PRUDENTIAL INTERNATIONAL INVESTMENTS ADVISERS, LLC. Global Investment Outlook & Strategy March 2016 Stocks likely to Recover Further with Improving Growth & Recession Fears Easing, Fresh Stimulus from ECB, BoJ & China, Emerging Central Banks Ease with Fed Rate Hikes on Pause, Improved Valuations & Modest Earnings Growth Bonds Supported by Modest GDP Growth, Low Inflation, Safe Haven Demand, ECB-BoJ Easing & Fed Rate Hikes on Pause John Praveen s Global Investment Outlook for March 2016 expects global stock markets to continue to stabilize and recover following the sell-off in early 2016 with growth improving & easing of recession fears, favorable interest rate & liquidity backdrop with fresh stimulus from ECB, BoJ & PBoC and Fed on hold in March, attractive valuations and modest earnings growth. John Praveen, PhD Chief Investment Strategist Stocks: After the carnage in January, global stock markets posted a smaller decline in February with developed markets down -1.7% while Emerging market (EM) stocks were flat. Stocks rallied in early March with easing of recession fears, oil prices recovering from multi year lows, and further stimulus expectations from the ECB & BoJ. Developed market stocks gained 4.2% (as of March 11th), trimming YTD losses to -3.2%. Emerging markets rallied 5.6%, trimming YTD losses to 0%. Looking ahead, further stock market stabilization and recovery is likely to be driven by: 1) Fresh Draghi-Kuroda Put, China Easing & Fed Rate Hikes on Pause, BoE Hikes Delayed, Rate Cuts in India & Other EMs: The global liquidity and interest rate backdrop has turned favorable with fresh stimulus from the ECB, the Bank of Japan and China s PBoC. Further, the Fed is likely to delay the next rate hike, opening a window for Emerging central banks to sneak in a few rate cuts to support domestic growth; 2) Recession Fears Easing with Slower but Improving Global Growth: After the growth scare in early 2016, recession fears have began to ease with macro data pointing to GDP growth rebound in the U.S., U.K. and Japan, while Eurozone growth remains modest but steady. The Emerging economies growth outlook remains mixed with China trying to stabilize, India improving but Brazil and Russia in recession; 3) Improved Valuations as equity P/E multiples have declined with the recent market correction. In addition, the decline in bond yields has increased the relative attractiveness of stocks with the earning yield gap widening; 4) Modest Earnings Growth: Global earnings growth expectations continue to be revised down on slower GDP growth. FOR MORE INFORMATION CONTACT: Theresa Miller Phone: 973-802-7455 Email: theresa.miller@ prudential.com Bonds: Global bond yields continued to decline in February with recession fears, the BoJ cutting rates to negative, the ECB set to expand QE stimulus, and the Fed likely to delay rate hikes. Looking ahead, bonds remain supported by: 1) Fresh QE Stimulus: The ECB delivered an aggressive stimulus package in March. The BoJ is likely to adopt further easing measures and the Fed is likely to pause rate hikes; 2) Low inflation in the U.S., Eurozone, U.K. and Japan with weak oil prices renewing deflation fears; 3) Modest Growth in Japan and Eurozone, and risk of a negative feedback loop from oil induced stress in the credit markets and banking system into the real economy; and 4) Safe haven demand with Brexit risk, geopolitical tensions and terrorism fears. However, yields could face modest upward pressure from: 1) Easing of Recession Fears with macro data pointing to GDP growth rebound in the U.S., U.K. and Japan, while Eurozone growth remains modest; 2) Bond valuations remain expensive relative to stocks with the sharp decline in bond yields. 