PRUDENTIAL INTERNATIONAL INVESTMENTS ADVISERS, LLC. Global Investment Outlook December 2013 Financial Market Outlook: Stock Rally Continues with Fed Taper Delay, ECB Rate Cut & Further Easing Likely, Improving GDP Growth, Solid Q3 Earnings Growth & Easing Risks in Middle East & Europe. Bond Yields under Modest Upward Pressure with Improving GDP Growth & Easing Global Risks. Yield Rise Limited with Low Inflation, ECB Rate Cut & Further ECB Easing Measures, Fed QE Taper Delay. John Praveen, PhD Chief Investment Strategist John Praveen s Global Investment Outlook December 2013 expects the equity market rally to continue in the near-term with the Fed delaying QE Taper, the ECB cutting rates and likely to undertake further easing to ward off deflationary pressures in Eurozone, improving H2 GDP growth, solid Q3 earnings growth, stocks rerated with easing of risks in Europe and the Middle East. Stocks: Global equity markets were very volatile in October with a sharp correction in early October following the U.S. Government shut-down and risk of a debt default. However, markets recovered as the Congress and White House agreed on a short-term extension of the debt ceiling, averting a debt default, for now. The equity rally continued in early November with a surprise rate cut by the ECB, improving economic data and better-than-expected Q3 earnings in the U.S. and Europe. Through mid-november (18th), the Developed Market index is up 23.3% YTD, while the Emerging Market index is up 2%. Looking ahead, the equity rally is likely to continue in the near-term with: 1) Interest rate tail winds persisting; 2) The global recovery remains on track to improve in Q4; 3) Earnings outlook remains solid; 4) Equity multiples rise as stocks rerated with easing of global risks but valuations are not yet stretched; 5) Easing of Eurozone risks; and 6) improving risk appetite with easing of Middle East tensions. FOR MORE INFORMATION CONTACT: Theresa Miller Phone: 973-802-7455 Email: theresa.miller@ prudential.com Bonds: Global bond yields continued to decline in October with Fed QE taper delay and inflation continuing to decline. Looking ahead, bond yields are likely to come under renewed upward pressure from: 1) GDP growth in the U.S. and Eurozone remain on track to strengthen, while growth remains solid in Japan; & 2) Bond valuations remain expensive relative to stocks. However, the rise in yields is likely to be limited by: 1) Low inflation in the Eurozone (0.7%) and U.S. (1.2%) with the risk of Eurozone slipping into deflation; 2) Further rate cuts and other unconventional easing measures by the ECB to ward off disinflationary pressures; the Fed unlikely to begin QE taper in December; 3) The U.S. government shut-down expected to depress U.S. Q4 GDP growth. 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 Rally Continues with Fed QE Taper Delay, ECB Rate Cut & Further Easing Likely, Improving GDP Growth, Solid Q3 Earnings Growth & Easing Risks in Middle East & Europe. Bond Yields under Modest Upward Pressure with Improving Growth & Easing Risks. Yield Rise Limited with Low Inflation, Further ECB Easing Measures & QE Taper Delay. Stock Market Outlook (November 2013): Global stocks markets were very volatile in October with a sharp correction in early October following the U.S. Government shutdown and risk of a debt default. However, markets recovered as the Congress and White House agreed on a short-term extension of the debt ceiling, averting a debt default, for now. Markets were also supported by the nomination of Janet Yellen as the