PRUDENTIAL INTERNATIONAL INVESTMENTS ADVISERS, LLC. Global Investment Outlook & Strategy April 2017 Stock Markets likely to Grind Higher as Expectations of Strong Earnings Growth & Improving Global GDP Growth offset by Uncertainty about Trump Tax Cuts & Stimulus Plans. Progress on Trump s Reflation Agenda likely to be Catalyst for Next Leg of the Equity Rally Stock markets are likely to grind higher in the near-term as optimism about stronger earnings growth and improving GDP growth is tempered by uncertainty about Trump s pro-growth agenda after the ACA repeal set-back. However, progress on Trump s tax cuts and stimulus plans is likely to be the catalyst for the next leg of the equity rally. John Praveen, PhD Chief Investment Strategist Stocks: Equity markets were volatile in March, with a brief relief rally with the Fed striking a dovish tone at the March meeting, despite raising rates. Stocks sold off in late March as the Trump administration failed to repeal the Affordable Care Act (ACA) raising concerns about the approval of Trump tax cuts and spending plans. However, stocks rebounded at monthend. Developed markets rose 1.0% in March (through the 30 th ), taking 2017 YTD gains to 5.2%. Emerging Markets gained 2.4% in March taking YTD gains to 8.1%. Despite the March setback, stock markets are likely to grind higher driven by: 1) Strong Earnings Growth with global earnings expected to rise around 13% in 2017 with improved GDP growth, and a boost to U.S. earnings from Trump tax cuts and reduced regulations; 2) Improved Global Growth with stronger U.S. GDP growth fueled by Trump stimulus, while U.K. and Eurozone remain on track to improved growth. Japanese GDP is expected to remain steady with export recovery. Emerging economies growth is on track to improve; 3) Liquidity & Interest Rate Support despite Central Bank Policy Divergence: Developed central bank policies are diverging with the Fed raising rates, while the ECB and the BoJ continue to provide QE stimulus, and the BoE remains on hold. Among Emerging central banks, rate cuts in Brazil, Russia and some economies, are offset by rate hikes or rates on hold in others. However, equity valuations have become expensive and are likely to be headwinds for further gains. In addition, stocks continue to face risks including: 1) Delays or setback in approval of Trump tax cuts or spending plans; 2) The Fed turning hawkish in response to rising inflationary pressures from Trump stimulus; 3) The Trump administration pursuing protectionist policies; and 4) Brexit & French elections uncertainty. Despite these near-term concerns, progress on Trump s tax cuts and stimulus plans is likely to be the catalyst for the next leg of the equity rally. FOR MORE INFORMATION CONTACT: Mayura Hooper Phone: 973-367-7930 Email: Mayura.hooper@ prudential.com Bond Outlook: Bond yields rose in early March with Fed signaling a March rate hike. However, yields fell with the Trump administration unable to repeal the ACA. Looking ahead, bond yields are likely to range-trade in the near-term, while remaining under upward pressure in the medium-term. In the near-term, bond yields are likely to trade in a range with: 1) Headline Inflation likely to ease as base effects of the sharp decline in oil prices in early 2016 fall out of calculation; 2) Safe Haven Demand with French elections uncertainties; 3) Soft Q1 GDP Growth: While GDP growth is on track to improve in H2 2017, Q1 GDP growth may be soft; and 4) Central Bank Support with the ECB and BoJ continuing QE buying, while the Fed remains dovish despite raising rates in March. In the medium-term, bond yields are likely to remain under upward pressure with: 1) Improved Global Growth with U.S. GDP growth strengthening in H2 2017 fueled by Trump stimulus, while Eurozone and U.K. are on track to improved growth; 2) Risk of Aggressive Fed Rate Hikes if inflation pressures increase, and ECB starting QE taper in H2 2017. 