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 Stabilize After Early 2016 Turbulence. Stocks likely to Recover with ECB Rate Cut & QE Expansion in March, BoJ likely to Expand QQE, Fresh Stimulus from China, Emerging Central Banks Ease with Fed Rate Hikes on Pause. Recession Fears Ease Bond Yields Decline Further in February on Recession Fears, Central Bank Easing & Equity Volatility. Bonds Supported by Modest Growth, Low Inflation, Safe Haven Demand & ECB-BoJ Easing Stock Market Outlook (March): After the January/early February carnage, global stock markets stabilized in late February and rallied into early March with recession fears easing on improved macro data, oil prices recovering from multi year lows, positive signals from China s National People's Congress, and expectations of further stimulus from the ECB & BoJ. US stocks (S&P 500) gained 4.7% (as of March 11th), trimming YTD losses to - 1.1%, with the gains led by the Energy sector as oil prices troughed. Eurozone stocks rose 4.1% following the ECB meeting, trimming YTD losses to -5.7%. Japanese stocks gained a solid 4.8% as the yen weakened. Developed market stocks gained 4.2% (as of March 11th), trimming YTD losses to -3.2%. Emerging market (EM) stocks rallied 5.6% in March, trimming YTD losses to a modest 0%. Looking ahead, global equity markets are likely to continue to improve with recession fears easing, fresh stimulus from the ECB, the PBoC and the BoJ, the Fed putting rate hikes on pause giving room for Emerging Central banks to provide stimulus. In addition, valuations have improved as stock P/E multiples declined while the fall in bond yields have improved the relative attractiveness of stocks. Finally, the earnings outlook remains positive, excluding the energy sector. 1) Liquidity & Interest Rate Backdrop Remains Favorable with Fresh Draghi-Kuroda Put, China Easing & Fed Rate Hikes on Pause, BoE Hikes Delayed, Rate Cuts in India & Other EMs: After the interest rate jitters in late 2015- early 2016 following Fed rate lift-off in December, the global liquidity and interest rate backdrop has again turned favorable with fresh stimulus from the ECB, the BoJ and PBoC and the Fed hitting the pause button on its rate normalization process. Meanwhile, the BoE remains on hold, indefinitely in 2016. In addition, the Fed delaying further rate hikes open a window for Emerging central banks to sneak in a few rate cuts to support domestic growth. In Europe, the ECB delivered an aggressive stimulus package at its March 10th meeting with broad-based rate cuts and expansion of QE purchases to boost growth & lift inflation to target. The ECB cut all Eurozone interest rates, lowering the deposit rate by another -10bps (to -0.4% from -0.3%), and cutting the refinancing rate and marginal lending rate by 5 bps each taking the refinancing rate to zero & marginal lending rate to 0.25%. In addition, the ECB increased monthly QE asset purchases by 20bn to 80bn (from April) and expanded QE buying to corporate non-bank investment grade debt. The ECB staff revised down Eurozone macro forecasts with GDP growth of 1.4% (2016), 1.7% (2017) & 1.8% (2018) and inflation at 0.1%, 1.3% and 1.6%, respectively. The Fed is due to meet next on March 16th. The minutes of the Fed s January meeting and Statements by Fed Governors indicate the Fed remains concerned about negative impact of weakening Chinese growth and depressed oil prices on U.S. GDP growth, and the importance of taking international feedback loops fully into account when calibrating U.S. monetary policy. Given the recent turmoil in financial markets and further policy easing by the ECB, BoJ and China s PBoC and their impact on the U.S. economy and the dollar, the Fed is likely to delay further rate hikes. The BoJ is likely to announce additional easing measures in the coming months as Japanese GDP growth remains modest and inflation remains low. Further, the yen has appreciated sharply in the past two months offsetting the impact of negative interest rate which the BoJ introduced in January. The negative interest rates were designed to stimulate lending by taxing idle bank reserves, lower the yield curve and borrowing costs and also put downward pressure on the yen. The BoJ is likely to adopt further easing measures in June after confirming its economic outlook. The BoJ is expected to further cut policy interest rate to -30 bps from -10 bps and further increase ETF purchases. The BoE meets next on March 17th and is expected to leave monetary policy unchanged. With recent 2 For informational use only. Not intended as investment advice.
