PRUDENTIAL INTERNATIONAL INVESTMENTS ADVISERS, LLC. Global Investment Outlook February 2015 Stocks to Fully Rebound from Late 2014/Early 2015 Sell-off with ECB Launching Aggressive QE, Rate Cuts by Several Developed & Emerging Central Banks, Improved GDP Growth, Solid Q4 Earnings Growth & Attractive Valuations Bond Yields likely to Rise with Solid GDP Growth in U.S. & U.K., Japan GDP Rebound, Eurozone Stabilizing, Expensive Valuations & Fed Rate Hike Uncertainty John Praveen, PhD Chief Investment Strategist John Praveen s Global Investment Outlook for February 2015 expects global stock markets to fully rebound from the late 2014/early 2015 sell-off with the ECB launching aggressive, open-ended QE, rate cuts by several Developed & Emerging central banks, oil prices trying to stabilize, evidence of improving GDP growth, and easing concerns about Greece exit from the Euro. Stocks: Global stock markets ended 2014 on a weak note with a late December sell-off on plunging oil prices, collapse of the Russian ruble and Greek elections uncertainty. Stock markets are off to a rocky start in early 2015 with concerns about Greece exit from the Euro, anxiety about the ECB s decision on QE, and the relentless decline in oil prices fuelling fears about deflation and global growth. Looking ahead, we expect global stock markets to fully rebound from the late 2014 & early 2015 sell-off driven by: 1) Fresh ECB QE liquidity & interest rate cuts by several central banks; 2) Improved global growth with fresh liquidity and rate cuts, and the boost to consumer spending from low oil prices; 3) Solid Q4 earnings results; and 4) Valuations support as stocks have become even more attractive with the plunge in bond yields. Bonds: Bond yields declined in December as the relentless plunge in oil prices raised concerns about global growth and deflation. Yields fell further in early 2015 on expectations of ECB launching full-fledged QE, and further decline in oil prices adding to deflation fears. FOR MORE INFORMATION CONTACT: Theresa Miller Phone: 973-802-7455 Email: theresa.miller@ prudential.com Looking ahead, bond yields are likely to rise with upward pressure from: 1) Improved global growth with solid GDP growth in the U.S. and U.K., Japanese growth rebound, Core Eurozone economies stabilizing and the Periphery strengthening; 2) The Fed and BoE remain on track to raise rates in 2015; 3) Bond valuations have become even more expensive relative to stocks with yields falling in late 2014 and further in early 2015. However, the rise in bond yields is likely to be limited by: 1) ECB launching full-fledged, open-ended QE in January, rate cuts by several developed & emerging central banks; 2) Deflation fears as the plunge in oil prices has pushed headline inflation into negative territory in the Eurozone (-0.2%), and below 1% in the U.S. (0.8%) and U.K. (0.5%). 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: Global Stock Markets off to Rocky Start to 2015 after ending 2014 on a Weak Note. Stocks to fully Rebound from Late 2014/Early 2015 Sell-off with ECB Launching Open-Ended QE, Rate Cuts in Denmark, Canada, India & Several Other Emerging Markets, & Evidence of Improved GDP Growth. Solid Q4 Earnings Growth & Attractive Valuations Relative to Bonds also Lift Stocks Bond Yields Likely to Rise with Solid GDP Growth in U.S. & U.K., Japan GDP Rebound, Eurozone Stabilizing, Expensive Valuations & Fed Rate Hike Uncertainty. ECB QE, BoJ Stimulus & Falling Inflation Likely to Cap Rise in Yields Stock Market Outlook (February): Global stock markets ended 2014 on a weak note with a late December sell-off on plunging oil prices, collapse of the Russian ruble and Greek elections uncertainty. The Developed markets index declined -1.7% (US$) in December, trimming gains for 2014 to just 2.9%. Emerging Market stocks fell -4.8% in December as strong gains in China were offset by the collapse in Russia and Greece, and continued decline in Brazil. For full year 2014, the emerging markets index declined -4.6% (US$). Stock markets are off to a rocky start in early 2015 with concerns about Greece Euro exit, anxiety about the ECB decision on QE, and the relentless decline in oil prices adding to fears about deflation. As of January 21, developed market stocks were down -0.9%, while emerging markets gained 2.1%. Stocks rebounded following the ECB decision on January 22 to undertake a 1.14 trillion, open-ended QE program to buy sovereign and sector private debt. Looking ahead, we expect global stock markets to fully rebound from the early 2015 sell-off driven by: 1) Fresh ECB QE liquidity & interest rate cuts by several central banks; 2) Improved global growth with fresh liquidity and rate cuts, and the boost to consumer spending from low oil prices; 3) Solid Q4 earnings results; and 4) Valuations support as stocks have become even more attractive with the plunge in bond yields. 