PRUDENTIAL INTERNATIONAL INVESTMENTS ADVISERS, LLC. Global Investment Outlook & Strategy February 2017 Global Stock Market Rally likely to Continue with Solid Q4 Earnings & Stronger 2017 Earnings, ECB & BoJ Continue QE Buying, Modest Fed Hikes, Improved Emerging Markets Growth & Some Rate Cuts The global equity rally is likely to continue with solid Q4 earnings and a further boost to 2017 earnings growth from Trump tax cuts and reduced regulation, improved GDP growth led by stronger U.S. GDP from fiscal stimulus, the ECB & BoJ continuing QE buying, while Fed rate hikes are likely to be modest and gradual. John Praveen, PhD Chief Investment Strategist FOR MORE INFORMATION CONTACT: Mayura Hooper Phone: 973-367-7930 Email: Mayura.hooper@ prudential.com Stocks: Global stock markets rose in January as markets awaited the announcement of new policies from the Trump administration. Earlier in December, global stock markets continued the post U.S. election rally on optimism that Trump tax cuts, reduced regulations and increased spending will boost corporate earnings and GDP growth in 2017. The developed markets gained 1.5% in January (through the 30 th ) following the 6.8% gain in 2016, while emerging markets rose 4.3%, following the 7.1% gain in 2016. Looking ahead, the stock market rally is likely to continue, driven by: 1) Solid Q4 earnings and strong 2017 earnings growth with a boost to U.S. earnings from Trump tax cuts and reduced regulation, strengthening GDP growth and stronger Energy & Materials earnings from higher oil and commodity prices; 2) Improving global GDP growth with U.S. GDP growth strengthening from Trump s tax cuts, increased infrastructure and defense spending, and reduced regulations. GDP growth in Eurozone and U.K. is likely to remain modest with limited Brexit impact, ECB stimulus and currency weakness boosting exports. Japanese GDP is expected to improve with export recovery on weak yen, BoJ QE & fiscal stimulus. Emerging Economies growth is likely to improve with Brazil and Russia emerging from recession; 3) Liquidity & interest rate backdrop remains supportive but less favorable in 2017 than in 2016 as continued QE stimulus from the ECB and the BoJ is offset by rate hikes by the Fed. The Fed is likely to raise rates at a gradual and measured pace and has signaled three rate hikes in 2017. However, the stimulus baton in the U.S. is passing from monetary to fiscal policy in 2017. Among Emerging Markets, falling inflation in some countries (India, Brazil, Russia) gives their central banks room to cut rates, while others (Mexico, Turkey) are likely to raise rates or remain on hold due to inflation pressures, or to keep pace with Fed rate hikes or to defend their currencies. Bonds: Bond yields were mixed in January, rising in Eurozone & U.K., but flat in the U.S. and Japan. Yields were relatively unchanged in December after the sharp rise in November. Looking ahead, bond yields are likely to remain under upward pressure with: 1) Improving global growth with U.S. GDP growth strengthening with fiscal stimulus, modest GDP growth in Eurozone, U.K. and Japan; 2) Rate hikes with the Fed on track for three rate hikes in 2017, with the risk of more aggressive rate hikes if U.S. inflation rises faster than expected with Trump reflation; 3) Inflation rising with higher oil and commodity prices from OPEC production cuts and fading base effects from early 2016 oil price declines. However, bonds remain supported by: 1) QE stimulus from the ECB & BoJ. The ECB continues its QE buying, having extended the program from March 2017 to year-end. The BoJ continues the purchase of JGBs. The BoE is likely to remain on hold due to Brexit risks; 2) Safe haven demand from Brexit & European elections uncertainties. 1 *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.