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: Stock Markets likely to Grind Higher as Expectations of Strong Earnings Growth & Improving Global Growth offset by Uncertainty about Trump s Pro-Growth Agenda. Progress on Trump Tax Cuts & Stimulus Plans likely to be Catalyst for Next Leg of the Rally Bond Yields likely to Range-trade in Near-term with Soft Q1 GDP Growth, Pull back in Headline Inflation & Safe Haven Demand from French Election Concerns Stock Market Outlook (March-April): The global stock market rally slowed in early March as markets braced for the Fed rate hike at its March meeting, awaited details about Trump s stimulus plans, and oil prices weakened. Stocks enjoyed a brief relief rally with the Fed striking a dovish tone at the March meeting, despite raising rates. However, stocks sold off in late March as the Trump administration was unable to repeal the Affordable Care Act, raising concerns about the approval of Trump tax cuts and increased spending, despite Republican control of both House and Senate. Stocks recovered at month-end with improved U.S. macro data. Developed markets rose 1.0% in March (through the 30 th ), taking 2017 YTD gains to 5.2%. Emerging Markets gained 2.4% in March taking YTD gains to 8.1%. After a strong rally since U.S. elections, stock markets are likely to grind higher in the near-term as optimism about stronger earnings growth and improving global GDP growth is tempered by uncertainty about Trump administration s reflation agenda. However, progress on Trump s tax cuts and stimulus plans is likely to be the catalyst for the next leg of the equity rally. Further stock market gains are likely to be driven by: 1) Strong earnings growth with improved GDP growth and boost to U.S. earnings from Trump tax cuts & reduced regulations; 2) Improved global growth as strong U.S. GDP growth likely to lift other developed & emerging economies; 3) Liquidity & interest rate support despite central bank policy divergence. 1) Strong Earnings Growth in 2017 with Improved GDP Growth & Boost to U.S. Earnings from Trump Reflation: Global earnings growth are expected to post a strong recovery in 2017, rising around 13%, after a modest 3% increase in 2016. The U.S. Q4 earnings season is ending with corporate results coming out better than expected and earnings on track to rise 7.8% YoY after rising 4.3% in Q3. U.S. earnings are expected to strengthen to over 11% growth in 2017 with upside risks. Corporate earnings are expected to benefit from the likely approval of Trump tax cuts and reduced regulations. GDP growth is expected to strengthen over the year, providing support to revenue growth. Further, corporate margins are likely to widen with tax cuts and reduced regulations. Energy and Material sector earnings have started benefiting from the rise in commodity prices and likely to strengthen in coming quarters. Financials earnings are likely to benefit from better interest margins with the Fed hiking rates in March and likely to hike further over 2017. Eurozone earnings are expected to grow around 13% in 2017 after declining -1% in 2016. Earnings growth is expected to be supported by the rebound in Energy sector earnings, while Industrials are expected to be the drag. Sales growth expectations are increasing after the stronger than expected sales growth in Q4 with the weak euro supporting exports and sales. Eurozone Q4 2016 earnings posted a strong 15.1% YoY rebound after declining -5% in Q3. Japanese earnings growth for 2017 is expected to strengthen to around 13% after 12% in 2016 with a boost from the yen depreciation. Japanese earnings are also likely to benefit from a pickup in sales growth with global growth on track to strengthen in 2017 and with the government s fiscal stimulus expected to provide support to GDP growth. In addition, the weak yen is likely to provide a boost to exporters. Financing costs for corporates remain low with the BoJ continuing its QE asset purchases. Banks are likely to benefit from the BoJ s yield curve policies which are keeping it steep and improving the profitability of banks. Emerging Markets earnings growth is expected to strengthen to around 16% in 2017 after around 8% earnings in 2016. EM Asia earnings growth has been revised higher to around 15% after 3% in 2016. Latin American earnings are expected to rise 20% in 2017 after 56% jump in 2016, while EMEA earnings growth is expected around 9% for 2017. 2) Improved Global GDP Growth: The global growth outlook continues to improve with stronger U.S. GDP growth fueled by Trump tax cuts, increased spending and reduced regulation. Eurozone and U.K. growth remain on track to improved growth in 2017 with ECB stimulus, euro and sterling weakness boosting exports. Japanese GDP is expected to remain steady with export recovery on weak yen and fiscal stimulus. Emerging economies growth is on track to improve. 2 For informational use only. Not intended as investment advice.
