PRUDENTIAL INTERNATIONAL INVESTMENTS ADVISERS, LLC. Global Investment Outlook April 2014 Stocks to Rebound & Post Further Gains as Global Growth Strengthens after Q1 Soft Patch, Earnings Rebound, Low Interest Rates & Gradual QE Taper. Escalating Ukraine Crisis & Other Emerging Market Uncertainties Pose Near-term Risks Bond Yields Likely to Rise as GDP Growth Strengthens after Soft Q1 & No Fresh ECB, BoJ Stimulus. Low Inflation, Low Rates & Measured Fed QE Taper, & Ukraine Safe Haven Demand Likely to Limit Rise in Yields John Praveen, PhD Chief Investment Strategist John Praveen s Global Investment Outlook April 2014 expects stock markets to remain volatile in the near-term with heightened Ukraine risks, China growth concerns, and other Emerging Market uncertainties. Looking beyond these near-term risks, global equity markets are likely to rebound and post gains in 2014 fuelled by favorable interest rate backdrop, global GDP rebound, solid earnings outlook and reasonable valuations. Stocks: After a rocky January, stocks rebounded in February with the Fed reassuring that U.S. rates will remain low for an extended period, ECB signaling fresh stimulus in March, and on growing confidence of a growth rebound after the Q1 weakness. Developed markets gained 4.8% in February while Emerging markets rose 3.2%. Markets struggled in early March as the Ukraine tensions morphed into global geo-political crisis. Through March 20th, developed markets declined -1.3% and the emerging markets index fell -2.7%. Looking beyond the near-term risks in Ukraine, China and other Emerging Markets, we expect equity markets to post further gains in 2014 driven by: 1) Continued favorable interest rate backdrop with low interest rates and liquidity support; 2) Global growth remains on track to strengthen after the Q1 soft patch with solid growth in the U.S., U.K. and Japan, a steady recovery in the Eurozone, and Emerging economies stabilizing; 3) Earnings rebound as GDP growth improves and margins remain healthy; and 4) Valuations remain reasonable with P/E multiples still below long-term averages. FOR MORE INFORMATION CONTACT: Theresa Miller Phone: 973-802-7455 Email: theresa.miller@ prudential.com Bonds: Developed market bond yields were flat in February as the equity rebound was offset by the escalating Ukraine crisis. EM yields fell with equity rebound and easing risks. Looking ahead, bond yields are likely to rise again with upward pressure from: 1) Global growth on track to strengthen after the Q1 soft patch; 2) The Fed continues QE taper, the ECB and BoJ refraining from providing fresh stimulus despite Eurozone deflation risks and the tax hike in Japan; and 3) Easing of global risks and improving risk appetite as the Ukraine crisis deescalates and EM turmoil eases. However, the rise in bond yields is likely to be limited by: 1) Inflation remaining low in Eurozone and U.S; 2) The Fed pledging to keep U.S. policy accommodative for an extended period, dropping the 6.5% unemployment threshold, and the ECB and BoJ may be forced to provide fresh stimulus with Eurozone deflation risks and to offset the impact of the April tax hike in Japan. 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 Rebound in February on Expectations of ECB Stimulus & Growth Rebound. Stocks Fall in Early March as Ukraine Crisis Escalates. Stocks to Rebound as Growth Recovery after Q1 Soft Patch & Earnings Rebound, Fair Valuations, Low Interest Rates & Gradual QE Taper Bond Yields Likely to Rise as GDP Growth Strengthens after Soft Q1 & No Fresh ECB & BoJ Stimulus Stock Market Outlook (April 2014): After a rocky January when emerging market struggles caused a big market correction, stocks rebounded in February with new Fed Chair Yellen reassuring that QE taper will be measured and U.S. rates will remain low for an extended period, ECB signaling it is likely to undertake fresh stimulus in March, and Emerging market currencies stabilized as their central banks raised rates. Further, markets began to look beyond the Q1 soft patch with growing confidence of a growth rebound in the U.S. and globally after the Q1 weakness. Developed markets gained 4.8% (US$) in February after falling -3.8% in February. The U.S. S&P 500 index rose 4.3% in February reaching a new record high (1878) on expectations of GDP rebound in Q2 after weather distortions depress Q1 GDP. Further, U.S. Q4 earnings were strong as 65% of the S&P 