Market Outlook: Stocks end Volatile 2016 with a Strong Rally in Developed Markets on Expectations of Trump Reflation. Stocks add to Gains in January as Markets Await Trump Policy Announcements Global Stock Market Rally likely to Continue with Solid Q4 Earnings & Stronger 2017 Earnings, ECB & BoJ Continuing QE Stimulus, Modest Fed Hikes, Improved Emerging Markets Growth & Rate Cuts Bond Yields likely to Remain Under Upward Pressure with Stronger U.S. GDP Growth with Trump Reflation, Risk of More Aggressive Fed Tightening & ECB QE Taper, Inflation Inching Higher Stock Market Outlook (February): Global stock markets rose in January as markets awaited the announcement of new policies of the Trump administration. Earlier in December, global stock markets continued the post U.S. election rally on optimism that Trump tax cuts, reduced regulations and increased spending will boost corporate earnings and GDP growth in 2017. The Developed Markets index gained 1.5% in January (through the 30th) following the 6.8% gain in 2016 while Emerging Markets rose 4.3%, following the 7.1% gain in 2016. Looking ahead, the stock market rally is likely to continue, driven by: 1) Solid Q4 earnings and strong earnings growth in 2017; 2) Improving global growth with Trump s reflation boosting U.S. GDP growth and lifting global growth; 3) Central Bank policies remain supportive with ECB and BoJ continuing QE stimulus, several Emerging markets are likely to cut rates, while the Fed is likely to be on a gradual, modest rate hike path. However, valuations have become less compelling with P/E multiples rising, and the gap between stocks-bond earnings yield narrowing. 1) Solid Q4 Earnings Growth & Strong Earnings in 2017: Global earnings are expected to rebound to around 13% in 2017 after recovering in H2 2016 with fading drag from Energy and Materials earnings and boost to U.S. earnings from Trump s tax cuts, reduced regulations and increased spending. Earnings are expected to rebound in the U.S. to around +12%, with upside risks. Earnings in the Eurozone (+13%) and UK (+21%) are expected to rebound after the declines in 2016 while Japanese earnings expectations (+10%) have been revised higher with the yen depreciating. Emerging Markets earnings (+13%) are expected to strengthen in 2017 with improving GDP growth and rising commodity and energy prices. The U.S. Q4 earnings season kicked off in mid-january with solid earnings reports. Q4 earnings are on track to improve further to +6.1% after recovering in Q3 with +4.3% earnings growth. Energy sector earnings are expected to turn positive, rising 4.9%, after steep declines in previous quarters. Financials (15.4%), Info Tech (7.8%) and Healthcare (5.7%) are expected to be the other key drivers of Q4 earnings growth. U.S. earnings are expected to strengthen further to around 12% in 2017 with upside risks. Strong U.S. earnings growth in 2017 is likely to be driven by Trump tax cuts, reduced regulations and increased spending. In addition, the drag from lower oil and commodity prices on Energy and Material sector earnings is likely to abate in 2017. The corporate tax rate is likely to be cut to around 25% from 35%, providing a 4% boost to earnings. Trump s fiscal stimulus is likely to give a boost to GDP growth which in turn should lift corporate profits and earnings. Financials earnings are likely to benefit from better interest margins with the Fed on track to hike rates three times during 2017. Eurozone earnings are expected to rebound to around 15% in Q4 2016 after declining -5% in Q3 driven by Energy earnings (+34.7%), Consumer Discretionary (+103%) and Healthcare (17.3%). However, Info Tech (-17%) and Utilities (- 20.5%) are expected to be drags on overall earnings. Eurozone earnings are expected to grow around +13% in 2017 after declining in the first three quarters of 2016. However, Eurozone earnings expectations may be too optimistic as there are increased political uncertainties from elections in the major economies. UK earnings are expected to rise +21% in 2017 after a -2% drop in 2016. However, there is still uncertainty about the impact of Brexit on the economy and corporate earnings. Japanese earnings growth is expected to remain solid, around 10% in 2017 after 10% growth in 2016 with a boost from yen depreciation. Japanese earnings expectations have improved with the yen depreciating. Japanese earnings are also likely to benefit from the Abe government s fiscal stimulus which is expected to boost GDP growth in coming quarters. Further, financing costs are likely to remain attractive with the BoJ keeping bond yields low which should help companies keep financing costs under control. 2 For informational use only. Not intended as investment advice.