next Chair of the Federal Reserve. In Europe, Italy pulled back from the brink as Prime Minister Letta s fragile coalition survived confidence vote. However, in Germany, Chancellor Merkel remained in protracted negotiations to find a coalition partner. In late October, markets got a boost from solid Q3 earnings reports from several U.S. and European companies. The developed market (MSCI World) index rose 3.9% (LC) in October, taking YTD gains to 21.4%. The U.S. (S&P 500) gained 4.5% taking YTD gains to 23.2%. Japan was flat on the month for YTD gains of 38.8%. Eurozone gained 5.7% to take YTD gains to 17.4%. Emerging markets gained 3.9% in October following 3.6% rise in September. The gains in the past two months helped the emerging market index to post YTD gains 2.1% wiping out losses from earlier in the year. The emerging market gains were led by Latin America which rose 4.3% in October with outperformance in Argentina (7.9%), Peru (7.7%) and Brazil (5.6%). EMEA gained 4.1% led by Czech Republic (9.8%), Egypt (9.8%) and Poland (5.7%). EM Asia underperformed the other emerging markets rising 3.8% with gains in India (8.4%), Philippines (7.1%), Pakistan (6.6%) and Indonesia (6.3%). The equity rally continued in early November with a surprise rate cut by the ECB, improving economic data and better-than-expected Q3 earnings in the U.S. and Europe. The ECB surprised markets by cutting the policy rate to new record low of 0.25% (from 0.5%) as plunge in October Eurozone inflation to 0.7% raised the specter of disinflation. U.S. Q3 GDP surprised on the upside, growing 2.8% annualized after 2.5% in Q2. Business confidence continues to rise in all regions. The Global Composite PMI rose from 53.3 to 55.5 in October with gains in both manufacturing and services activity and pointing to a good start of Q4. Through mid-november (18th), the Developed Market index is up 23.3% LC YTD, while the Emerging Market index is up 2%. Looking ahead, the equity rally is likely to continue as stocks remain supported by: 1) Interest rate tail winds persisting; 2) The global recovery remains on track to improve; 3) Earnings outlook remains solid; 4) Equity multiples rise as stocks rerated with easing of global risks but valuations are not yet stretched; 5) Easing of Eurozone risks; and 6) improving risk appetite with easing of Middle East tensions. Interest Rate Tail Winds Persist; Fed QE Taper Delayed to December/Early 2014. ECB Surprise Rate Cut with Eurozone Deflation Risk. BoJ Continues QE, BoE on Extended Hold. Emerging Central Banks Unwind Tightening: The Fed left policy unchanged at their late October meeting, continuing QE at $85 bln and delayed taper to December or early 2014. According to the Fed's statement, economic activity and labor market conditions have improved, but the Fed preferred to wait for more evidence of improved growth before beginning QE taper. The nomination of Janet Yellen as the next Fed Chair suggests that even if the Fed starts QE Taper, Fed policy will remain highly accommodative for an extended period. The ECB surprised markets by cutting the policy rate to 0.25% (from 0.5%) at the November meeting. The surprise ECB move appears designed to ward off disinflationary pressures in the Eurozone with headline inflation plunging to 0.7% in October. The ECB expects a "prolonged period of low inflation, to be followed by a gradual upward movement" to 2%. This suggests that the ECB needs to cut rates further to prevent disinflation and deflation from 2 For informational use only. Not intended as investment advice.