500 companies beat expectations. The Eurozone gained 7% in February after declining -4.8% in January as Eurozone recovery remained on track after ending 2013 on a healthy note, and on expectations of fresh ECB stimulus in March. Japanese stocks declined -0.5% in February as the yen strengthened and the BoJ indicated that fresh stimulus was unlikely, in the near-term. Emerging markets gained 3.2% in February after the -6.6% decline in January. Emerging market stocks were helped by stabilization in currencies. Emerging Asia gained 3.2%, Emerging Europe (EMEA) gained 3.1% and Latin America gained 2.2%. Gains in EM Asia were led by Indonesia (10.2%), Philippines (9.5%), Thailand (4.3%) and Malaysia (3.8%). China (2.6%) and India (2.2%) underperformed. EMEA gains were led by Greece (17.1%), Poland (12%) and South Africa (9.2%). Russia was a drag (-2.4%). Latin American gains were led by Argentina (19.4%), Chile (8.4%) and Colombia (3.8%). Brazil (-0.5%) and Mexico (-4.7%) continued to underperform. Following the February rally, markets struggled in March as the Ukraine tensions morphed into global geo-political crisis with Russia annexing Crimea after a rigged referendum, the U.S. and Europe threatening to impose tougher sanctions, and potential Russian retaliation by cutting off gas supplies to Europe (which depends on Russia for 30% of gas supplies). Fears about China growth and credit defaults were another nagging concern. However, markets recovered some of the losses following the Crimea referendum (March 16). Through March 20th, the developed markets declined -1.3% and the emerging markets index fell -2.7%. Looking beyond the near-term Ukraine risks, China growth and credit concerns, and other Emerging Market uncertainties, we expect global equity markets to post further gains in 2014 driven by: 1) Continued favorable interest rate and liquidity backdrop; 2) Global growth on track to strengthen after the Q1 soft patch; 3) Earnings rebound as GDP growth improves & healthy margins; 4) Valuations still remain reasonable. 1) Favorable Interest Rate Backdrop & Liquidity Support: The interest rate backdrop remains supportive of stocks, despite no fresh stimulus from the ECB and the BoJ and several Emerging central banks raising rates. The U.S. Federal Reserve continues its gradual, measured taper, cutting asset purchases by another $10bn to $55bn from $65bn at the March meeting. The Fed also modified its forward guidance shifting from quantitative targets to qualitative assessment. The Fed s revised qualitative forward guidance will now take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Fed statement also indicated that even when the economy is near full employment and inflation is near target, economic conditions may warrant keeping rates low for an extended period. 2 For informational use only. Not intended as investment advice.
While the ECB refrained from providing fresh stimulus at the March meeting, ECB President Draghi assured that the ECB would be ready to employ all its instruments to provide fresh stimulus. The ECB expects inflation to average 1% in 2014, 1.3% in 2015, and 1.5% in 2016, meaning that inflation remains below the ECB s 2% target for the next two years. Eurozone deflation risks are increasing and may force the ECB to provide fresh stimulus over the next few months. The BoE left U.K. monetary policy unchanged at their early March meeting. With inflation declining to 1.9% YoY in January, the BoE is likely to remain for hold in 2014. The Bank of Japan left interest policy unchanged at its March meeting and did not increase asset purchases to offset the impact of the April tax hike. The BoJ maintained its headline economic assessment of gradual recovery in Japan. Among Emerging Central Banks, Brazil, India, Russia, Turkey & South Africa remain in tightening mode. China has been on hold but financial conditions have tightened. Other emerging central banks in Asia (Taiwan, Korea), Eastern Europe (Poland, Hungary and Czech Republic) and Latin America (Mexico) remain on hold. 2) Global Growth on Track to Strengthen after Q1 Soft Patch: Despite soft macro data in early 2014 in the U.S. and China, global GDP growth remains on track to strengthen in 2014 after the Q1 soft patch. The U.S. economy hit a spot patch in early 2014 with severe winter storms taking a toll on consumer and business investment spending. Further, inventories are also