Emerging Markets earnings are expected to strengthen to around 13% in 2017 after 8% growth in 2016. EM Asia earnings are expected to strengthen to around 12% from around 2% while LatAm earnings are expected to rise 18% after rebounding 59% in 2016 following declines in the previous two years. EMEA earnings growth is expected to remain solid around 9% after 9% growth in 2016. 2) Strong U.S. GDP Growth with Trump Reflation likely to lift Global GDP Growth in 2017: The global economy ended Q4 2016 on a solid note and global growth is on track to strengthen in 2017 with stronger U.S. GDP growth fueled by Trump tax cuts, increased spending & supply-side reforms. GDP growth in Eurozone and U.K. is likely to be modest with ECB stimulus and curreny weakness boosting exports. Japanese GDP is expected to improve with export recovery on weak yen and fiscal stimulus. Emerging economies growth is likely to improve with steady growth in China, Brazil and Russia recover after deep recessions, India rebounds in H2 2017 after the currency demonetization drag in Q4 2016 and H1 2017, and higher oil & commodity prices boosts GDP growth in commodity exporters. U.S. GDP growth slowed to 1.9% annualized in Q4 (first estimate) from the solid 3.5% pace in Q3. The Q4 slowdown was largely driven by a big drag from trade as the boost to Q3 GDP from soybean exports was reversed in Q4. The headline GDP number exaggerates the slowdown as U.S. domestic demand remained solid with gross domestic purchases (GDP excluding trade) strengthening to 3.5% in Q4 from 2.6% in Q3 with rising investment spending and inventories offsetting a modest slowdown in consumption. Looking ahead to 2017, U.S. GDP growth is expected to strengthen driven by Trump tax cuts, reduced regulation and increased spending on infrastructure and defense. Eurozone GDP growth improved to 2% annualized in Q4 after Q3 growth was revised up to 1.6% (from 1.4%). Of the four countries reporting, Spain remained solid at 2.8%, while France strengthened to1.6% from 0.8% in Q3. Germany is on track to rebound to 2% after the Q3 weakness. Looking ahead to 2017, Eurozone GDP growth is expected to remain stable around 1.5% after an estimated 1.6% growth in 2016. GDP growth in 2017 is likely to be driven by consumption spending which is likely to be supported by falling unemployment. Further, exports are likely to improve with weaker Euro and stronger U.S. growth. However, elevated political uncertainty with elections in France, Germany, Netherlands & Czech Republic is likely to cast a shadow on investment spending. U.K. GDP grew 2.4% annualized in Q4, matching the pace from Q3. Full details are not yet available, but services were largely responsible for the solid Q4 growth. The U.K. economy remains resilient and weathered the Brexit impact with GDP growth slowing modestly to 2% in 2016. U.K. GDP growth is likely to slow to around 1.5% in 2017 with continued uncertainty about soft vs, hard Brexit. Japan s GDP growth is expected to remain stable in Q4 2016 and Q1 2017, around 1.2% annualized, after a stronger than expected 1.3% growth in Q3. Net exports are likely to remain solid and contribute positively to GDP growth with the yen depreciating. For full-year 2017, Japanese GDP is likely to grow around 1.2% in 2017 driven by a recovery in business investment spending and a boost to exports from weak yen. Among Emerging Economies, China s GDP growth is expected to be stable around 6.5% in 2017 with steady consumption and exports, but higher infrastructure spending. India s GDP growth is expected to slow in Q4 and H1 2017 with a drag from currency demonetization. However, growth is expected to rebound in H2 2017 with consumer spending remaining solid, RBI likely to cut interest rate further, and increased government infrastructure spending. Brazil is on track to emerge from recession with GDP expected to grow around 1% in 2017 with interest rate cuts, rising oil and commodity prices, and improving political environment enabling President Temer to pursue market-friendly reforms. Russia s GDP is expected to grow around 1.2% in 2017 benefitting from rising oil prices and recovering domestic demand with rate cuts. Taiwan s economy is expected to recover modestly to 1.8% in 2017 with strengthening exports. Mexican GDP growth is expected to slow to 1.8% in 2017 with rate hikes and trade uncertainty with the Trump administration policies. 3) Liquidity & Interest Rate Backdrop Remains Supportive but less Favorable than in 2017: The global liquidity and interest rate backdrop remains supportive but less favorable in 2017 than in 2016 as continued QE stimulus from the ECB and the BoJ is offset by Fed rate hikes. The Fed raised U.S. policy rates by 25bps in December, lifting the fed funds target range to between 0.5% and 0.75%. Looking ahead to 2017, the Fed remains on track to gradual, measured rate hikes and the Fed s dot plot indicates three rate hikes in 2017. The Trump administration s policies are likely to be reflationary with the potential to lead to inflationary pressures either from fiscal stimulus or trade policies. If 3 For informational use only. Not intended as investment advice.