1) Liquidity & Interest Rate Support as QE Stimulus by ECB & BoJ, Rate Cuts by Several Developed & Emerging Markets likely to offset Modest Fed & BoE Rate Hikes: Financial markets enjoyed synchronized global central bank monetary policies during the last few years. However, central bank policies are expected to be desynchronized in 2015 with the U.S. Fed & U.K. BoE on track to start rate hikes, while the ECB undertakes QE and the BoJ expands QE, several developed and emerging central banks cut rates and provide fresh stimulus. Despite the central bank cross currents, global stock markets are likely to be supported by plentiful liquidity and low interest rates as fresh QE liquidity from the ECB and BoJ, rate cuts and stimulus by several central banks should offset the modest rate hikes by the Fed and the BoE. Further, with the plunge in oil prices pushing the already low inflation closer to deflation, the Fed and BoE could delay rate hikes into late 2015, while the ECB and the BoJ may be forced to undertake more aggressive QE stimulus. The ECB launched an aggressive, open-ended QE program at the January 22 meeting. The ECB announced that it will buy 60bn/month in sovereign and private sector debt. Total asset purchases would amount to 1.14 trillion by September 2016. The ECB QE program is around 0.6% of Eurozone GDP, which is bigger than the Fed QE but smaller than the BoJ QE. The new buying program starts in March and will continue at least until September 2016. However, the program is basically open-ended with the ECB assuring that if inflation does not rise towards the ECB s 2% target, the ECB will extend the bond buying program. With the ECB currently buying 13bn in asset-backed securities (ABSSP) and covered bonds (CBPP3), there will be a net increase of around 50bn in fresh buying of euro-denominated investment-grade securities issued by Eurozone governments and agencies and European institutions in the secondary market. The maturities of bonds purchased will range from two to 30 years including inflation-linked debt. Bond purchases will be decentralized with the National Central Banks (NCBs) taking a key role, but the ECB will coordinate and the Governing Council will retain control. Stocks rallied and the Euro fell further after the ECB announcement. The U.S. Federal Reserve is on track to hike rates in 2015 after ending its QE program in November 2014. At its December meeting the Fed reassured that it can be patient in beginning to normalize the stance of monetary policy. This suggests that the Fed rate policy is data-dependent, implying that the first rate hike could occur in early or 2 For informational use only. Not intended as investment advice.
late 2015, depending on the evolution of economic data. Current expectations are for the Fed to begin raising rates in mid 2015. However, with inflation already low (0.8% in December) and the collapse in oil prices likely to put further downward pressure on headline inflation, the Fed could push rate hikes into late 2015. The Bank of England (BoE) left U.K. monetary policy unchanged at their January meeting. Strong U.K. GDP growth (3% expected in Q4) suggests that the BoE remains on track to start raising rates before other developed central banks. However, low inflation, weak wage growth and downside risks to growth suggest that the BoE is unlikely to raise rates before mid-2015, at the earliest. The Bank of Japan (BoJ) made no changes to its asset purchase policy in January despite cutting its inflation forecast. Governor Kuroda noted that while the lower energy prices may weigh on inflation in the short-term, it is likely to stimulate the economy and support a rise in inflation in the medium-term. Given Governor Kuroda's focus on wages and consumer behavior, the BoJ is likely to pay close attention to winter bonuses and spring wage negotiations, in addition to inflation expectations, before deciding on further increases in its QE asset purchase program. China and several other emerging central banks were expected to cut rates and undertake other easing measures during 2015 with falling inflation. The plunge in oil prices has put downward pressure on inflation giving room for the central banks to provide fresh stimulus to boost growth which remains fragile. However, several central banks, including India, Romania, Egypt and Peru surprised markets by cutting rates in early January. In addition, some developed central banks (Denmark and Canada) also cut rates. However, Brazil raised rates in January with inflation remaining elevated. Further rate hikes are likely in Brazil and Russia with high inflation and weak currencies. 