PRUDENTIAL INTERNATIONAL INVESTMENTS ADVISERS, LLC. Global Investment Outlook & Strategy November 2015 John Praveen, PhD Chief Investment Strategist FOR MORE INFORMATION CONTACT: Theresa Miller Phone: 973-802-7455 Email: theresa.miller@ prudential.com Stock Markets Likely to Remain in Uptrend with ECB & BoJ Set to Expand QE Stimulus, Fiscal & Monetary Stimulus in China, Rate Cuts in Other EMs, Fed Delays Rate Liftoff or Modest Rate Hikes, Solid Q3 Earnings, GDP Rebound after Soft Q3 & Valuation Support Bond Yields Likely to Rise Modestly with GDP Rebound in U.S. & U.K., Improving Growth in Eurozone & Japan and Fed Rate Uncertainty John Praveen s Global Investment Outlook for November 2015 expects global stock markets to remain in an uptrend supported by an even more favorable liquidity and interest rate backdrop, GDP growth on track to improve after a soft Q3, solid earnings outlook with Q3 earnings upside surprises and valuations remain supportive. Stocks: Global stock markets staged a powerful rally in October following the sharp sell-off in Q3 with the ECB signaling expansion of QE stimulus, the PBoC cutting rates again, the Fed delaying rate lift-off in October and strong Q3 earnings results. Developed markets gained 7.8% (LC) in October wiping out YTD losses for YTD gain of 2%. Emerging markets rose 5.3% trimming YTD losses to -4.2%. Looking ahead, stocks are likely to remain in an uptrend with: 1) Increased liquidity & interest rate support with the ECB and the BoJ on track to expand QE stimulus, fiscal and monetary stimulus in China and rate cuts in Emerging Markets. While the Fed is on track to start rate liftoff, the rate hikes are likely to be gradual and modest, giving several Emerging central banks room to cut rates further; 2) GDP Growth in Developed Economies on track to improve after the soft Q3 while Emerging Markets (EM) stabilize: Global growth slowed in Q3 as the U.S. and U.K. hit a soft patch but are on track to rebound in Q4. Eurozone GDP growth remains modest but improving with ECB QE and improving financial conditions, weak Euro boosting exports and low oil prices. In Japan, GDP growth is on track to improve after the Q2 contraction; 3) Solid Earnings Outlook: The Q3 earnings season has started and initial results show U.S. and Eurozone companies beating expectations. Japanese earnings expectations for 2015 remain strong, around 18%. However, Emerging Markets earnings growth for 2015 has been further revised lower; and 4) Valuation Support: Stocks remain cheap relative to bonds but the earnings yield gap narrowed as bond yields remained stable but equity earnings yield fell as P/E multiples rose. Bonds: Global bond yields were mixed in October as weak U.S. & U.K. GDP data, low inflation, Fed rate liftoff delay, and ECB signaling QE expansion offset the strong rally in global stock markets. Looking ahead, bond yields are likely to rise modestly with upward pressure from: 1) Healthy GDP growth after the soft Q3 with U.S. and U.K. GDP on track to rebound in Q4, improving GDP growth in Eurozone and Japan; 2) Continued Uncertainty about Fed Rate Lift-off after the Fed delays the start of rate normalization in October; 3) Bond valuations remain expensive relative to stocks with bond yields remaining low and stock valuations improving with the Q3 sell-off. However, bonds are supported by: 1) QE Expansion by the ECB and the BoJ; 2) Low inflation in the U.S., U.K. and Japan, and Eurozone inflation around zero; and 3) Safe haven demand with lingering China slowdown concerns and simmering Geopolitical tensions. *Prudential International Investments Advisers, LLC. (PIIA) is a business of Prudential Financial, Inc., (PFI), which is 1 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: Equity Markets Rebound in October on Solid Q3 Earnings & Fresh Liquidity. Stock Markets Likely to Remain in Uptrend with ECB & BoJ Set to Expand QE Stimulus, Fiscal & Monetary Stimulus in China, Rate Cuts in Other EMs, Fed Delays Rate Liftoff/Modest Rate Hikes, Solid Q3 Earnings, GDP Rebound after Soft Q3 & Valuation Support