the Trump administration's policies lead to higher inflation expectations, then the Fed could raise rates at a faster pace than the current expectations of three rate hikes in 2017. The ECB continues its QE buying in 2017, having extended the program from March 2017 to year-end. However, the ECB announced a slowing of the pace of purchases to 60bn per month from March from 80bn. At the January meeting, President Draghi downplayed the recent increase in headline inflation, attributing it to energy and food price base effects and signaled that the ECB would look through rise in headline inflation as there are no signs of rise in core inflation. Thus, the ECB is likely to continue QE buying in 2017, erring on the side of caution and not undertake premature tightening and short-circuit the fragile recovery. The BoE left monetary policy unchanged at the final meeting of 2016 in mid-december. The BoE is likely to remain on hold in 2017 but has left itself open to tighten or loosen policy depending on the impact of Brexit uncertainty on growth and the impact of the weaker Sterling on inflation. The Bank of Japan remained on hold in January keeping JGB yield target at 0%, and annual pace of JGB purchases at 80 trn. The BoJ is likely to keep policy unchanged and adopt a wait and see mode with the Fed on track to hike interest rates over the year. However, the BoJ might be prompted to step up monetary easing if inflation remains negative. Emerging central bank policies are likely to be mixed in 2017. Central banks in India, Brazil & Russia are likely to cut rates and undertake easing measures as falling inflation gives them scope to cut rates. China is expected to remain on hold and unlikely to expand stimulus due to concerns about financial stability. Taiwan, Korea, Hungary, Czech Republic and Poland are expected to remain on hold with improving growth outlook. Mexico is expected to raise rates further in tandem with the Fed and to keep the peso from weakening. Turkey is expected to raise rates to contain inflation and defend the currency. 4) Valuation Stock market P/E multiples rose across the major markets in December and further in January. The S&P 500 trailing P/E multiple rose to 20.96X in December from 20.55X in November with the index gaining 1.8% during the month. The U.S. P/E multiple rose further in January as U.S. stocks continued to post gains with the 1.4% rise in the S&P 500 index pushing the P/E multiple higher to 21.2X in January and remains well above the long-term average of 19.51X. The P/E multiple for Japanese stocks (TOPIX) rose to 19.8X in December from 19.15X in November with the index gaining 3.3% for the month. The multiple rose further to 20X in January with the index gaining 1%. In Eurozone, the STOXX P/E rose to 27.36X in December from 26.06X in November with the index up 5.7%. Further, the multiple increased to 27X in January with the index rising 0.3%. The Developed Markets (DM) P/E multiple remains above the long-term average of 20.5X (20 years average). Emerging Market (EM) stock valuations improved in December with the P/E easing to 14.34X from 14.6X in November with EM stocks down a -0.1% during the month. EM stock P/E multiples are still below their long term (20-year) historical average of 15X. Stocks-Bonds Earnings Yield Gap narrowed modestly in December and fell further in January with bond yields rising. The yield gap between U.S. stocks-bonds was unchanged at 2.33% in January after narrowing to 2.33% in December from 2.49% in November. Bottom-line: Global stock markets rose in January as markets awaited the announcement of new policies of the Trump administration. Earlier in December, global stock markets continued the post U.S. election rally on optimism that Trump tax cuts, reduced regulations and increased spending will boost corporate earnings and GDP growth in 2017. The Developed Markets index gained 1.5% in January (through the 30th) following the 6.8% gain in 2016 while Emerging Markets rose 4.3%, following the 7.1% gain in 2016. Looking ahead. the stock market gains are likely to be driven by: 1) Solid Q4 earnings and strong earnings growth in 2017 with boost to U.S. earnings from Trump corporate tax cuts and reduced regulation, strengthening GDP growth and a rebound in Energy & Materials earnings with higher oil and commodity prices. U.S. earnings are already recovering in H2 2016 and are likely to get an extra boost in 2017 from the Trump reflation, and rebound to over 12%, with risks to the upside. Earnings in Eurozone (+13%) and UK (+21%) are expected to rebound after the declines in 2016, while Japanese earnings (+10%) are expected to remain solid. Emerging Markets earnings are expected to strengthen in 2017 (+13%) driven by improvement in earnings growth across major emerging markets; 2) Improving global GDP growth with U.S. GDP growth strengthening from Trump s tax cuts and reforms, increased infrastructure and defense spending, and reduced regulations. GDP growth in Eurozone and U.K. is likely to remain modest with limited Brexit impact, ECB stimulus and currency weakness boosting exports. Japanese GDP is expected to improve with export 4 For informational use only. Not intended as investment advice.
