PRUDENTIAL INTERNATIONAL INVESTMENTS ADVISERS, LLC. Global Investment Outlook September 2013 Financial Market Outlook: Stocks likely to Remain in Modest Uptrend with Low Rates & Plentiful Liquidity, Improving Growth in U.S. & Eurozone, Solid Japan Growth, Healthy Earnings & Fair Valuations Bond Yields likely to Remain under Upward Pressure with Improving GDP Growth & QE Taper Chatter. Rise in Yields likely to be Capped by Continued Central Bank Buying & Low Inflation John Praveen, PhD Chief Investment Strategist John Praveen s Global Investment Outlook - September 2013 expects global stock markets to remain in a modest uptrend with the Fed unlikely to begin QE taper before Q4 2013 or early 2014, and continued support from other developed central banks. Global growth is also improving with the U.S. and Eurozone posting upside growth surprises in Q2 while growth remains solid in Japan. Improving earnings outlook and supportive valuations are other positives for stocks. Stocks: Equity markets rallied in July on Fed reassurance about QE taper, fresh optimism about Abe s third arrow with the LDP upper house election victory, continued Eurozone stabilization and Chinese policy makers reaffirming their objective of over 7% growth. Looking ahead, global equity markets are likely to post further modest gains with: 1) Developed central banks remaining committed to keeping interest rates low for an extended period and continuing to provide liquidity; The Fed unlikely to begin QE taper until late Q4 or early Q1 with inflation below the Fed s 2% target; 2) Improving global growth with upside growth surprises in the U.S. & Eurozone; 3) Earnings outlook remains solid with improving GDP growth in the U.S. and Europe and continued solid growth in Japan; 4) Valuations remain supportive; and 5) Improving risk appetite with easing of Eurozone risks. FOR MORE INFORMATION CONTACT: Lisa Villareal Phone: 973-367-2503 Email: Lisa.villareal@ prudential.com However, in the near-term, market volatility is likely to remain high with: 1) Escalating tensions in Egypt threatening to destabilize the Middle East region and cause a spike in oil prices; 2) Renewed chatter that strong U.S. macro data could prompt the Fed to start QE taper as early as September; 3) Continued growth disappointment in China and other emerging economies and policy tightening to defend weak currencies and tackle inflation. Bonds: Bond yields are likely to remain under upward pressure from: 1) Improving GDP growth; 2) Strong U.S. GDP and ISM readings prompting the Fed to start QE taper as early as September; and 3) Bond valuations remain expensive relative to stocks. However, bonds remain supported by: 1) Ongoing bond purchases by other developed central banks and their commitment to keeping interest rates low for an extended period; 2) Low inflation in the developed economies; 3) Renewed increase in safe haven demand as escalating tensions in Egypt threaten to destabilize the Middle East region; and 4) Sluggish EM 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: Stocks Post Further Gains on Fed QE Reassurance, Remain in Modest Uptrend with Low Rates & Liquidity, Improving Growth in U.S. & Eurozone, Healthy Earnings & Fair Valuations Bond Yields likely to be under Upward Pressure with Improving GDP Growth & QE Taper Chatter. Yields Rise likely to be Capped by Continued Central Bank Buying & Low Inflation Stock Market Outlook (September 2013): Global equity markets rallied in July on Fed Chairman Bernanke s reassurance that QE tapering does not imply interest rate tightening and that tapering would start only if labor market and inflation conditions permit. In Japan, the Abe-led LDP/Komeito coalition won the upper house elections on July 22 fuelling optimism about the launch of Abe s third arrow and a new growth strategy. Eurozone continued to stabilize on optimism of a Merkel third term in the German elections in September and