2) Global Growth on Track to Modest Recovery in 2015 led by U.S. & U.K., Japan GDP Rebound & Eurozone Stabilization: After the growth disappointment in 2014, global GDP growth is on track to improve in 2015 with ECB launching QE, BoJ expanding QE, rate cuts and easing measures by several developed and emerging central banks and the boost to consumer spending from the plunge in oil prices. GDP growth in the U.S. and U.K. remains solid, Japanese economy on track to strengthen further in 2015 after rebounding in Q4 2014, Eurozone Core economies are recovering, and the Periphery continues to strengthen. Chinese GDP growth is expected to remain stable, around 7%, while GDP growth is expected to strengthen in Emerging Asia led by India, Taiwan, Korea and Indonesia. However, Brazil and Russia are expected to continue to struggle leading to modest growth in Latin America & Emerging Europe. The U.S. economy remains solid, with improved business spending, solid consumption, housing remaining stable and no fiscal drag. The U.S. ended H2 2014 on a strong note with Q3 GDP growth revised up to 5% and Q4 growth tracking around 3.5%. The outlook for consumer spending remains solid, with steady job growth, improving confidence and the wealth effects from the rising stock and bond markets and the boost to purchasing power from lower energy prices. Earlier, U.S. Q3 GDP was revised up to 5% QoQ annualized from 3.8% in the second reading and 3.5% in the initial estimate. After struggling in 2014, Eurozone Core economies are on track to recover and the Periphery strengthens with ECB launching full-fledged QE, weak Euro and lower oil prices. The recovery in the Core Eurozone economies should also be supported by easing of Ukraine tensions, while the Periphery economies are boosted by fading effects of the financial crisis. Eurozone GDP is expected to grow a modest 0.9% YoY in Q4. Earlier in Q3, Eurozone GDP grew a modest 0.8% QoQ annualized after 0.4% in Q2. The Japanese economy is expected to strengthen further in 2015 after rebounding in late 2014. GDP growth is expected to get a boost from another fiscal stimulus package, postponement of the 2015 tax hike, lower energy prices, fresh BoJ stimulus, and further decline in the yen supporting exports. The Abe cabinet approved a Yen 3.5tn economic stimulus package. Earlier, the second round of consumption tax increase (to 10% from current 8%) scheduled for October 2015 had been postponed for 18 months. Japanese GDP growth is estimated to rebound to around 3% in Q4 2014 after contracting -1.9% in Q3 and -7.1% in Q2. 3 For informational use only. Not intended as investment advice.
Emerging economies GDP growth is expected to improve in Asia but remain modest in Latin America and Emerging Europe. The decline in oil and commodity prices have started to help importers (India, Turkey) relative to exporters (South Africa, Brazil & Russia) and this is likely to continue into 2015 as commodity prices are expected to remain weak in the first half of 2015. Among Emerging Asian economies, GDP growth in India, Taiwan, Korea and Indonesia is on track to strengthen with interest rate cuts, lower oil and commodity prices. China GDP growth is expected to remain stable around 7%. However, Brazil & Russia are expected to continue to struggle with rate hikes, lower oil and commodity prices and fiscal tightening in Brazil. 3) Solid Q4 Earnings, Healthy Earnings Outlook in 2015: U.S. Q4 earnings season began on a strong note while Eurozone & Japanese earnings outlook remains solid. Global earnings are expected to grow around 7% in 2015 after 6% growth in 2014. Earnings expectations for 2015 and estimates for 2014 have been revised down following the sharp decline in oil prices and downward revisions to the energy sector earnings. Earnings growth for 2015 are led by double-digit earnings growth in the Eurozone (10%), Japan (13%). Earnings are expected to grow around 7% in the U.S. and Emerging Markets (both revised down from 12%). Earnings growth in 2015 is largely driven by solid GDP growth in the U.S. & U.K., GDP rebound in Japan, Eurozone growth improving, and emerging economies strengthening. Eurozone and Japanese earnings are also expected to get a boost from weaker Euro and Yen. Profit margins had widened over 2014 and expected to remain solid in 2015, providing support for earnings growth. 