expected to be a big drag on Q1 GDP, a payback for the strong contributions to growth in H2 2013. U.S. GDP growth in Q1 2014 is tracking around 1.7%. However, U.S. GDP growth is expected to rebound in Q2 to around 3%, once the economy gets past the weather-related distortions in Q1. The Eurozone economy remains in a steady, but modest, recovery in 2014 after ending 2013 on a healthy note. The ECB continues to see a gradual recovery with GDP growth improving from 1.2% in 2014 (revised up from 1.1% in the December forecast). Economic indicators in early 2014 are positive with improving business confidence and outlook for consumer spending. Earlier, Eurozone Q4 GDP growth strengthened to 1.1% QoQ annualized from 0.6% in Q3. Japan s Q4 GDP growth was revised down to 0.2% QoQ (0.7% annualized), from initially reported 0.3% QoQ (1.0% annualized). While headline Q4 GDP disappointed, real domestic demand (GDP less trade) grew 3.0% YoY, while net exports were a big drag. However, Japan s GDP is expected to accelerate to over 3% in Q1, fuelled by frontloading of demand ahead of the April VAT hike. At its March meeting, the BoJ maintained its headline economic assessment, ( recover gradually ) and upgraded its outlook for capex and industrial production. The U.K. economy remains solid and GDP growth is expected to strengthen to over 3% in Q1 after 2.9% in Q4. The BoE raised its 2014 GDP forecast to 3.2% from 2.4% driven by solid investment spending. Growth in the emerging economies remains soft in early 2014 as severe winter storms depressed export demand from developed economies, while China data remains soft. A rebound in the U.S. and China after the Q1 soft patch could jump-start EM exports and boost GDP growth. Domestic demand in the EM remains subdued with rate hikes, political turmoil and lack of fiscal stimulus. China s economic activity disappointed in early 2014 with IP, Fixed Asset Investment (FAI) and retail sales, all weaker than expected. However, the official GDP target for 2014 was reaffirmed at 7.5% by Premier Li Keqiang at the National People s Congress in early March. GDP growth slowed in late 2013 in India (4.7% YoY), Taiwan (2.8%), Brazil (1.9%) and Mexico (0.7%). 3) Earnings Rebound after Q1 Soft Patch: Earnings growth remains on track to rebound as global growth strengthens after the Q1 soft patch. However, earnings outlook for Q1 has been revised down in line with downgrades to Q1 GDP growth expectations, especially in the U.S. Reflecting the Q1 earnings downward revision, earnings growth for full year 2014 has been revised lower to 10% YoY from expectations of around 11% earlier in the year. U.S. Q4 earnings season is ending with earnings growth tracking 9.6% for the quarter with 65% of the companies beating expectations. Solid 3 For informational use only. Not intended as investment advice.
margins were the key driver with companies pursuing efficiency gains and operating leverage while revenue growth remained modest at just 1%. Earnings expectations for Q1 2014 have been revised down to just 3% from 6.5% at the beginning of the year with U.S. Q1 GDP growth tracking under 2%. Eurozone earnings remain on track to rebound with around 12% growth in 2014 driven by improving GDP growth. European earnings growth for Q4 2013 are tracking just 0.5%, but are expected to improve to around 9% in Q1 2014 with favorable base effects and improving economy. Japanese earnings growth for 2014 has been revised lower to around 13% with earnings growth driven by solid GDP growth and weak yen. However, strengthening yen carries risk to Japanese earnings growth. Emerging Markets earnings growth is expected around 9% in 2014 after 4% in 2013 as GDP growth stabilizes and improves over the year. 4) Valuations Remain Reasonable: Stock market P/E multiples rose during February as equity markets posted strong gains during the month to erase January losses. However, developed markets are still reasonably valued, while emerging markets are cheap. The P/E multiple for the Developed Markets rose to 17.9X in February, in line with valuations at the end of 2013, from 17.4X in January. While current stock market valuations are well above the levels seen in early 2013 due to strong stock market, gains, valuations still remain well below their historical averages with Developed Market P/E multiples below their long term average of 21.2X. Emerging Market stock valuations rose