activity data pointing to improving GDP growth. Chinese stocks rose with policy makers reiterating their objective to attain over 7% growth in 2013 and announcing several mini-stimulus packages, easing the fears of the June liquidity crunch. The Developed Market (MSCI World) index rose 4.7% in July, taking YTD gains to 15.5%. The July gains were led by Eurozone (6.2%) and the U.K. (6.6%), followed by the U.S. (5.1%). Emerging Market stocks continued to underperform, posting modest gains of 1.2% in July, but down -5.2% YTD. Stocks continued to post further gains in early August as U.S. Q2 GDP came in at 1.7%, well above expectations of sub-1% growth, while solid ISM data pointed to a strong start to Q3 GDP. Further, the Fed July statement had a dovish tone which continued to calm market concerns about QE taper. In Europe, the ECB remains committed to leave policy rates low for an extended period. Eurozone Q2 GDP also surprised on the upside as strong growth in Germany (2.9% annualized) and France (1.9%) lifted Eurozone out of recession. Eurozone Q2 GDP grew 1.1% (annualized) ending six quarters of negative GDP growth. Meanwhile in the U.K., the BoE under new Governor Carney joined the Fed and ECB by committing to keep interest rates low until unemployment falls below 7%. However, stocks pared gains in mid-august on escalating tensions in Egypt. Through mid-august (19th) the Developed Market index is up 14.5% YTD, while the Emerging Market index is down -4.5%. Looking ahead, global equity markets are likely to remain in an uptrend with interest rate and liquidity support, improving growth, supportive valuations and healthy earnings growth: Interest Rates & Liquidity Support & Fed Reassurance about QE Taper: The Fed, ECB, and BoE left monetary policy unchanged in late July and early August. The July Fed statement had a dovish tone with references to soft growth, higher mortgage rates and inflation undershooting Fed s 2% target. The Fed continues to reassure that QE tapering does not imply rate tightening and that tapering would start only if labor market and inflation conditions permit. With inflation undershooting the Fed s 2% target, QE taper is unlikely to begin till late Q4 or early Q1. The ECB remain committed to leave policy rates low for an extended period. With growth beginning to stabilize, ECB may not cut rates, but is likely to take concrete measures to improve credit flow to SMEs. In U.K., the BoE under new Governor Carney committed to keep interest rates low until unemployment falls below 7%. The BoJ remained on hold in August and made no changes to its asset purchase policy. The bank remains positive about the improvement in the Japanese economy and expects inflation to turn positive. Emerging central banks remain on hold or have even adopted tightening measures to address elevated inflation and support weak currencies. While China refrained from cutting rates due to credit bubble concerns, the PBC announced mini-measures to ease liquidity pressures. In India, the RBI continues its tightening measures with the rupee remaining under pressure. Brazil's central bank is likely to continue raising the Selic rate to over 9.5% (after hiking it by 50bps to 8.5% in July) as bank remains concerned about the significant risk to inflation from a weak currency. 2 For informational use only. Not intended as investment advice.