Bond Yields likely to Rise Modestly with GDP Rebound in U.S. & U.K., Improving Growth in Eurozone & Japan, Fed Rate Uncertainty. However, Bonds Supported by QE Expansion by ECB & BoJ, Low Inflation & Safe Haven Demand on China Concerns & Geopolitical Tensions Stock Market Outlook (November): Global stock markets enjoyed a strong rally in October after the sharp sell-off in Q3 with the ECB signaling expansion of QE stimulus, the PBoC cutting rates again, the Fed delaying rate lift-off in October and strong Q3 earnings results. Developed market stocks gained 7.8% (LC) in October wiping out YTD losses for YTD gain of 2%. Emerging market stocks also staged a recovery in October with the Emerging Markets index gaining 5.3%, trimming YTD losses to -4.2%. Looking ahead, after staging a powerfully rally in October that almost wiped out the Q3 losses, stocks are likely to remain in an uptrend with additional liquidity and interest rate support and strong earnings growth. The liquidity and interest rate backdrop has turned even more favorable with the ECB and BoJ set to expand QE stimulus, fiscal and monetary stimulus in China, additional rate cuts in other EMs, and further delay in Fed rate lift-off or modest rate hikes. The earnings outlook is solid with Q3 earnings season off to strong start. GDP growth is on track to improve after the soft Q3. Valuations remain supportive. 1) Liquidity & Interest rate Backdrop turns more Favorable with ECB and BoJ set to Expand QE, Additional Rate Cuts in China & Other EMs, Further Delay in Fed Rate Lift-off: The global liquidity and interest rate backdrop turned even more favorable with the ECB and the BoJ on track to expand QE buying while China s PBoC cut rates and reserve requirements again in October. The ECB left monetary policy unchanged at its late October meeting but President Draghi sent a strong signal that the ECB is set to expand QE stimulus at the December meeting. Some ECB members evidently pushed for action at the October meeting, but it appears that the majority wanted to wait until new economic forecasts become available in December. According to Draghi, the ECB Governing Council had a broad discussion on the pros and cons of employing different policy instruments and is open to different stimulus options. The ECB Governing Council instructed the relevant Eurosystem committees to assess the various policy options, similar to what it did in November 2014 ahead of QE expansion in Q1 2015. This suggests that the ECB is preparing the ground work for additional stimulus to be announced in December. The People s Bank of China (PBoC) continues to undertake easing measures with a combination of cuts in interest rates and reserve requirements (RRR) in October. The PBoC cut the benchmark lending rate by 25bps to 4.35% and the deposit rate by 25bps to 1.5%. In addition, the PBoC also cut the RRR by 50bps for all financial institutions and by another 50bps for those financial institutions that have met the macro prudential requirements and made certain level of micro and rural loans. Along with monetary easing the government has accelerated the implementation and funding of infrastructure projects and various policies to support growth. These measures are expected to help stabilize growth in the near term and offset some of the downward pressure from weakness in the property and industrial sectors. The Bank of Japan (BoJ) remained on hold in October but downgraded its outlook for GDP growth and inflation. Further growth data has been weaker than expected pointing to another soft GDP growth reading in Q3 while core inflation continues to be negative. With the ECB set to expand QE in December, further easing measures in China, soft GDP growth and weak inflation outlook, the BoJ is also likely to expand QE in coming months. The U.S. Federal Reserve decided to further delay interest rate liftoff at the October 27-28 meeting with U.S. Q3 activity data weakening while inflation data continues to remain well below Fed s target. However, the Fed left the door open to raising rates at the final 2015 meeting in December, expressing confidence that the U.S. economy is still 2 For informational use only. Not intended as investment advice.