modestly to 11.9X in February from 11.6X in January and still well below valuation levels of 12.8X seen in early 2013. Bottom-line: After a rocky January, stocks rebounded sharply in February with Fed reassurance that QE taper will be measured and U.S. rates will remain low for an extended period, the ECB signaling fresh stimulus in March, and Emerging market currencies stabilized as their central banks raised rates. Further, markets began to look beyond the Q1 soft patch with growing confidence of a growth rebound after the Q1 weakness. Developed markets gained 4.8% in February after falling -3.8% in February. Emerging markets rose 3.2% after falling -6.6% in January. Following the February rally, markets struggled in March as the Ukraine tensions morphed into global geo-political crisis with the risk of tougher U.S. & European sanctions and Russian retaliation. Fears about China growth and credit defaults also weighed on markets. Through March 20th, the developed markets declined -1.3% and the emerging markets index fell -2.7%. Looking beyond the near-term Ukraine risks, China growth and credit market concerns and other Emerging Market uncertainties, we expect global equity markets to post further gains in 2014 driven by: 1) Continued favorable interest rate and liquidity backdrop with the U.S. Fed continuing its measured QE taper, and reassuring that U.S. rates will remain low for an extended period, even after the unemployment rate falls below 6.5%. The ECB assuring that it stands ready to provide fresh stimulus if the economic recovery falters. With Eurozone deflation risks increasing, the ECB may be forced to provide fresh stimulus over the next few months. The Bank of Japan may also be forced to increase stimulus to offset the impact of the April tax hike. Among Emerging Central Banks, while some (Brazil, India, Russia, Turkey & South Africa) remains in tightening mode, others remain on hold (China, Taiwan, Korea, Poland, Hungary, Czech Republic and Mexico); 2) Global growth remains on track to strengthen after Q1 soft patch with U.S. GDP growth expected to rebound in Q2 from the weak Q1. The Eurozone remains in a steady, but modest, recovery in 2014. U.K. GDP growth expected to strengthen in 2014. Japan s GDP is expected to rebound in Q1 with frontloading of demand ahead of the April VAT hike. While China s economic data was weak in early 2014, the National People s Congress in early March reaffirmed the official GDP target for 2014 at 7.5%; 3) Earnings Rebound after Q1 Soft Patch: Earnings growth remains on track to rebound to around 10% as global growth strengthens after the Q1 soft patch; 4) Valuations remain reasonable. While P/E multiples rose in February as equity markets posted strong gains, developed markets are still reasonably valued and still below long term average. Emerging markets are still cheap as their P/E multiples remain well below long-term averages, given their 2013 declines. 4 For informational use only. Not intended as investment advice.
However, the escalating Ukraine crisis poses risks to markets and the global recovery. Following the Russian annexation of Crimea, the potential for further Putin adventures in Eastern Ukraine, the U.S. and Europe threatening tougher sanctions, and potential Russian retaliation by cutting off gas supplies to Europe could short circuit the European and global recovery and lead to a market sell-off. Fears about China growth and credit defaults are another nagging concern. Market volatility is also likely to remain elevated until markets see evidence of strengthening GDP growth and are convinced that Fed will keep U.S. rates low for an extended period despite QE taper. These risks are likely to keep markets volatile in the near-term. Nonetheless, continued favorable interest rate backdrop, global GDP rebound beyond the soft Q1, solid earnings outlook and reasonable valuations are likely to lift stocks higher, beyond the near-term risks in Ukraine, China concerns and other Emerging Market uncertainties. Bond Market Outlook: Developed Bond Yields Flat, EM Yields Decline in February. Yields Likely to Rise as GDP Growth Strengthens Developed market bond yields were flat in February as the equity rebound was offset by the escalating Ukraine crisis. EM yields fell with equity rebound and easing risks. Looking ahead, bond yields are likely to rise again with upward pressure from: 1) Global growth