taking hold in Eurozone. With Eurozone rates near zero, ECB is likely to use QE & other unconventional tools (negative deposit rates & forward guidance) to preempt disinflation. The ECB also observed that confidence indicators are consistent with continued modest GDP growth in H2. The BoE left monetary policy unchanged in November with policy rates at 0.5% and asset purchases at 375bn. High inflation (2.6% YoY in August) and strong Q3 GDP growth (3.2%) will likely prevent the BoE from easing policy. In Japan, the BoJ left policy on hold at its late October meeting. In its semi-annual outlook, the bank remains confident of achieving its inflation target of 2% by end of FY 2015. The BoJ revised its real GDP growth outlook for FY2014 to 1.5% from 1.3%. Among Emerging Markets, some central banks (Chile, Mexico, and Hungary) have cut rates with a confluence of favorable global events (Fed's taper delay, US government/debt showdown resolution, and Yellen nomination). However, India and Brazil have continued to tighten to fight inflation and stabilize currencies, while other central banks (China, Korea, Taiwan, Turkey, and Russia) remain on hold. GDP Growth on Track to Improve with U.S. Q3 GDP upside surprise & limited drag from government shut down: The global recovery remains on track to strengthen with limited damage from the U.S. government brief shut-down in early-october. Business confidence continues to rise in all regions with the Global Composite PMI rising to 55.5 in October from 53.3 with gains in both manufacturing and services activity across all regions. The PMI readings were above long-term averages in the US and UK, solid in China, and the strongest reading on record in Japan. In the U.S., the rise in ISM manufacturing index (56.4) and nonmanufacturing index (55.4) in October suggests limited drag from the Government shut-down and U.S. GDP growth remain on track to strengthen, despite the Q4 slowdown. U.S. Q3 GDP surprised on the upside, growing 2.8% QoQ annualized after 2.5% in Q2 and 1.1% in Q1. The Q3 acceleration was driven by consumption spending adding 1% and inventories contributing 0.8% to GDP growth. There were also modest contributions from residential investment (0.4%), trade (0.3%), and business investment (0.2%). Overall government spending was a smaller drag (adding 0.04%) than in Q2 as a pickup in state and local spending offset the - 1.7% decline in federal spending with non-defense spending down -3.3% on sequester cuts. While the Q3 GDP growth was impressive, Q4 GDP growth is expected to slow to under 2% due to the impact of the government shutdown and payback for the big inventory build-up in Q3. Eurozone remains on a modest recovery path, despite the Q3 GDP disappointment. Eurozone GDP grew 0.4% QoQ annualized in Q3 slowing from 1.1% in Q2. Among countries, German GDP growth slowed to 1.2% from a stronger 2.8% in Q2, while French growth contracted -0.4% after 2%. Spanish GDP edged up 0.4% after -0.4%, while Italian GDP continued to contract -0.4%, smaller than the -1.2% decline in Q2. Business confidence composite PMI pulled back to 51.9. The index is consistent with positive, but tepid GDP growth. U.K. GDP growth accelerated to 3.2% annualized in Q3 from 2.7% in Q2. Improving business confidence, rising employment, and favorable retail sales. U.K. PMI business confidence rose to a record high of 60.7 in October. Japan s GDP posted a better than expected 1.9% rise in Q3 and is expected to strengthen further to over 3% in Q4 with a boost from the Abe fiscal stimulus package and front loading of consumption spending ahead of the 2014 tax increase. Domestic demand was the driver of Q2 GDP growth, rising 3.6%, while net trade was a drag, declining -2%. Prospects for emerging markets growth are mixed with an uptick in PMI s pointing to acceleration in manufacturing growth, while export growth has lost momentum. China s economy is likely to slow from the 7.8% GDP rebound in Q3 with September data indicating softer industrial activity, retail sales and fixed asset investment. Leaders of the Chinese communist party (CPC) met in early November for the third plenary meeting of the CPC. The CPC released an initial communique affirming the importance of policies to promote social stability. GDP growth 3 For informational use only. Not intended as investment advice.