The U.S. economy remains healthy with Q1 GDP growth expected around 2.0% annualized pace after 2.1% growth in Q4. Domestic demand remains solid with rising retail sales, an improving labor market, consumer confidence at a record high, and strengthening business confidence with ISM indexes at high levels. Further, the Trump administration s tax cuts, reduced regulations and increased spending are expected to boost growth in H2. President Trump has proposed a $1 trillion infrastructure spending plan and a $54bn increase in defense spending, while the Treasury is working on plans for corporate and personal tax cuts. Earlier, U.S. Q4 GDP growth was revised up to 2.1% in the third estimate. Eurozone GDP is expected to grow at a healthy pace in 2017, around 1.8% with solid domestic demand and a boost to export from the weak Euro and stronger global growth. At its March meeting, the ECB was more upbeat on Eurozone economic outlook and revised up Eurozone growth forecasts, with GDP expected to rise 1.8% in 2017 (1.7% earlier). Eurozone investment spending outlook is positive with strengthening business confidence, while consumer spending is supported by low unemployment with Eurozone unemployment at its lowest level since 2009. The U.K. economy remains resilient, defying expectations of a slowdown as the Brexit impact remains smaller than expected, thus far. U.K. Q4 GDP growth was revised up to 2.8% annualized from 2.4% initially reported. However, U.K. GDP growth is on track to slow to around 2% in Q1 with increased Brexit uncertainty with the May Government triggering Article 50 of the Lisbon Treaty on March 29 th, setting in motion Brexit talks with the EU. Japanese GDP growth is expected to improve to around 1.2% in Q1 2017 from 1% in Q4 2016 and strengthen further over the year, driven by improving business investment spending and exports while consumption spending remains modest. Among Emerging Economies, China s GDP growth is expected to be stable around 6.5% in 2017 and data for January-February is showing a solid start to 2017. India s GDP growth is on track to rebound faster than expected from the currency demonetization drag in late 2016, driven by solid consumer spending, pickup in industrial activity and increased government infrastructure spending. Brazil remains on track to emerge from recession with modest GDP growth in Q1 2017 as aggressive rate cuts spur investment spending, and the boost to exports from the recovery in commodity prices and weak Real. The Russian economy continues to improve following the contraction in 2016 with recovering oil prices, higher real wages, improving consumer confidence and strengthening Ruble. Taiwan s GDP growth is expected to remain solid in Q1 2017 as industrial production and export growth remain resilient with strong demand for electronic components. Mexican GDP is expected to grow around 2.5% in 2017, driven by healthy consumption. However, rate hikes and trade uncertainty with the Trump administration are negatives. 3) Central Bank Policy Divergence in Developed & Emerging Markets: After synchronized rate cuts and QE stimulus measures over the last several years, Developed central bank policies are diverging with the Fed raising rates, while the ECB and the BoJ continue to provide QE stimulus, and the BoE remains on hold. Emerging central banks are also mixed as falling inflation (Brazil & Russia) gives their central banks room to cut rates, while some EM central banks are likely to remain on hold (China, India, Indonesia, Hungary & Poland), and others are likely to raise rates on inflation concerns or to keep pace with Fed hikes (Mexico & Turkey). The Fed raised the Funds rate by 25bps at its March meeting as fully choreographed and widely expected. The Fed s dot plot was largely unchanged with the median of interest rate projections still indicating three rate hikes in 2017 (including the March hike) and three hikes in 2018. The Fed struck a dovish tone regarding the pace of future rate increases stating that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate. The ECB continues its QE buying in 2017, at a reduced pace of 60bn per month from April. At the March meeting, the ECB President Draghi was more upbeat on Eurozone economic outlook. However, despite the improved growth outlook and easing of deflation concerns, the ECB reiterated its commitment to continuing QE buying through 2017. In addition, President Draghi reaffirmed that interest rates are likely to remain at present or lower levels for an extended period, well past the horizon of the net asset purchases. The BoE left monetary policy unchanged at their March meeting. However, several members expressed concerns about inflation. Thus, while the BoE is expected to remain on hold in 2017, rising inflation and a smaller impact from Brexit could prompt the bank to raise rates earlier than had been previously expected. The BoJ remained on hold in March. The bank is likely to keep policy unchanged in the near term with inflation still below the BoJ s target despite turning positive recently and as the bank monitors the impact of the Spring wage negotiations on inflation. 3 For informational use only. Not intended as investment advice.