GDP Growth Gaining Traction in Q2 after Sluggish Q1, on Track to Improve Further in Q3: After a weak Q1, global growth appears to be gaining traction with U.S. and Eurozone posting upside growth surprises in Q2. U.S. Q2 GDP growth surprised on the upside, rising 1.7% QoQ annualized, well above consensus expectations of sub-1% growth, and likely to be revised higher to around 2%. Looking ahead, the U.S. economy is on track to strengthen further to 2.3% GDP pace in Q3 with contributions from housing and consumer spending. Eurozone Q2 GDP also surprised on the upside as Germany (2.9% annualized growth) and France (1.9%) lifted Eurozone out of recession with 1.1% GDP growth in Q2. U.K. GDP grew at a solid 2.4% annualized pace in Q2 with manufacturing, construction and services all contributing to growth. Solid business confidence suggests the economy has good momentum in Q3. Japan disappointed with Q2 GDP slowing to 2.6% QoQ annualized pace, but the economy continues to have good momentum as the Q2 slowdown was largely inventory related. Growth in Emerging economies remains sluggish as weak global trade continues to weigh on EM exports. China s economy weakened further in Q2 to 7.5% YoY pace, but Chinese policy makers reiterated their objective to attain over 7% growth in 2013 and announced several mini-stimulus packages. Valuations Rise in August on Strong Stock Gains: Equity market P/E multiples rose in July with developed market stocks posting strong gains during the month. Earlier, the May-June mini-correction helped improve valuations. While the rise in stock prices put upward pressure on P/E multiples, these were offset to some extent by the stronger than expected Q2 earnings results especially in the U.S. Emerging Markets stock valuations rose slightly given the modest gains posted by EM stocks and remain attractive relative to DM stocks with EM stocks underperforming by over 20% YTD. Despite the recent rise, P/E multiples remain below the long term averages across most equity markets. Earnings Outlook Solid Driven by Improving GDP Growth: Global earnings growth expectations for 2013 remain solid, around 12%, driven by improving global GDP growth in H2. In the U.S., Q2 earnings results have come out stronger than expected, driven by Financials and Consumer Discretionary sectors. U.S. earnings growth is expected to improve to around 9% in H2 as GDP growth strengthens. Japan earnings growth outlook for 2013 remains strong around 60% driven by solid GDP growth and yen depreciation. Eurozone earnings expectations should improve with recession ending in Q2 and growth improving further in H2. However, Emerging Markets earnings growth expectations for 2013 have been revised lower to around 9% with sluggish GDP growth. Bottom-line: Global equity markets continued to post solid gains in July on Fed reassurance about QE taper, fresh optimism about Abe s third arrow and a new growth strategy following the LDP victory in the July 22 upper house elections, continued Eurozone stabilization and Chinese policy makers reiterating their objective to attain over 7% growth in 2013. Stocks posted further gains in early August on Q2 upside growth surprise in the U.S. and Eurozone and supportive central bank comments. However, stocks pared gains in mid-august on escalating tensions in Egypt and the risk of a destabilizing spike in oil prices. Through mid-august (19th) the Developed Market index is up 14.5% YTD, while the Emerging Market index is down -4.5% YTD. Looking ahead, global equity markets are likely to remain in an uptrend with: 1) Developed central banks remain committed to keeping interest rates low for an extended period and continue to provide liquidity; The Fed is unlikely to begin QE taper until late Q4 or Q1 with inflation undershooting the Fed s 2% target. 2) Improving global growth with Eurozone recession ending in Q2 and on track to modest growth in H2; U.S. growth strengthening in H2 after the Q2 GDP upside surprise; continued solid growth in Japan with Abe launching the new growth strategy; Chinese policy makers reiterating their objective to attain over 7% growth in 2013. 3) Earnings outlook remains solid driven by improving H2 GDP growth in the U.S. and Europe and continued solid growth in Japan. 4) Valuations remain supportive and market multiples remain below long-term averages despite the rise in July, & 5) Improving risk appetite with easing of Eurozone risks. 3 For informational use only. Not intended as investment advice.