expanding at a moderate pace. Further, even though the pace of job growth slowed in recent months, the Fed indicated that labor market indicators, on balance, show that underutilization of labor resources has diminished since early 2015. The Fed also dialed down its concerns about recent global economic and financial developments dampening U.S. economic activity but is monitoring developments abroad. Like the U.S. Fed, the BoE is on track to start raising U.K. rates given the solid GDP growth. However, U.K. inflation remains low, while GDP growth slowed in Q3. Recent BoE communications suggest that with muted price pressures and the Fed decision to delay rate lift-off to late 2015/early 2016, the BoE is unlikely to begin hiking rates before early 2016. Several emerging central banks have been cutting rates or are on track to cut rates. 2) U.S. & U.K. GDP Growth on Track to Rebound after Soft Q3, Modest but Improving Growth in Eurozone, Japan Recovering from Q2 Contraction. Emerging Economies Stabilizing: Global growth slowed in Q3 as the U.S. and U.K. hit a soft patch but are on track to rebound in Q4. Despite the Q3 slowdown, U.S. GDP growth remains healthy with solid consumption supported by wage growth and low oil prices. The housing market is healthy and the fiscal drag is declining. However, the energy sector capex has slowed and is a drag on overall Capex. U.K. GDP growth also remains solid with low unemployment, strong housing market and low interest rates. Sterling strength is a drag on exports. Eurozone GDP growth remains modest but improving with ECB QE and improving financial conditions, weak Euro boosting exports and offsetting the China impact. Low oil prices are a positive. In Japan GDP growth slowed after the strong Q1 as the China slowdown offsets positive benefits of weak yen, low oil prices & BoJ QE stimulus. The boost from earlier fiscal stimulus is fading. Consumption is steady but production and exports are weak. BoJ QE expansion is likely to jump-start growth. The U.S. economy hit a soft patch in Q3 with GDP growth slowing to 1.5% after the solid 3.9% growth pace in Q2. Weak inventories were largely responsible for the Q3 slowdown. Inventories subtracted -1.4% from Q3 GDP growth. However, other components of GDP, consumption spending (+2.2%), business investment (+0.3%), residential investment (+0.2%) and government spending (+0.3%) made positive contribution to Q3 growth. Net trade made no contribution to GDP after adding 0.2% in Q2. U.K. Q3 GDP growth disappointed, coming in at modest 2% annualized pace. Earlier, U.K. GDP grew a solid 2.8% QoQ annualized in Q2, rebounding from a modest 1.6% growth in Q1. Eurozone GDP is expected to grow around 1.7% in Q3 after 1.6% in Q2. With Grexit risk reduced following the solid win by the Syriza party in the September 20 th Greek snap election and reappointment of Tsipras as PM, Eurozone can look forward to steady improvement in the growth outlook. However, a likely collapse of Greek Q3 GDP as a result of the closure of banks in July and the resulting turmoil is likely to subtract from the Eurozone Q3 GDP. While Greece GDP accounts for less than 2% of the Eurozone GDP, a large plunge in Greek GDP would still dent Eurozone GDP. Further, the Volkswagen scandal is likely to take a toll on German GDP. Japan s GDP growth expectations for Q3 have been further revised lower to around 1% after contracting -1.2% in Q2 as the impact of China slowdown offsets the benefits of weak yen, low oil prices, BoJ QE stimulus and solid labor market. The Emerging economies continue to struggle but appear to be stabilizing as the impact of China slowdown on EM Asia is partially offset by improved growth in India. GDP growth remains modest in Latin America & EM Europe as Brazil & Russia remain in recession. 