4) Stock Valuations Improved in December with Stock Pullback towards Year-end: Stock market P/E multiples declined modestly in December. The P/E multiple for developed markets (DM) declined to 18X in December and are now close to the 17.9X level at the beginning of 2014. DM valuations remain well below the long term average of 21.2X. The trailing P/E multiple for the U.S. S&P 500 ended December 2014 at 18.2X, rising from 17.2X in January 2014. The P/E for the Japanese market (TOPIX) ended 2014 at 16.1X, around the 16.2X multiple at the end of 2013. The P/E multiple for Eurozone stocks (STOXX 600) eased to 21.3X from 21.6X in November but well above the 19.5X multiple at the end of 2013. Emerging Markets (EM) stock multiple rose to 13.2X in December from 12.1X in January 2014 as earnings growth disappointed in 2014. Stock valuations have become cheaper relative to bonds with the plunge in bond yields and improvement in equity yields. Bottom-line: Global stock markets ended 2014 on a weak note with a late December sell-off on plunging oil prices, collapse in the Russian ruble and Greek elections uncertainty. Stock markets are off to a rocky start in early 2015 with the relentless decline in oil prices fuelling fears about global growth and deflation. Concerns about Greece exit from the Euro are adding to market volatility. As of January 21, developed market stocks were down -0.9%, while emerging markets gained 2.1%. Stocks rebounded following the ECB decision on January 22 to undertake an aggressive 1.14 trillion, open-ended QE program. Looking ahead, we expect global stock markets to fully rebound from the late 2014/early 2015 sell-off with the ECB launching aggressive, open-ended QE on January 22, rate cuts by Denmark, Canada, India and several other Emerging central banks, oil prices trying to stabilize, easing concerns about Greek exit from the Euro, evidence of improving GDP growth. Stock markets are likely to fully recoup the late 2014/early 2015 losses and post broad-based gains driven by: 1) Continued Liquidity & Interest Rate Support as the ECB launches an aggressive, open-ended QE in January, rate cuts by several developed and emerging central banks, and fresh liquidity measures in China. Further, with U.S. and U.K. inflation down below 1%, the Fed and BoE may delay rate hikes; 2) Improved global growth with fresh liquidity and rate cuts, and the boost to consumer spending from the plunge in oil prices. GDP growth in the U.S. and U.K. remains solid, Japanese growth rebounded in Q4 and on track to strengthen further in 2015 with fresh fiscal stimulus. Eurozone Core economies are recovering and the Periphery remains healthy, growth in India and other emerging economies are on track to improve with rate cuts in early 2015; 3) Solid Q4 Earnings. Healthy Earnings Outlook in 2015: U.S. Q4 earnings season began on a strong note and Eurozone and Japanese earnings outlook remains solid with improving growth and 4 For informational use only. Not intended as investment advice.
weak Euro and Yen boosting earnings. Global earnings are expected to grow around 7% in 2015 driven by solid GDP growth in the U.S. & U.K., Japan GDP rebound, improved growth in Eurozone and weak Yen and Euro; and 4) Valuations Support: Stock market valuations improved as P/E multiples declined in December and further in early January. Equity P/E multiples are well below long term averages. Stock-bond relative valuation improved further as stocks have become cheaper relative to bonds with the plunge in bond yields and improvement in equity yields. Stocks ended 2014 on a weak note and had a rocky start to 2015 with the relentless fall in oil prices, and fresh concerns about Greece exit from the Euro. However, we expect stocks to stabilize and fully rebound with the ECB launching a 1.14 trillion, open-ended QE program in January, several developed and emerging central banks cutting rates, evidence of improved GDP growth, and solid earnings growth. However, market volatility is likely to remain elevated with concerns about Greek elections and potential Greek exit from the Euro, and oil prices continuing to struggle raising questions about global demand and raise deflation fears. Bond