Emerging central bank policies remain mixed in H1 2017. Central banks in Brazil, Russia and other EMs are likely to cut rates. China tweaked policy, moving to a neutral/tightening bias while in India, the RBI has moved to a neutral stance and is likely to remain on hold in the near-term. Taiwan, Korea, Indonesia, Hungary, Czech Republic and Poland are expected to remain on hold with an 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) Equity Valuations have become Expensive, likely to be Headwinds to Further Market Gains: While markets are likely to be supported by strong earnings and strengthening GDP growth, equity valuations have become expensive and are likely to be headwinds for further market gains. Stock market P/E multiples continue to rise with price gains and weakness in earnings in 2016. The trailing P/E multiple for the S&P 500 index was stable at 21.8X in March (through the 30 th ) from 21.8X in February but up from 21.0X in January, with the index flat on the month in March. The U.S. P/E multiple remains above its long-term average of 19.52X. The P/E multiple for Japanese stocks (TOPIX) was 18.5X in March, unchanged from February and higher than the 18.4X recorded in January with the index declining a modest -0.5% in March after 0.9% gains in February. In Eurozone, the STOXX P/E rose to 26.4X in March from 24.4X in February and 24.2X in January with the index gaining 2.76% and 2.81% respectively in March and February. The Developed Markets (MSCI World Index) P/E multiple rose to 22.5X in February from 21.1X in January. DM valuations remain above the long-term average of 20.5X (20 years average). Emerging Market (EM) stock valuations rose in February to 15.1X from 14.9X in January with EM stocks rising 1.6% during the month. EM stock P/E multiples are now in line with their long term (20-year) historical average of 15.0X. The Stocks-Bonds Earnings Yield Gap narrowed in February with bond yields rising. The yield gap between U.S. stocks-bonds widened to 2.3% in March from 2.2% in February and 2.3% in January. Bottom-line: Equity markets were volatile in March, with a brief relief rally after the Fed s March meeting, but sold off in late March as the Trump administration failed to repeal the Affordable Care Act. Stocks recovered at month-end with improved U.S. macro data. Developed markets rose 1.0% in March (through the 30 th ), taking 2017 YTD gains to 5.2%. Emerging Markets gained 2.4% in March taking YTD gains to 8.1%. Despite the March setback, stock markets are likely to grind higher driven by: 1) Strong Earnings Growth with global earnings expected to rise around 13%. U.S. corporate earnings are expected to strengthen to over 11% in 2017 with upside risks (from just 1% in 2016) with stronger GDP growth and a boost to U.S. earnings from Trump tax cuts and reduced regulations. Earnings in the Eurozone (+15%) and UK (+22%) are expected to rebound after the declines in 2016, while Japanese earnings are expected to strengthen to 13% with weak yen. Emerging Markets earnings are expected to strengthen in 2017 to around 16% with improving GDP growth and rising commodity prices; 2) Improved Global Growth with stronger U.S. GDP growth fueled by Trump stimulus. Eurozone and U.K. remain on track to improved growth. Japanese GDP growth is expected to remain steady with export recovery on weak yen. Emerging economies growth is on track to improve; 3) Liquidity & Interest Rate Support despite Central Bank Policy Divergence: After synchronized rate cuts and QE stimulus measures over the last several years, developed central bank policies are diverging with the Fed raising rates, while the ECB and the BoJ continue to provide QE stimulus, and the BoE remains on hold. The Fed raised rates by 25bps in March and remains on track to raise rate two more times in 2017, but at a gradual pace. The ECB continues its QE buying in 2017 at a lowered pace of 60bn from April. The ECB reassured in March that interest rates are likely to remain at present or lower levels for an extended period. The BoE is likely to remain on hold in 2017, but rising inflation and a smaller impact from Brexit could prompt the BoE to raise rates earlier than expected. The BoJ is likely to keep policy unchanged with inflation on a slow trajectory towards the bank s target. Among Emerging Markets, falling inflation is leading to rate cuts in Brazil & Russia, while Mexico and Turkey are likely to raise rates on inflation concerns or to keep pace with Fed hikes. Other EM central banks are likely to remain on hold. While markets are likely to be supported by strong earnings and improving GDP growth, equity valuations have become expensive and are likely to be headwinds for further gains. Stock market P/E multiples continue to rise on a combination of strong price gains and weak earnings. P/E multiples in most markets are above or near long-term averages. 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. In addition, stocks continue to face risks 4 For informational use only. Not intended as investment advice.