3) Valuation Stock Market Multiples Improve Sharply After Market Correction in Q3: Stock market P/E multiples, both in developed markets (DM) and emerging markets (EM), improved in Q3 following the sharp correction in global stock markets. However, P/E multiples rose in October following the strong stock market rally. U.S. (S&P 500) trailing P/E multiple rose to 18.6X in October from 17X at the end of September as U.S. stocks rose 8.3% in October after declining - 8.7% in the previous two months. The U.S. P/E is now modestly above the 18.2X level at the end of 2014. The P/E for Japanese stocks (TOPIX) rose to 16.2X in October from 14.7X at the end of September as the index rose a sharp 10.4% in October. The P/E for Eurozone stocks (STOXX 600) also rose to 23.6X in October from 20.6X at the end of September. Stocks remain cheap relative to bonds. The earnings yield gap (EYG) between U.S. stocks and bonds decreased in October after widening significantly in Q3. The earnings yield on U.S. stocks dropped to 5.43% in October from 5.87% at the end of September while the 10-year Treasury yield rose modestly to 2.09% from 2.04%. The yield gap between U.S. stocks-bonds declined to 3.34% in October from 3.83% in September, but still well above its long-term (20-3 For informational use only. Not intended as investment advice.
year) average of 1.2%. Eurozone stocks remain cheap relative to bonds on EYG basis with the yield gap narrowing to 3.96% from 4.26% as the yield on Eurozone stocks dropped to 4.47% in October from 4.85% in September while the 10- year Bund yield decreased relatively modestly to 0.51% from 0.59% in September. The Eurozone EYG remains well above its long-term average of 3.4%. The Japanese stocks earnings yield gap reduced to 5.91% from 6.45% in September, still above its long-term average of 4.1%. 4) U.S. Q3 Earnings Season Started on a Solid Note. Eurozone Earnings Outlook Remains Solid. Japanese Earnings Expectations Remain Strong Despite Softer GDP Growth. EM Outlook Remains Weak: The Q3 earnings season started and initial results show U.S. and Eurozone companies beating expectations. In the U.S., 70% of companies beat expectations. Excluding energy, S&P 500 earnings are expected to rise around 3% in Q3 after 1.5% rise in Q2. Eurozone earnings outlook for full year 2015 have been revised slightly lower to 9% due to drag from Energy and Materials sectors. Eurozone earnings growth remains supported by improving GDP growth and weak euro boosting sales and margins. Japanese earnings expectations for 2015 remain strong, around 18%. Japanese companies are expected to benefit from the weak yen and lower energy and commodity prices. Emerging Markets earnings growth for 2015 has been further revised lower to 0%. EM Asia earnings growth is expected around 7% while LatAm earnings are expected to fall - 16.6% and EMEA earnings expected to decline -12.1%. Bottom-line: Global stock markets rallied in October following the sharp sell-off in Q3 with the ECB signaling expansion of QE stimulus, the PBoC cutting rates again, the Fed delaying rate lift-off and strong Q3 earnings results. Developed market stocks gained 7.8% (LC) in October wiping out YTD losses for YTD gain of 2%. Emerging markets also rebounded, gaining 5.3% trimming YTD losses to -4.2%. Looking ahead, stocks are likely to remain in an uptrend with additional liquidity and interest rate support and strong earnings growth. The liquidity and interest rate backdrop has turned even more favorable with the ECB and BoJ set to expand QE stimulus, fiscal and monetary stimulus in China, rate cuts in other EMs, and further delay in Fed rate lift-off or modest rate hikes. The earnings outlook is solid with Q3 earnings season off to strong start. GDP growth is on track to improve after the soft Q3. Valuations remain supportive. Further stock market gains are likely to be driven by: 1) Increased liquidity & interest rate support with the ECB and the BoJ on track to expand QE stimulus, and fiscal and further monetary stimulus in China. The ECB sent strong signals at the October meeting that it is set to expand QE stimulus at the December meeting and appears to be preparing the ground work for additional stimulus measures to be announced in December. The BoJ is also likely to expand QE buying. While the Fed is on track to start rate liftoff, the rate hikes are likely to be gradual and modest, giving several Emerging central banks room to cut rates further. 