnings are expected around 41% in Earnings momentum remains strong. Modest Overweight. Energy Oil prices are likely to remain range bound due to increased risk aversion and increased supply offset by increasing demand from the pickup in H2 activity. Further, demand from emerging economies remains solid. Energy earnings are expected to rise 30% in European Energy sector valuations are cheaper relative to that of U.S. Sector valuations are expensive. Neutral. Financials - Sector is pressured due to the uncertain regulatory environment on capital requirements in the U.S. and the Greek debt crisis casting a shadow on European banks. While EM Financials are benefiting from strong loan growth and attractive valuations, they are offset to some extent by interest rate hikes. Sector earnings expected to rise 15% in Neutral. Consumer Staples - The sector is likely to underperform the more cyclical sectors as growth rebounds in the U.S. and Japan. Despite the recent correction in energy prices, margin pressures remain due to elevated food and commodity prices. However, the sector is likely to benefit from considerable emerging markets consumer exposure. Staples earnings are expected to rise 8% in Neutral. Healthcare - The sector has benefited from the safe haven gains due to increased market uncertainty during Q2. However, earnings are expected to rise just 5% in 2011 as sales growth remains weak. Pharma continues to be under the threat of expiring patents and headline risks. Biotech stocks are likely to be bid up by Pharma companies looking to acquire new products. Underweight. Telecomm Services - Pricing for the sector has remained very weak due to discounts, more than offsetting the strong demand for Telecomm services on increased use of smart phones. Telecomms earnings are expected to rise just 3% in Telecomms have a high dividend yield and the low Price/Cash Earnings multiple. Underweight. Utilities - The sector has recovered from the steep declines after the Japanese earthquake. However, the sector is unlikely to underperform as risk appetite increases. Earnings growth has been revised slightly higher to 6% for The sector has a very high dividend yield and low forward P/E multiple. Underweight. Investment Strategy Summary: Asset Allocation: Raise Stocks to Modest Overweight; Reduce Bonds to Modest Underweight; Global Equities: Overweight: U.S., Emerging Markets, Japan; Underweight: U.K. and Eurozone; Global Bonds: Modest Overweight: Japan, U.S., Eurozone: Underweight: U.K.; Global Sectors: Overweight: Industrials Modest Overweight: Materials, Consumer Discretionary, Info Tech; Neutral: Energy, Consumer Staples, Financials; Underweight: Healthcare, Telecomms, Utilities; Currencies: Overweight: EM Currencies; Neutral: Yen & U.S. Dollar; Underweight: Euro & Sterling. 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 2011 For Informational Use Only. Not Intended As Investment Advice. See Disclosures on the last page for important information. Page 5