downgrades to U.K. GDP growth and inflation forecasts, and uncertainty about U.K. referendum on EU membership and risk of Brexit, the BoE is likely to remain on hold and rate hikes are likely pushed out indefinitely into late 2016. China s PBoC provided fresh stimulus after the Lunar New Year break, cutting the required reserve ratio (RRR) by -50bps on February 29th. The rate cut is expected to release around RMB 700bn of liquidity. This should counter some of the ongoing capital outflows and help lower short-term rates which spiked recently. In addition to PBoC measures, Premier Li, in a speech at the G20 meeting, stated that China will increase aggregate demand, strengthen structural reform efforts and implement measures to foster healthy and stable development of capital markets. The PBoC is expected to provide further stimulus through cuts in RRR and policy rates. Some other Emerging central banks are likely to ease, others are on hold, except Mexico which raised rates in mid-february to defend the peso against further depreciation. 2) Recession Fears Easing with Q1 GDP Rebound in U.S., U.K. & Japan, Steady Growth in Eurozone; Emerging Economies Mixed with China Stabilizing, India Improving but Brazil & Russia remain in Recession: Financial markets were rocked by recession fears in early 2016 with the U.S. and U.K. hitting a soft patch in late 2015 and Japan continued to struggle. The relentless decline in oil price in late 2015 to below $35 and further to below $30 in early 2016 stoked fears about weak demand and the health of the global economy even though 80% of global GDP is produced in oil importing countries who stand to benefit from lower oil prices. The oil price plunge also took a toll on energy Capex with a collapse in drilling activity and shale implosion. Also fuelling growth concerns were fears of a negative feedback loop into the real economy from stress in the credit markets and banking sector with energy exposure, just as the sub-prime crisis morphed into the great recession in 2008. The disappointing Q4 GDP data pointed to slowing growth momentum and added to recession fears. However, recession fears have began to ease with macro data in early 2016 pointing to GDP growth rebound in the U.S., U.K. and Japan, while Eurozone growth remains modest but steady. Growth in China remains around 6.5%, while India is on track to improve. U.S. GDP growth is on track to rebound to around 2% in Q1 with solid consumer spending, inventory rebuild and smaller drag from investment spending. The U.S. labor market remains solid with the economy adding over 200,000 jobs per month in early 2016 and the unemployment rate remains low at 4.9%. Further, while business confidence remains soft, it is improving with ISM manufacturing index inching back toward the 50 level and the ISM services remains above 50. Further, Q4 GDP was revised higher pointing to better momentum. Eurozone GDP grew 1.2% QoQ annualized in Q4, with modest growth, around 1%, in Germany, France, Italy, Portugal and Netherlands and stronger growth in Spain (3.2%), but a decline in Greece (-2.4%). Looking ahead, Eurozone Q1 GDP is expected to remain steady around 1.5% with consumption spending supported by rising retail sales and falling unemployment. U.K. GDP is expected to rise 2.2% QoQ annualized in Q1, improving from 2% in Q4, supported by consumer spending while investment spending remains soft. Japan s Q4 GDP was revised higher to a smaller contraction of -1.1% annualized from the initial estimate of -1.4%. Japanese GDP growth is expected to rebound to around 2% in Q1 2016, driven by a recovery in consumption spending, business investment spending remaining solid and with net exports expected to be net positive due to sharply lower imports. The Emerging economies growth outlook remains mixed with China stabilizing, India improving but Brazil and Russia in recession. China s macro data for early 2016 (delayed due to Chinese New Year) are likely to show a slow start to 2016. China s National People s Congress (NPC) in March 2016 set real GDP growth target between 6.5-7% with Premier Li saying that this growth pace will allow China to create sufficient jobs and maintain a stable labor market. India s GDP growth is expected to improve to over 7.5% driven by solid consumption spending, improving business investment spending and higher government spending. Brazilian economy remains in recession with GDP sinking -5.9% YoY in Q4. GDP is expected to decline -4% in 2016, after contracting -3.8% in 2015, with fiscal consolidation, weak investment spending, and high unemployment. Mexican GDP growth is expected to remain stable at the 2.5% pace in Q1 with continued support from consumer spending. Russia s economy continues to deteriorate with recent data showing weakness in industry, retail trade and services. 3 For informational use only. Not intended as investment advice.