on track to strengthen after the Q1 soft patch with solid Q2 GDP growth in the U.S., U.K. and Japan, steady recovery in Eurozone, and Emerging Economies stabilizing; 2) The Fed continues QE taper, albeit at a gradual, measured pace, the ECB and BoJ refraining from providing fresh stimulus despite Eurozone deflation risks and the tax hike in Japan; and 3) Easing of global risks and improving risk appetite as Ukraine crisis de-escalates and EM turmoil eases. However, the rise in bond yields is likely to be limited by: 1) Inflation remaining low in Eurozone and U.S; 2) The Fed pledging to keep U.S. policy accommodative for an extended period, dropping the 6.5% unemployment threshold, and the ECB and BoJ may be forced to provide fresh stimulus with Eurozone deflation risks and to offset the impact of the April tax hike in Japan. Investment Strategy: Stocks Stabilize in February, Struggle in March on Escalating Ukraine Crisis. Stocks to Rebound as GDP Growth Strengthens, Earnings Rebound, Low Rates & Gradual QE Taper Asset Allocation: Stocks vs. Bonds Remain Overweight in Stocks but keep Modest Overweight with Ukraine Risks & Emerging Market Uncertainties Stocks Equities rebounded in February on growing confidence of a growth rebound after the soft Q1. Markets struggled in early March with the escalating Ukraine crisis. Looking beyond the Ukraine crisis, we expect stocks to post further gains in 2014 driven by continued favorable interest rate backdrop, global growth rebound beyond the Q1 soft patch, solid earnings outlook and reasonable valuations. However, we keep a modest overweight in stocks due to the Ukraine risks, China growth concerns and other Emerging Market uncertainties. Bonds Keep bonds at modest underweight as yields are likely to rise again with global GDP growth rebound after the soft Q1, the Fed continues QE taper, no fresh stimulus from the ECB and BoJ, and bond valuations remain expensive relative to stocks. Global Equity Market Strategy: Tactically Reduce Eurozone & U.K. to Neutral on Ukraine Risks & Raise U.S. to Modest Overweight as Safe Haven Eurozone: Tactically lower to Neutral with increased Ukraine risks and no fresh ECB stimulus. Remain strategically positive on Eurozone. UK: Tactically lower to Neutral with escalating Ukraine risks & earnings downgrades. Remain strategically positive with solid growth outlook. 5 For informational use only. Not intended as investment advice.
US: Tactically upgrade to Modest Overweight on safe haven gains from escalating Ukraine crisis. Strategically neutral/underweight with limited scope for P/E expansion. Japan: Lower to Underweight as the BoJ refrains from easing to offset April tax hike, while yen strength and tax hike are risks to GDP growth and stocks. Emerging Markets: Remain Underweight as Ukraine crisis escalates, fears about China growth & credit markets and other EM uncertainties. Global Bond Market Strategy: Yields likely to Rise again as Global Growth Strengthens after Q1 Soft Patch & No Fresh ECB Stimulus Eurozone: Remain Overweight with low inflation and modest GDP growth. Potential for fresh ECB stimulus with deflation risks rising. Japan JGBs: Neutral as BoJ does not expand asset purchases and Q1 GDP to rebound after weak Q4. Low inflation & weak Q2 growth positive for JGBs. U.S. Treasuries: Neutral with GDP rebound after soft Q1 and Fed continuing QE taper, but offset by low inflation and potential safe haven demand from Ukraine crisis. Emerging Market Debt: Underweight as political concerns in several Emerging Markets reduces risk appetite. Improving global GDP growth outlook a positive for EM debt. U.K. Gilts: Remain Underweight as yields under pressure from solid GDP growth and further BoE stimulus unlikely. Global Sector Strategy: Overweight: Industrials; Modest Overweight: Info. Technology & Financials; Neutral: Energy, Telecommunication Services, Healthcare, Materials; Underweight: Consumer Discretionary, Consumer Staples & Utilities. Currency Strategy: Overweight: Euro & Sterling; Neutral: Yen & U.S. Dollar; Underweight: EM Currencies. 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. 2014 Prudential Financial, Inc. and it related entities. Prudential, the Prudential logo and the Rock symbol are service marks of Prudential Financial, Inc. and it related entities, registered in many jurisdictions worldwide. 6 For informational use only. Not intended as investment advice.