recovery on weak yen, BoJ QE and fiscal stimulus. Emerging Economies growth is likely to improve with steady growth in China, recovery in Brazil and Russia from deep recessions, India rebounds after the currency demonetization drag on growth, and higher oil & commodity prices combined with U.S. infrastructure spending boosts Commodity exporters; 3) Liquidity & interest rate backdrop remains supportive but less favorable in 2017 as continued QE stimulus from the ECB and the BoJ is offset by rate hikes by the Fed. However, the Fed is likely to raise rates at a gradual and measured pace and has signaled three rate hikes in 2017. Further, the stimulus baton in the U.S. is passing from monetary to fiscal policy in 2017. Among Emerging Markets, falling inflation in some countries (India, Brazil, Russia) gives their central banks room to cut rates, while others (Mexico, Turkey) are likely to raise rates or remain on hold due to inflation pressures, or to keep pace with Fed rate hikes or to defend their currencies. However, valuations are not compelling / expensive limiting gains: Stock market valuations increased in 2016 with P/E multiples rising on a combination of price gains and weak earnings. P/E multiples in the developed markets are above or near long-term averages, though still below long-term average in the emerging markets. The relative attractiveness of stocks has also decreased with the earnings yield gap between stocks and bonds narrowing with a rise in bond yields and fall in equity earnings yield. However, stocks face several risks which could keep markets volatile. These include 1) Fed turning more hawkish in response to Trump fiscal stimulus increasing inflationary pressures; 2) Trump administration embarking on protectionist policies and trade conflicts; and 3) Brexit & European political uncertainty with elections in France, Germany, Netherlands, Czech Republic and risk of snap elections in Italy. Bond Yields Mixed in December. Yields likely to Remain Under Upward Pressure with Stronger U.S. GDP Growth with Trump Reflation, Risk of Aggressive Fed Tightening & ECB Taper, Rising Inflation Bond yields were mixed in January, rising in Eurozone & U.K., but flat in the U.S. and Japan. Eurozone yields rose 26bps to 0.46% in January, while U.K. yields jumped 38bps to 1.47%. U.S. yields rose 4bps to 2.48% in January, while Japanese yields rose 3bps to 0.07%. Earlier, yields were relatively flat in December after the sharp rise in November. Looking ahead, bond yields are likely to remain under upward pressure with: 1) Improving global growth with U.S. GDP growth strengthening to around 3% from Trump s tax cuts and reforms, increased infrastructure and defense spending, and reduced regulations. GDP growth in Eurozone and U.K. is likely to remain modest with limited Brexit impact, ECB stimulus and currency weakness boosting exports. Japanese GDP is expected to improve with export recovery on weak yen and BoJ QE stimulus; 2) Rate hikes with the Fed on track to raise rates three times in 2017. However, the Fed could raise rates more aggressively if U.S. inflation rises faster than expected with Trump reflation. The BoE is expected to remain on hold in 2017, but could be forced to hike rates if further Sterling weakness lead to higher inflation; 3) Inflation rising with higher oil and commodity prices from OPEC production cuts and fading base effects from earlier oil price declines. However, bonds remain supported by: 1) QE stimulus from the ECB & BoJ. The ECB continues its QE buying in 2017, having extended the program from March 2017 to year-end. President Draghi downplayed the recent increase in headline inflation, and signaled the ECB is unlikely to undertake premature tightening. The BoJ continues the purchase of JGBs so that the 10-year yield remains around 0%. The BoE is likely to remain