3) Global Earnings Outlook Continues to be Revised Lower with Slower Global Growth: Global earnings growth expectations continue to be revised down on slower global growth. Current expectations are for earnings to grow a modest 4% in 2016. The Q4 earnings season finished on a positive note with earnings declining a smaller-than-expected -3.4%. However, earnings growth is expected to remain negative in the H1 before rebounding in H2 2016. Eurozone earnings outlook has been further revised lower due to slower GDP growth outlook but remains supported by the euro depreciation and ECB easing measures. Japanese earnings growth expectations for 2016 remain solid, around 10% driven by the weak yen, low oil and commodity prices, and modest wage growth. Emerging Markets earnings outlook has been further cut down to 4% for 2016 from earlier expectations of 7% growth as Chinese growth expectations have been revised down further. 4) Valuations Improve as Equity P/E Multiples Ease in February on Stock Market Declines: The Developed Markets (DM) P/E multiple declined further in February to 17.62X from 17.95X in January and 19.02X in December as the MSCI World Index declined -1.7% for the month. DM valuations are well below the long-term average of 20.43X (20 years average). Emerging Market (EM) stock valuations inched down to 12.61X in February from 12.66X in January with EM stocks remaining flat for the month. The current EM multiple is well below its long term (20-year) historical average of 15.05X. The valuation discount between EM and DM stocks has tightened slightly to 5.0X from 5.29X due to a larger decline in DM valuation multiple in February relative to EM. Stocks more attractive relative to Bonds as Earnings Yield Gap Widens with Stocks Declining & Bond Yields Falling. The relative attractiveness of stocks continues to improve with falling bond yields causing the earnings yield gap (EYG) between stocks and bonds to widen. The earnings yield on U.S. stocks increased modestly to 5.72% in February from 5.70% in January while the 10-year Treasury yield dropped to 1.73% from 1.92% in January. The yield gap between U.S. stocks-bonds rose to 3.98% in February from 3.78% in January, well above its long-term (20-year) average of 2.0%. Eurozone stocks remain cheap relative to bonds on EYG basis with the yield gap tightening slightly to 3.84% from 3.87% as the yield on Eurozone stocks fell to 3.95% in February from 4.2% in January while the 10-year Bund yield fell to 0.11% from 0.32% in January. The Eurozone EYG remains well above its long-term average of 3.5% (10-year average). The Japanese stocks earnings yield gap rose sharply to 7.01% at the end of February from 6.19% in January, well above its long-term 10-year average of 4.2%. Bottom-line: After the January carnage, global stock markets posted a smaller decline in February with developed markets down -1.7%, led by Japan (-9.4%) but with smaller declines in Eurozone (-3.2%) and the U.S. (-0.4%). Emerging market (EM) stocks were flat for the month after declining -5.3% in January. Gains in Latin America (2.6%) and Emerging Europe (0.8%) were offset by losses in Emerging Asia (-0.8%). Stocks rallied in early March with easing of recession fears, oil prices recovering from multi year lows, and further stimulus expectations from the ECB & BoJ. Developed market stocks gained 4.2% (as of March 11th), trimming YTD losses to -3.2%. Emerging market rallied 5.6%, trimming YTD losses to 0%. Further stock market stabilization and recovery is likely to be driven by: 1) Fresh Draghi-Kuroda Put, China Easing & Fed Rate Hikes on Pause, BoE Hikes Delayed, Rate Cuts in India & Other EMs: After the interest rate jitters in late 2015 and early 2016 following Fed rate lift-off in December, the global liquidity and interest rate backdrop has again turned favorable with fresh stimulus from the ECB, the BoJ and PBoC. Further the Fed is likely to delay the next rate hike, opening a window for Emerging central banks to sneak in a few rate cuts to support domestic growth; 2) Recession Fears Easing with Slower but Improving Global Growth: After the growth scare in early 2016, recession fears have began to ease with macro data pointing to GDP growth rebound in the U.S., U.K. and Japan, while Eurozone growth remains modest but steady. Growth in China remains around 6.5%, while India is on track to improve. After the Q4 disappointment, U.S. GDP growth is on track to rebound to around 2% in Q1 with solid consumer spending, inventory rebuild and smaller drag from investment spending. Eurozone GDP growth is expected to remains steady around 1.5% in Q1 with modest growth in Germany, France, Italy, Portugal and Netherlands and stronger growth in Spain. U.K. GDP is expected to improve in Q1 while Japan is expected to rebound after the Q4 contraction. The Emerging economies growth outlook remains mixed with China trying to stabilize, India improving but Brazil and Russia in recession; 3) Improved 4 For informational use only. Not intended as investment advice.
Valuations as equity P/E multiples have declined with the recent market correction. In addition, the decline in bond yields has increased the relative attractiveness of stocks with the earning yield gap widening; 4) Modest Earnings Growth: Global earnings growth expectations continue to be revised down on slower GDP growth. Current expectations are for earnings to grow a modest 4% in 2016. U.S. earnings are expected to grow 4% in 2016 on slower U.S. GDP growth as well as lower oil and commodity prices. Eurozone and Japanese earnings outlook remains solid with weak currency tailwinds. Emerging Markets earnings are expected to recover to around 4% in 2016 after the -8% decline in 2015. However, stocks are likely to remain volatile with: a) Continued oil price uncertainty and lingering fears about the negative feedback loop into the real economy from the oil-induced stress in the credit market and banking system; b) Concerns about