PRUDENTIAL INTERNATIONAL INVESTMENTS ADVISERS, LLC. Global Investment Outlook December 2014 Stocks Rebound from Early October Sell-off & Surge with Liquidity Boost from Japan, Eurozone & China Global Stock Markets to Rally into Year-end Fueled by BoJ Stimulus, ECB Set to Launch QE, Fed on Hold, China Rate Cut & Mini Stimulus, Rate Cuts & Easing Measures by Emerging Central Banks, Improved H2 GDP Growth, Solid Earnings & Fair Valuations Bond Yields Likely to Rise with solid GDP Growth in the U.S. & U.K., Eurozone Stabilizing, Expensive Valuations & Fed Rate Hike Uncertainty John Praveen, PhD Chief Investment Strategist John Praveen s Global Investment Outlook for December 2014 expects global stock markets to rally into year-end fueled by BoJ stimulus, ECB prepares to undertake fullfledged QE, China rate cut & mini stimulus, Fed on hold, improved GDP growth in the U.S. and U.K., solid earnings growth & fair valuations. Stocks: Stock markets rebounded from the early October sell-off with sharp rally in late October with easing of Ebola pandemic fears and strong Q3 earnings results. Developed market stocks continued to rally in November with a fresh liquidity boost from the BoJ and ECB, and a surprise rate cut in China. Through November 28, developed markets are up 1.8% to take YTD returns to 4.7%. Emerging markets declined -1.1%, and are up 0.2% YTD. Looking ahead, we expect the global equity rally to continue into 2014 year-end fueled by: 1) Fresh stimulus in Japan, Eurozone & China, the Fed on hold, BoE rate hikes pushed out into 2015, and easing measures by Emerging central banks; 2) Global growth on track to modest H2 recovery with solid growth in the U.S. & U.K., and Eurozone stabilizing; 3) Strong Q3 earnings results and solid earnings outlook with improving GDP growth; and 4) Valuations remains fair and stocks are cheap relative to bonds. We expect U.S. stocks to reach and surpass our 2014 year-end target of 2100 for the S&P 500 index and 18,000 for the Dow. Bonds: Bond yields plunged in early October as weak Eurozone growth, deflation fears and Ebola pandemic scare triggered a sharp sell-off in equity markets leading to safe haven demand for bonds. Yields rose in late October as equity markets rebounded. FOR MORE INFORMATION CONTACT: Theresa Miller Phone: 973-802-7455 Email: theresa.miller@ prudential.com Looking ahead, bond yields are likely to rise with; 1) Solid GDP growth in the U.S. and U.K., while Eurozone appears to be stabilizing. Japan GDP contracted in Q3 but is likely to recover in Q4 with fiscal and BoJ stimulus; 2) The Fed ended QE in October and while the Fed has assured that U.S. rates will remain on hold for a considerable period, there is likely to be increased uncertainty about Fed exit strategy; 3) Bond valuations are expensive relative to stocks. However, the rise in bond yields is likely to be limited by: 1) Low inflation in the developed economies with risk of Eurozone sliding into deflation; 2) Fresh BoJ stimulus, while the ECB is laying the ground work to undertake full-fledged QE; 3) Lingering geopolitical tensions in Ukraine and the Middle East. 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 to Rally into Year-end Fueled by BoJ Stimulus, ECB Prepares to Undertake QE, Fed on Hold, China Rate Cut & Mini Stimulus, Rate Cuts & Easing Measures by Emerging Central Banks, Improved H2 GDP Growth, Solid Earnings & Fair Valuations Bond Yields Likely to Rise with Improved H2 GDP Growth, Expensive Valuations & Fed Rate Hike Uncertainty. Low Inflation, ECB QE, BoJ Stimulus & Geopolitical Tensions Likely to Cap Rise in Yields Stock Market Outlook (December): Stock markets posted modest gains in October fully erasing the losses from late September and early October. Developed markets (MSCI World) gained a modest 0.6% (US$) in October while Emerging markets rose 1.1% (US$). Developed market stocks continued to rally in November with a fresh liquidity boost from the BoJ and ECB, strong Q3 earnings results and a surprise rate cut in China. Through November 28, developed markets are up 1.8% to take YTD returns to 4.7%. Emerging markets declined -1.1% in November, dragged lower by a sharp decline in Emerging Eastern Europe (-7.8%). Emerging markets are up 0.2% YTD. Looking ahead, we expect the equity rally to continue into year-end fueled by: 1) Continued liquidity & interest rate support with fresh stimulus in Japan, Eurozone & China. 2) Global growth remains on track to modest H2 recovery; 3) Solid Earnings Outlook with Improving GDP Growth after strong Q3 Earnings; and 4) Stocks cheap relative to bonds. 1) Continued Liquidity & Interest Rate Support with Fresh Stimulus from BoJ, ECB & PBoC: The interest rate jitters which rocked markets in early October eased as financial markets got another liquidity boost from the BoJ and subsequently from the ECB and a surprise rate cut by China s PBoC. The BoJ surprised markets by announcing an aggressive expansion of stimulus, while the ECB started laying the ground work to undertake full-fledged QE having overcome internal opposition, especially from Germany. The ECB has indicated that it will expand its balance sheet by 1trn to the 2012 level of around 3trn. The ECB has already started purchase of Asset Backed Securities (ABSPP) and is due to start buying covered bonds (CBPP3) in late Q4. China s PBoC continues to provide stimulus with a surprise rate cut in November after targeted, mini liquidity injections in recent months. The Fed ended QE in October with no Taper Tantrums with the Fed reassuring that it will keep U.S. rates low for an extended period implying the first rate cut is unlikely until mid-2015. In the U.K., a BoE rate hikes have been pushed out further into 2015 with weak inflation data and some slowing of growth momentum. Several Emerging