on hold due to Brexit risks; 2) Safe haven demand from Brexit and European political uncertainty with elections in France, Germany, Netherlands, Czech Republic and risk of snap elections in Italy. Investment Strategy: Asset Allocation: Equity Rally to Continue with Stronger Earnings Growth & Improved GDP Growth Stocks - Keep Overweight as the stock market rally is likely to continue, driven by solid Q4 earnings and with a boost to 2017 U.S. earnings from Trump tax cuts and reduced regulation, improving U.S. growth with Trump s reflation, ECB and BoJ continuing QE, and rate cuts by some Emerging central banks. Bonds Remain Underweight as yields are likely to remain under upward pressure with U.S. GDP growth strengthening with Trump stimulus, modest GDP growth in Eurozone, U.K. and Japan, the Fed on track for three rate hikes in 2017, and inflation inching higher. 5 For informational use only. Not intended as investment advice.
Global Equity Strategy: Remain Overweight in U.S. & Emerging Markets, raise Japan to Modest Overweight & remain Underweight in Eurozone & U.K. U.S.: Remain Overweight as the rally is likely to continue with stronger earnings & GDP growth with Trump tax cuts, reduced regulations and increased spending. However, the risk of aggressive Fed rate hikes could cut short the rally. Emerging Markets: Remain Modest Overweight with improving earnings outlook, rate cuts by some EM central banks. Emerging economies growth is likely to improve modestly with steady growth in China, Brazil and Russia recover. However, risk of reduced capital flows is a negative. Japan: Raise to Modest Overweight with solid earnings and recent yen depreciation further boosting earnings, and BoJ continues QE buying. However, GDP growth remains modest. U.K.: Remain Modest Underweight as further BoE stimulus less-likely with inflation risk on Sterling plunge, hard or soft Brexit uncertainty. Eurozone: Keep Modest Underweight with modest GDP growth, elevated political uncertainty with a heavy election calendar. ECB continues QE buying but risk of QE taper tantrum with rising inflation. Global Bond Market Strategy: Yields remain under Upward Pressure with GDP Rebound, Trump Stimulus & Fed Tightening Japan JGBs: Modest Overweight with JGB yields likely to remain low with inflation remaining low, modest GDP growth and BoJ continuing QE. EM Debt: Modest Overweight with improving growth outlook with China stable, Brazil and Russia recover from recessions, rate cuts likely in some Emerging Markets with falling inflation. However, risk of continued capital outflows with higher Treasury yields and strong dollar. Eurozone: Remain Neutral with modest GDP growth, and the ECB continuing QE asset purchases. Rise in headline inflation unlikely to prompt ECB to taper QE as core inflation remains low. U.K. Gilts: Modest Underweight with risk of rising inflation from sterling weakness, Brexit uncertainty, BoE easing unlikely but slowing GDP growth. U.S. Treasuries: Modest Underweight as Treasury yields likely to remain under pressure with boost to U.S. GDP growth from Trump stimulus, Fed continues rate hikes and risk of more aggressive rate hikes if Trump stimulus fuels inflation. Global Sector Strategy: Overweight: Financials; Modest Overweight: Energy, Materials, Industrials & Information Technology; Neutral: Healthcare, Consumer Discretionary & Telecomms; Underweight: Consumer Staples, Real Estate & Utilities. Follow us on Twitter: www.twitter.com/prustrategist 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. 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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. 2017 Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo and the Rock symbol are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide. 6 For informational use only. Not intended as investment advice.