Chinese growth (level and mix), currency fluctuations and policy-makers ability to stabilize markets and engineer a smooth landing; c) Questions about the banking system especially the NPL problem and impact of negative interest rates; d) Risk of U.K. leaving the EU ( Brexit ) in case of a NO Vote in the U.K. referendum on EU membership; e) Heightened geo-political tensions. Bond Market Outlook: Yields Fall in February on Recession Fears. Bonds Supported by Modest GDP, Low Inflation, Safe Haven Bid Global bond yields continued to decline in February. Yields fell sharply in early February on safe haven demand with recession fears, concerns about stress in the banking system, and global equity markets falling. Yields were also under downward pressure with the BoJ cutting rates to negative, the ECB signaling QE expansion in March, and the Fed likely to pause in its rate normalization process. Low inflation and weak oil prices added to downward pressure on yields. Bond yields rose in late February with easing recession fears and equity markets starting to stabilize. At the end of February, U.S. 10-year treasury yields declined to 1.74% (from 1.92%), Eurozone yields fell to 0.11% (from 0.32%), and U.K yields sunk to 1.34% (from 1.56%). Japanese yields turned negative, falling to -0.07% from 0.10%. Looking ahead, bonds remain supported by: 1) Fresh QE Stimulus: The ECB delivered an aggressive stimulus package at its March meeting with broad-based rate cuts and QE expansion. The BoJ is likely to adopt further easing measures after the January rate cut. The Fed is likely to pause its rate normalization process, and the BoE remains on hold; 2) Low inflation in the U.S., Eurozone, U.K. and Japan with weak oil prices renewing deflation fears; 3) Modest Growth in Japan and Eurozone, and risk of a negative feedback loop from oil induced stress in the credit markets and banking system into the real economy; and 4) Safe haven demand with Brexit risk, geopolitical tensions and terrorism fears. However, yields could face modest upward pressure from: 1) Easing of Recession Fears with macro data pointing to GDP growth rebound in the U.S., U.K. and Japan, while Eurozone growth remains modest but steady; 2) Bond valuations remain expensive relative to stocks with the sharp decline in bond yields. Investment Strategy: Asset Allocation: Stocks vs. Bonds - Stocks to Recover with Easing Recession Fears, ECB-BoJ Put. Bonds supported by Modest Growth Stocks Modest Overweight with further market recovery likely on easing recession fears with improving GDP growth in the U.S. & U.K., Japan recovery and Eurozone steady, fresh stimulus from ECB, BoJ & China, Fed rate hikes on pause, improved valuations & modest earnings growth. However, oil price volatility and China concerns remain risks. Hence modest overweight. Bonds - Modest Overweight as bonds remain supported by modest GDP growth, low inflation, ECB-BoJ easing & Fed delaying rate hikes, safe haven demand on Brexit fears and elevated geopolitical tensions. Global Equity Strategy: Remain Overweight in Eurozone; Lower Japan to Neutral. Keep EM Asia at Neutral, Raise Latin America & EM Europe to Neutral; Keep U.K. at Neutral; Lower U.S. to Underweight 5 For informational use only. Not intended as investment advice.
Eurozone: Remain overweight with ECB s aggressive stimulus package of rate cuts & QE expansion, solid earnings, modest but improving GDP. Japan: Lower to Neutral as further BoJ stimulus & solid earnings growth offset by risk of strengthening yen and growth disappointment. Emerging Markets: Keep EM Asia at Neutral with China uncertainty offset by rate cuts in India & other EM; Raise LatAm & EM Europe to Neutral with Brazil in recession but heading toward resolution of the Dilma impeachment proceedings, oil & commodity prices stabilizing. U.K.: Remain Neutral with BoE rate hikes pushed out further into late 2016 and Q1 GDP rebound offset by Brexit risk. U.S.: Lower to Underweight on reduced safe haven demand as markets trying to stabilize. Fed rate hikes on pause, GDP rebound after weak Q4, healthy earnings excluding Energy, improved valuations. Further strong dollar headwinds and weak energy earnings remain drags. Global Bond Market Strategy: Yields Fall in February on Growth Fears. Bonds Supported by Modest GDP, Low Inflation, Safe Haven Bid Eurozone: Remain Overweight with ECB s aggressive stimulus package of rate cuts & QE expansion, low inflation and modest GDP growth. Japan JGBs: Modest Overweight with BoJ likely to expand QE after January rate cut, low inflation and modest GDP growth. U.K. Gilts: Remain Neutral with Q1 GDP rebound offset by low inflation, BoE rate hikes pushed out further into late 2016 & Brexit risk. EM Debt: Raise to Neutral with China stimulus, other EM rate cuts with Fed on hold, Brazil in recession but heading toward political resolution offset by slower capital flows & modest GDP growth. U.S. Treasuries: Modest Underweight with U.S. GDP rebound in Q1 after soft Q4 but offset by Fed rate hikes on pause, safe haven demand. Global Sector Strategy: Overweight: Consumer Discretionary & Information Technology; Modest Overweight: Industrials; Neutral: Energy, Materials, Healthcare, Financials; Underweight: Consumer Staples, Telecomms & 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. 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. 2016 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.