target is expected to remain at 7.5%. While a detailed list of reforms has not yet been provided, the document addresses issues surrounding agriculture, state-owned enterprises, and corruption. The government plans to create a reform policy committee to implement goals. India GDP growth is likely to stabilize around 4.5% YoY in Q3 after posting 4.4% growth in Q2. Korea's economy expanded a stronger than expected 3.3% YoY in Q3 from 2.5% in Q2, while Taiwan s GDP grew 1.6%. Brazilian GDP growth is expected to moderate to 2.5% YoY in Q3 from 3.3% in Q2 with interest rate hikes offsetting solid growth in industrial production (0.7% MoM in September). Mexican GDP is estimated to have grown 0.9% YoY in Q3 after 1.5% in Q2 with weakness in industrial production (-1.2% MoM in September). Stock Valuations Rise as Markets Rerated with Easing of Global Risks: Stock market P/E multiples rose further during October for the second consecutive month with equity markets posting strong gains during the month. P/E multiples for most markets rose as stocks got rerated with easing of global risks (U.S. debt default risk, QE taper risk, European risks, Syria and other Middle East risks). The P/E multiple for the Developed Markets rose to 17.5X in October from 16.9X and 16.3X in the previous two months. The rise in P/E multiples has been moderated to some extent by the stronger than expected earnings results. However, Developed Market P/E multiples still remain below their long term average of 21.2X. Emerging Market (EM) stock valuations rose during October with the trailing P/E multiple rising to 12.4X, still below the levels seen earlier in the year. EM stock valuations remain at a discount to Developed Market stocks despite the strong gains posted in the past two months given that EM stocks still lag DM stocks by -21.5% YTD. Earnings Outlook Remains Supported by Improving GDP Growth & Solid Margins: Earnings outlook remains solid, driven by global GDP growth on track to strengthen over the coming quarters while profit margins remain solid driven by cost controls. U.S. Q3 earnings results are coming in stronger than expected with 70% of the companies posting upside surprises, and earnings growth for the quarter tracking 4.2% and expected to strength further to around 9% in Q4. Eurozone earnings remain on track to recovery with the economy posting modest but positive growth. Japanese H1 earnings are tracking around 149% while sales posted a solid 16.8% growth. Earnings for full year 2013 are expected around 65% driven by solid GDP growth, recovery in EM growth and weak yen. Emerging Markets earnings outlook has stabilized with earnings growth around 7% in 2013 and improving to around 10% in 2014 as GDP growth recovers. Bottom-line: The equity rally continued from late October to mid-november with a surprise rate cut by the ECB, improving economic data and better-than-expected Q3 earnings in the U.S. and Europe. Through mid-november (18th), the Developed Market index is up 23.3% YTD, while the Emerging Market index is up 2%. Looking ahead, the equity rally is likely to continue in the near-term with the Fed delaying QE Taper, the ECB cutting rates and further easing likely by the ECB, improving GDP growth, solid Q3 earnings growth and easing risks in Europe and the Middle East. Stocks remain supported by: 1) Interest rate tail winds persisting with the Fed delaying QE taper to December or Early 2014. The ECB surprised markets by cutting the policy rate to new record low of 0.25% as plunge in October Eurozone inflation to 0.7% raised the specter of disinflation. The ECB is likely to cut rates further or use other unconventional easing measures to prevent disinflation/deflation from taking hold. While the BoJ was on hold in October, the bank is likely to increase its reflation measures to offset the impact of the 2014 consumption tax hike. Emerging central banks that have been tightening to address elevated inflation and defend weak currencies have been unwinding the tightening measures as their currencies are stabilizing; 2) The global recovery remains on track to improve with business confidence continuing to rise in all regions. U.S. Q3 GDP surprised on the upside (+2.8%). Eurozone remains on track to strengthen despite the Q3 GDP disappointment, while U.K. GDP growth remains solid. Japan s GDP growth in Q4 is expected to get a boost from fiscal stimulus (to offset impact of sales tax increase) and front loading of consumption spending ahead of the 2014 tax increase; 3) Earnings outlook remains solid 4 For informational use only. Not intended as investment advice.