2) GDP Growth in Developed Economies on track to improve after the soft Q3 while Emerging Markets (EM) stabilize: Global growth slowed in Q3 as the U.S. and U.K. hit a soft patch but are on track to rebound in Q4. While U.S. GDP growth slowed to 1.5% in Q3 and U.K. slowed to 2%, they are on track to rebound to around 3% in Q4. Eurozone GDP growth remains modest but improving with ECB QE and improving financial conditions, weak Euro boosting exports and offsetting the China impact, and low oil prices are a net positive. In Japan, GDP growth is on track to improve after the Q2 contraction. China GDP growth slowed to below 7% in Q3 with slower investment spending. However, the risk of hard landing is mitigated by fiscal and monetary stimulus. India s GDP growth remains in uptrend. However, Brazil and Russia remain in recession; 3) Solid Earnings Outlook: The Q3 earnings season started and initial results show U.S. and Eurozone companies beating expectations, albeit lowered expectations. Initial results show 70% of U.S. companies beating expectations. Eurozone earnings outlook for full year 2015 are expected around 9%, revised slightly lower due to drags from Energy and Materials sectors. Japanese earnings expectations for 2015 remain strong, around 18%. Emerging Markets earnings growth for 2015 has been further revised lower; and 4) Valuation Support: Stocks remain cheap relative to bonds but the earnings yield gap narrowed as bond yields remained stable but equity earnings yield fell as P/E multiples rose. Stock market P/E multiples, both in developed markets (DM) and emerging markets (EM), rose following the October rally. However, P/E multiples remain below levels at the beginning of the year and long-term averages. 4 For informational use only. Not intended as investment advice.
Global stock markets are likely to remain in an uptrend supported by an even more favorable liquidity and interest rate backdrop, GDP growth in developed economies on track to improve after the soft Q3, solid earnings outlook and valuation support. However, markets are likely to remain volatile in the near term with continued concerns about China slowdown and EM growth, uncertainty about Fed rate lift-off, low oil and commodity prices raising deflation concerns, and simmering geopolitical tensions in the Middle East & Turkey. Bond Market Outlook: Bond Yields Likely to Rise Modestly with GDP Rebound in U.S. & U.K., Improving Growth in Eurozone & Japan and Fed Rate Uncertainty Global bond yields were mixed in October with increase in U.S. and U.K. yields and decline in Eurozone and Japan. Yields rose in the beginning of the month as equity markets started to rally after the Q3 sell-off. However, weak activity data in the U.S. and U.K. suggesting slower Q3 GDP growth pushed yields lower in the middle of the month. Bonds were also supported by low inflation and the ECB signaling QE expansion. U.S. 10 year Treasury yields rose to 2.17% from 2.04%, while U.K. yields jumped to 1.92% from 1.66%. Eurozone yields fell to 0.53% from 0.59%, Japanese yields edged down to 0.29% from 0.35%. Looking ahead, bond yields are likely to rise modestly. Yields are likely to be under modest upward pressure from: 1) Healthy GDP growth in the Developed Economies after Soft Q3: The U.S. and U.K. hit a soft patch in Q3 but are on track to rebound in Q4. Eurozone GDP growth remains modest but improving while Japan is on track to improve after the Q2 contraction. Emerging markets appear to be stabilizing; 2) Continued Uncertainty about Fed Rate Lift-off: With the Fed choosing to delay rate lift-off in October on low inflation, the delay in starting the rate normalization process prolongs uncertainty; 3) Bond valuations remain expensive relative to stocks with bond yields remaining low, and stock valuations improving following the