However, in the near-term, market volatility is likely to remain high with: 1) Escalating tensions in Egypt threatening to destabilize the Middle East region and cause another spike in oil prices; 2) Renewed chatter that strong U.S. economic data could prompt the Fed to start QE taper as early as September; 3) Continued growth disappointment in China and other emerging economies and premature tightening to defend weak currencies and/or tackle inflation. While we remain strategically bullish on stocks, we keep a modest overweight in equities given the solid gains thus far by the developed markets (~15%) and the risk of increased volatility due to Egypt tensions, and renewed QE taper chatter ahead of the Fed s September meeting. Bonds: Yields likely to be Under Upward Pressure with Improving GDP Growth & QE Taper Concerns. Rise in Yields likely Capped by Continued Central Bank Buying & Low Inflation After the May-June spike, bond yields stabilized and inched lower in July on Fed reassurance that QE taper would be data dependent. Looking ahead, bond yields are likely to come under renewed upward pressure from: 1) Improving GDP growth with the U.S. and Eurozone posting upside growth surprises in Q2 and on track to strengthen further in Q3, while growth remains solid in the U.K. and Japan; 2) Despite Fed reassurance, there is a risk that strong U.S. GDP and ISM data could prompt the Fed to start taper as early as September; and 3) Bond valuations remain expensive relative to stocks. However, bonds remain supported by: 1) Ongoing bond purchases by developed central banks and commitment to keeping interest rates low for an extended period; 2) Low inflation in the developed economies; 3) Renewed increase in safe haven demand as escalating tensions in Egypt threaten to destabilize the Middle East region; and 4) Sluggish EM GDP growth. Investment Strategy: Maintain Modest Overweight in Stocks with Further Modest Gains on Low Rates & Liquidity, Improving Growth in U.S. & Eurozone, Healthy Earnings & Fair Valuations Asset Allocation: Stocks vs. Bonds Stocks Remain Modest Overweight: We remain strategically bullish on stocks as they remain supported by low interest rates and plentiful liquidity despite Fed QE taper risk, improving growth in the U.S., U.K. & Eurozone, solid growth in Japan, healthy earnings & fair valuations. However, we keep a modest overweight in equities given the solid gains thus far by the developed markets (+15%) and the risk of increased volatility due to Egypt tensions, and renewed QE taper chatter ahead of the Fed s September meeting. Bonds Lower Bonds to Modest Underweight as yields are likely to remain under upward pressure with improving GDP growth & Fed QE taper chatter. However, the rise in yields is likely to be capped by central bank buying & low inflation in the developed economies. Global Equity Markets: Raise Eurozone to Modest Overweight on Improving Growth. Keep Modest Overweight in Japan on Abe Optimism. Raise U.K. to Neutral on Solid GDP Growth. Lower Emerging Markets & U.S. to Underweight. 1. Japan Remain Modest Overweight on optimism about Abe s third arrow and new growth strategy, but uncertainty about details and risk of yen strength. 2. Eurozone Upgrade to Modest Overweight with easing of Periphery risks, continued ECB support, recession ending and improving GDP growth. 3. U.K. Upgrade to Neutral with solid Q2 GDP growth (2.4%) and good momentum in Q3, and BoE under new Governor Carney committing to keep rates low until unemployment fall below 7%. 4 For informational use only. Not intended as investment advice.
4. Emerging Markets - Lower to Modest Underweight on continued growth disappointments and central banks unable to provide a monetary boost with weak currencies and inflation risks. 5. U.S. Downgrade U.S. stocks to Underweight as U.S. likely to underperform with profit taking after strong YTD gains & QE taper chatter. Global Bond Markets: Eurozone bonds likely to outperform with low inflation and easing of Periphery risks 1. Eurozone: Remain Overweight as growth remains modest, despite recession ending, low inflation, ECB support and easing sovereign debt risks. 2. US Treasuries: Lower to Neutral with yields under pressure from improving growth but offset by low inflation and Fed taper reassurance. 3. Japan JGBs: Remain Neutral as yields range-bound. Downward pressure on yields from BoJ s buying offset by rising inflation expectations. 4. U.K. Gilts: Remain Underweight as inflation remains higher than in the U.S. & Eurozone, GDP growth was solid in Q2 and growth momentum remains strong in Q3. Global Sectors Modest Overweight: Industrials, Financials, Info. Tech. & Energy Neutral: Consumer Discretionary, Telecoms & Healthcare Underweight: Materials, Consumer Staples & Utilities Currencies Overweight: Euro & Sterling; Neutral: U.S. Dollar; Underweight: Yen & EM Asia & Latin American currencies The Euro is likely to remain strong as Eurozone GDP growth recovers and Eurozone sovereign risks continue to ease. The Japanese Yen is likely to weaken with reflation measures and continued BoJ asset purchases. EM Asia & Latin American currencies likely to remain weak with sluggish growth, elevated inflation and fear of reversal of capital flows with Fed QE taper. 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. 5 For informational use only. Not intended as investment advice.