Market Outlook: Yields likely to Rise with Improved 2015 GDP Growth, Expensive Valuation & Fed Rate Uncertainty Bond yields declined in December as the relentless plunge in oil prices raised concerns about deflation and weak global growth. Yields fell further in early 2015 on expectations of ECB launching full-fledged QE, and further decline in oil prices adding to deflation fears. Looking ahead, bond yields are likely to rise with upward pressure from: 1) Improved global growth with solid GDP growth in the U.S. and U.K., Japanese growth rebounded in Q4 and on track to strengthen further in 2015. Eurozone Core economies are recovering and the Periphery remains healthy; 2) The Fed and BoE remain on track to raise rates in 2015; 3) Bond valuations have become even more expensive relative to stocks with yields falling in late 2014 and further in early 2015. However, the rise in bond yields is likely to be limited by: 1) ECB launching an aggressive, open-ended QE program in January, rate cuts by several developed and emerging markets; 2) Growing deflation fears as the plunge in oil prices has pushed headline inflation into negative territory in Eurozone (-0.2%), and below 1% in the U.S. (0.8%) and U.K. (0.5%). Investment Strategy: Asset Allocation: Stocks vs. Bonds - Keep Equity Overweight as Stocks to Rebound with ECB QE, Several Central Banks Cut Rates Stocks Maintain overweight as stocks to rebound from the late 2014/early 2015 sell-off with the ECB launching fullfledged, open-ended QE in January, rate cuts by Denmark, Canada, India and other Emerging central banks, evidence of improving GDP growth, and strong Q4 earnings. Further, falling inflation likely to push out Fed rate hikes into late 2015. Bonds Remain modest underweight as bond yields are likely to rise with improved global growth as U.S. and U.K. GDP growth remains solid, Japanese growth rebound and Eurozone recovering. Further, the Fed and BoE remain on track to raising rates in 2015. Global Equity Strategy: Modest Overweight in Emerging Asia, Japan & Eurozone; Neutral in U.S.; Underweight U.K., Latin America & Emerging Europe Emerging Markets: Modest Overweight in Emg Asia with improved growth, China stimulus, India rate cuts & reforms; Underweight in Latin America & EM Europe: Weak GDP growth in Brazil, rate hikes & fiscal tightening, Petrobras scandal. Russia in recession, further rate hikes. Japan: Modest Overweight with GDP rebound, solid earnings growth and BoJ further expanding QE stimulus, Government Pension Fund (GPIF) increasing allocation to stocks. Eurozone: Modest Overweight with ECB launching open-ended, full-fledged QE including buying sovereign debt, Eurozone growth stabilizing. 5 For informational use only. Not intended as investment advice.
U.S.: Neutral as solid U.S. GDP growth and earnings growth offset by Fed set to raise rates. Dollar strength poses risks to U.S. exports & earnings. U.K.: Remain Underweight with BoE set to hike rates and weak earnings momentum with dominant energy sector. Global Bond Market Strategy: Yields likely to Rise with Improved GDP, Fed Uncertainty. Low Inflation & ECB QE likely to Cap Rise in Yields Eurozone: Remain Overweight with ECB launching 1.14 trillion, open-ended QE program, including buying sovereign debt, Eurozone inflation now negative & modest GDP growth. EM Bonds: Neutral as improving GDP growth, rate cuts by India s RBI & other emerging central banks offset by concerns in Russia, Greece and Brazil. Japan JGBs: Neutral with further BoJ QE offset by GDP rebound and GPIF AA shift to stocks & other risky assets. U.S. Treasuries: Modest Underweight as yields likely to rebound with U.S. GDP growth remaining solid, uncertainty about Fed s rate hikes. U.K. Gilts: Remain Underweight as yields under pressure with BoE to start rate hikes in 2015 and solid GDP growth. Global Sector Strategy: Overweight: Healthcare & Information Technology; Modest Overweight: Industrials & Financials; Neutral: Materials, Consumer Discretionary & Utilities; Underweight: Energy, Consumer Staples & Telecomms. Currency Strategy: Overweight: U.S. Dollar (solid GDP growth & Fed starts rate hikes); Neutral: Emerging Market Currencies (improving GDP growth & rate cuts in Asia, but Brazil & Russia continue to struggle) & Sterling (solid GDP growth but BoE rate hikes pushed out into mid-2015); Underweight: Euro & Japanese Yen (relatively modest GDP growth in Eurozone & ECB undertakes aggressive, open-ended QE; BoJ expands QE). 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.