Q3 sell-off. However, bonds are supported by: 1) QE Expansion: The ECB and the BoJ are on track to expand QE stimulus; 2) Low inflation in the U.S., U.K. and Japan, and Eurozone inflation around zero with low oil and commodity prices; and 3) Safe haven demand with lingering concerns about China and EM growth outlook, and simmering geopolitical tensions in the Middle East and Turkey. Investment Strategy: Asset Allocation: Stocks vs. Bonds - Stocks in Uptrend with Increased Liquidity & Strong Earnings. Modest Rise in Bond Yields Stocks Overweight as stocks are likely to remain in an uptrend with ECB & BoJ set to expand QE stimulus, fiscal & monetary stimulus in China, rate cuts in other EMs, Fed delays rate liftoff or modest rate hikes, solid Q3 earnings, GDP rebound after soft Q3 & valuation support. Bonds Modest Underweight as yields are likely to rise modestly with upward pressure from healthy GDP growth after soft Q3, Fed rate lift-off uncertainty, and expensive valuations relative to stocks. However, bonds supported by QE expansion by ECB and BoJ, low inflation and safe haven demand. Global Equity Strategy: Overweight in Eurozone & Modest Overweight in Japan. Upgrade EM Asia to Modest Overweight on China stimulus; Keep U.K. at Neutral; Remain Underweight in Latin America & EM Europe; Remain Underweight in U.S. Eurozone: Remain overweight with ECB sending strong signals about expanding QE stimulus in December and preparing the ground work for additional stimulus, solid earnings outlook, and modest but improving GDP. Japan: Modest Overweight. BoJ likely to expand QE buying, strong earnings with weak yen tailwinds & GPIF equity buying offset by soft GDP growth. Emerging Markets: Upgrade EM Asia to modest overweight with fiscal and monetary stimulus in China stabilizing markets and easing concerns about hard landing. Underweight in LatAm & EM Europe with Brazil & Russia in recession and weak oil & commodity prices. 5 For informational use only. Not intended as investment advice.
U.K.: Keep U.K. at Neutral with BoE rate hikes pushed out to early 2016 offset by soft GDP growth in Q3, energy sector earnings drag. U.S.: Remain Underweight to fund overweights in Eurozone and Japan. Fed delaying rate lift-off prolongs uncertainty about Fed policy. U.S. GDP growth slows to 1.5% in Q3. Earnings results beating lowered expectations in Q3 but strong dollar headwinds and weak energy earnings remain drags. Global Bond Market Strategy: Yields Likely to Rise Modestly on Healthy GDP in Developed Economies after Soft Q3 and Fed Rate Uncertainty Japan JGBs: Remain Overweight with the BoJ likely to increase QE asset purchases with inflation remaining low and modest GDP growth. Eurozone: Remain Overweight with ECB signaling QE expansion in December, low inflation and modest GDP growth. U.K. Gilts: Remain Neutral with GDP rebound after weak Q3 offset by low inflation and BoE rate hikes pushed out into early 2016. EM Debt: Remain Underweight with Fed rate uncertainty and simmering geopolitical tensions in Middle East offset modestly by China stabilization. U.S. Treasuries: Modest Underweight with U.S. GDP growth rebound in Q4 after soft Q3 and the Fed rate uncertainty. Global Sector Strategy: Overweight: Consumer Discretionary, Industrials & Information Technology; Modest Overweight: Healthcare & Financials; Modest Underweight: Energy, Materials; Underweight: Consumer Staples, Telecomms & Utilities. Currency Strategy: Overweight: U.S. Dollar (GDP rebound in Q4 after soft Q3 & Fed rate lift-off delay but on track to start rate hikes in December); Neutral: Sterling (BoE rate hikes pushed out into early 2016 with low inflation but GDP recovery after weak Q3); Underweight: Euro (ECB set to expand QE in December while Fed starts rate hikes, modest Eurozone GDP growth relative to US GDP rebound); & Japanese Yen (BoJ likely to expand QE stimulus with falling inflation, Fed starts U.S. rate hikes & relatively stronger U.S. GDP growth). 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. 2015 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.