with improving GDP growth in the U.S., Europe and Emerging Economies and continued solid growth in Japan; 4) Stock P/E multiples rose as markets were rerated with easing of global risks. However, valuations are not yet stretched as multiples remain below long-term averages as the price gains are partially offset by earnings growth; 5) Easing of Eurozone risks with improving domestic demand, easy monetary policy & strengthening financial conditions, political stability in Europe with a new lease of life for the Letta government in Italy and Chancellor Merkel forming a grand coalition in Germany; 6) improving risk appetite with easing of Middle East tensions. However, market volatility is likely to remain elevated with: 1) Current market expectations are that the Fed will not start QE Taper before Q1 2014; however, strong GDP and labor market data renew fears of Fed starting QE Taper in December; 2) Profit-taking after the strong YTD gains. Bonds: Bond Yields under Modest Upward Pressure with Improving Growth & Easing Risks. Yield Rise Limited with Low Inflation, Further ECB Easing Measures & QE Taper Delay Global bond yields continued to decline in October with uncertainty related to the U.S. government shutdown, risks of a U.S. debt default, Fed QE taper delay and inflation continuing to decline. Looking ahead, bond yields are likely to be under modest upward pressure from: 1) GDP growth in the U.S. and Eurozone remain on track to strengthen, while growth remains solid in Japan; & 2) Bond valuations remain expensive relative to stocks. However, the rise in yields is likely to be limited by: 1) Low inflation in the Eurozone (0.7%) and U.S. (1.2%) with the risk of Eurozone falling into deflation; 2) Further rate cuts and other unconventional easing measures by the ECB to ward off deflationary pressures; the Fed unlikely to begin QE taper in December; 3) The U.S. government shut-down depressing U.S. Q4 GDP growth. Investment Strategy: Increase Equity Overweight as Stock Rally Continues with Fed Taper Delay, ECB Rate Cut & Further Easing Likely, Improving GDP Growth, Solid Q3 Earnings Growth & Easing Global Risks Asset Allocation: Stocks vs. Bonds Increase Equity Overweight Stocks Increase Overweight: The equity rally is likely to continue in the near-term with the Fed delaying QE Taper, the ECB cutting rates and further easing likely by the ECB, the global recovery remains on track, earnings outlook remains solid, equity multiples rise as stocks rerated with easing of global risks but valuations are not yet stretched, and easing of risks in Eurozone & Middle East. Bonds Keep bonds at modest underweight as yields likely to be under modest upward pressure with GDP growth in the U.S. and Eurozone on track to strengthen in H2, while growth remains solid in Japan. However, this is offset by low inflation in the Eurozone (0.7%) and U.S. (1.2%), further rate cuts and other unconventional easing measures by the ECB and the Fed unlikely to begin QE taper in December. Global Equity Markets: Remain Modest Overweight in Japan, Eurozone & Emerging Markets. Modest Underweight in U.S. & U.K. Eurozone: Remain Modest Overweight with ECB rate cut and further easing measures likely, modest GDP growth, easing of Periphery risks. Japan: Remain Modest Overweight on solid GDP growth with Abe fiscal stimulus to offset drag from 2014 consumption tax hike. Yen rise a risk. Emerging Markets: Remain Modest Overweight with GDP improving and currencies stabilizing, continued capital flows with Fed QE taper delay & relatively attractive valuations. UK: Modest Underweight as further easing by BoE unlikely with relatively high inflation and solid growth momentum. 5 For informational use only. Not intended as investment advice.
U.S.: Remain Underweight as U.S. likely to underperform with profit-taking after strong gains, Fed taper uncertainty & Q4 GDP disappointment. Global Bonds: Yields likely to remain under modest Upward Pressure as Improving GDP Growth offsets Low Inflation Eurozone bonds: Remain Overweight with ECB rate cut and further easing measures likely, low inflation and modest GDP growth. US Treasuries: Modest Overweight with low inflation, downside risks to Q4 GDP growth due to government shut-down and Fed QE taper delay. EM Debt: Neutral as renewed capital flows with Fed QE Taper delay & modest GDP growth offset by still elevated inflation and policy tightening in many EMs. Japan JGBs: Modest Underweight as yields likely to be under pressure with solid GDP growth & rising inflation expectations but offset by BoJ buying. U.K. Gilts: Remain Underweight as yields under pressure from relatively higher inflation and solid GDP growth, further BoE stimulus unlikely. Global Sectors: Overweight: Industrials, Financials, Info. Technology Neutral: Materials, Healthcare, Telecommunication Services Underweight: Consumer Discretionary, Consumer Staples, Utilities Currencies: Overweight: U.S. Dollar & Sterling Neutral: Japanese Yen, EM Currencies Underweight: Euro 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. 2013 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.