which could keep markets volatile. These include: 1) Delay or set back in approval of Trump tax cuts, or spending plans; 2) The Fed turning hawkish in response to increasing inflationary pressures from Trump stimulus; 3) The Trump administration embarking on protectionist policies leading to trade conflicts; and 4) Brexit & European elections uncertainty, especially in France. Despite these near-term concerns, progress on Trump s tax cuts and stimulus plans is likely to be the catalyst for the next leg of the equity rally. Bond Yields Ease in March. Yields likely to Range-trade in Near-term but Under Upward Pressure in Medium-term with Stronger GDP Growth, Risk of More Aggressive Fed Tightening & ECB QE Taper Bond yields rose in early March with rising inflation and Fed officials signaling a March rate hike. However, yields fell as Fed statement was dovish, after raising rates. Yields fell further with the Trump administration unable to repeal the Affordable Care Act, raising concerns about the approval of Trump tax cuts and increased spending. U.S. yields (10-year Treasury) fell to 2.4% (through March 30 th ), pulling back from a high of 2.63%. Looking ahead, bonds yields are likely to range-trade in the near-term, while remaining under upward pressure in the medium-term. In the near-term, bond yields are likely to trade in a range with: 1) Easing Headline Inflation: The recent rise in headline inflation is due to the base effects of the sharp decline in oil prices in early 2016. As these fall out of calculation, inflation should retrace some of the recent increase; 2) Safe Haven Demand with European elections uncertainty, especially in France; 3) Soft Q1 GDP Growth: While GDP growth is on track to improve in H2 2017, Q1 GDP growth may be soft and bond friendly; and 4) Central Bank Support with the ECB and BoJ continuing QE buying, while the Fed remains dovish despite raising rates in March. In the medium-term, bonds yields are likely to remain under upward pressure with: 1) Improved Global Growth with U.S. GDP growth on track to strengthen in H2 2017 fueled by Trump tax cuts, increased infrastructure and defense spending and reduced regulations. Eurozone and U.K. remain on track to improved growth in 2017. The ECB and BoE revised up their forecast for Eurozone and U.K. growth reflecting healthier domestic demand and stronger global conditions; 2) Risk of Aggressive Fed Rate Hikes & ECB QE Taper: While the Fed tone in March was dovish and it remains on track to raise rates two more times in 2017, Fed could turn hawkish and raise rates more aggressively if U.S. inflation rises further with Trump reflation. The BoE is likely to remain on hold in 2017, but rising inflation and a smaller impact from Brexit could prompt the BoE to raise rates earlier than expected. While the ECB reiterated its commitment to continuing QE buying through 2017, improved GDP growth and higher inflation could force the ECB to consider QE taper well before 2017 end. Investment Strategy: Asset Allocation: Slower Equity Gains as Strong Earnings & Improved GDP offset by Trump Policy Uncertainty Stocks: Keep Overweight with equity markets likely to grind higher as optimism about stronger earnings and improving GDP growth is tempered by uncertainty about the Trump tax cuts and stimulus plans. Progress on Trump reflation agenda likely to be the catalyst for the next leg of the equity rally. Bonds: Remain Underweight as yields are likely to range-trade in the near-term with inflation reversal and slower Q1 GDP. Yields remain under upward pressure in medium-term with improved global GDP growth, risk of more aggressive Fed rate hikes and ECB QE taper. Global Equity Strategy: Modest Overweight in U.S., Emerging Markets & Japan, Underweight in Eurozone & U.K. U.S.: Modest Overweight as the equity rally is likely to continue, though at a slower pace, with stronger earnings & GDP growth with Trump tax cuts, reduced regulations and increased spending. However, uncertainty of approval of Trump agenda and risk of Fed turning hawkish could slow the rally. 5 For informational use only. Not intended as investment advice.
Emerging Markets: Remain Modest Overweight with improving earnings and GDP growth outlook, but central banks policies are mixed with rate cuts in Brazil & Russia and rate hikes in Mexico and Turkey. Further, Fed turning hawkish and dollar strength remain risks. Japan: Remain Modest Overweight with solid earnings and weak yen further boosting earnings and BoJ continues QE buying. However, GDP growth remains modest. U.K.: Remain Modest Underweight on Brexit uncertainty with the May Government triggering Article 50 of the Lisbon Treaty on March 29 th, setting in motion Brexit talks, rising inflation and risk of BoE raising rates earlier than expected. Eurozone: Keep Modest Underweight with modest GDP growth, elevated political uncertainty, especially with French elections, ECB continues QE buying but risk of QE taper with rising inflation. Global Bond Market Strategy: Yields likely to Range-trade in Near-term but under Upward Pressure in Medium-term with Stronger Growth Japan JGBs: Modest Overweight with BoJ continuing QE, inflation turns positive but low relative to other markets, and modest GDP growth. EM Debt: Modest Overweight on improving growth outlook with China stable, India rebounds, Brazil and Russia recover. However, central bank policies mixed with rate cuts in some EMs and rate hikes in others. Further, risk of capital outflows if Fed turns hawkish and dollar resumes uptrend. Eurozone: Remain Neutral with modest GDP growth, and the ECB continuing QE asset purchases. However, rising inflation could force the ECB to taper QE earlier than 2017 year-end. U.S. Treasuries: Tactically Raise to Neutral as yields likely to range-trade in the near-term with the Fed dovish, inflation likely to ease and risk of soft Q1 GDP. However, yields likely to be under upward pressure in medium-term with GDP strengthening with Trump stimulus and risk of Fed turning hawkish. U.K. Gilts: Modest Underweight as rising inflation could prompt the BoE to hike rates earlier than expected. Brexit uncertainty as the May Government initiated Brexit talks by triggering Article 50 of the Lisbon Treaty on March 29 th. Global Sector Strategy: Overweight: Financials, Info Tech; Modest Overweight: Energy, Materials & Industrials; 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. 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. 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.