central banks are cutting rates and/or likely to cut rates or take other easing measures in early 2015 with falling inflation. The ECB left interest rates unchanged at its November meeting but signaled a distinct easing bias, overcoming differences among ECB council members and instructing ECB staff to prepare the ground work for additional easing measures, presumably full fledged QE with broad-based government bond purchases. ECB President Draghi cited two triggers for full-fledged QE: a deterioration in the inflation outlook, or the failure of existing policies to boost the ECB s balance sheet adequately. President Draghi announced that asset purchases will have a sizeable impact on our balance sheet, which is expected to move towards the 3trn level at the beginning of 2012, or a 1trn increase from current level, around 2trn. The ECB decision was unanimous which suggests that the governing council managed to patch up differences over QE expansion, especially German opposition, paving the way for the ECB to undertake full fledged QE. The ECB provided additional information about their current asset purchase program. Covered bond purchases began in late October and purchases of ABS will start in late Q4. The Bank of Japan (BoJ) remained on hold in November after surprising markets with a significant stimulus expansion in late October. With inflation at the low end of the bank s expectations, the Bank announced the expansion of its balance sheet at an annual pace of 80 trillion, up from 50 trillion. The BoJ said that it would accelerate purchases of Japanese government bonds at an annual pace of up to 80 trillion, up from 50 trillion, and triple its purchases of exchange-traded funds (ETFs) and real-estate investment trusts (REITs) to 3tr and 90 billion, respectively. 2 For informational use only. Not intended as investment advice.
The U.S. Federal Reserve ended its Quantitative Easing program at its late October meeting, without another bout of Taper Tantrums by the Markets. The Fed reiterated that interest rates will remain at current low for a considerable time which means the first rate hike is unlikely before mid-2015. However, the Fed made its rate policy a bit more data-dependent, indicating that rate hikes could occur sooner or later than the Fed currently anticipates depending on the evolution of economic data. The Fed upgraded its assessments of current U.S. conditions, acknowledging the improvement in labor market conditions and inflation outlook. In the U.K., the Bank of England (BoE) left U.K. monetary policy unchanged at their November meeting. Low inflation, weak wage growth and downside risks suggest that the BoE rate hikes are pushed out into 2015. Emerging central bank policies have been mixed with some central banks easing rates and/or likely to ease in early 2015, while Brazil and Russia are raising rates to counter rising inflation and weakening currencies. The People s Bank of China (PBoC) surprised markets by cutting interest rates for the first time since July 2012. The rate cuts follow various targeted easing measures by the PBoC in recent months to provide inter-bank liquidity and lower money market rates and bond yields. Low inflation gives the PBoC room to undertake further easing measures to provide liquidity ahead of year-end. Other emerging central banks are on hold in Asia but India, Taiwan and Korea are likely to cut rates with easing inflation. In Eastern Europe, deflation risk is likely to prompt rate cuts in Hungary, Poland, and Czech Republic in early 2015. 2) Global Growth on Track to Modest H2 Recovery led by U.S. & U.K, & Eurozone Stabilization: Global GDP growth remains on track to a modest H2 recovery with solid GDP growth in the U.S. and U.K., and Core Eurozone stabilizing after the Q2 weakness while the Periphery remains healthy. Japan was a disappointment with GDP contracting in Q3 but is likely to recover in Q4 with fresh BoJ stimulus, another fiscal stimulus package and the postponement of second round of consumption tax increase. China s GDP growth remains stable in the 7-7.5% range and the policy makers continue to provide targeted stimulus to ensure that growth remains in this range. Growth in the other emerging economies continues to stabilize with improved growth in India, Taiwan, Korea, Turkey and Mexico. Brazil appears to be stabilizing, while Russia continues to struggle with sanctions and the sharp decline in oil prices. The U.S. economy remains solid, with Q3 GDP growth coming in stronger-than-expected at 3.9% annualized (3% expected) after 4.6% growth in Q2. Trade, consumption, and government spending were the key contributors to Q3 growth. Trade added a solid 1.3% to Q3 growth after -0.3% in Q2 as exports rose 7.8%, while imports fell -1.7%. Consumption spending grew 1.3% and added 1.2% to growth, down from 1.8% in Q2, with a slowdown in goods spending. Government spending rose 4.6% and added 0.8% to growth (0.3% in Q2), largely driven by increased defense spending. However, there was a slowdown in investment spending, to only 0.2% from 2.9% in Q2. Looking ahead, U.S. GDP growth is expected to remain solid in Q4, around 3%. The Eurozone economy appears to be stabilizing after the recovery stalled in Q2. Eurozone GDP grew a modest 0.8% QoQ annualized in Q3, according to the advance release, while Q2 GDP growth was revised higher to 0.4% (from 0% initially reported). The Q3 GDP increase allayed fears that the Eurozone economy is in imminent danger of slipping into recession. The annual pace of GDP growth was unchanged at 0.8% YoY. Full details of Q3 growth are not yet available, but a modest recovery in the Core economies lifted Eurozone GDP, while the Periphery remained healthy. U.K. growth outlook remains solid, with Q3 GDP growing 3% YoY after 3.2% in Q2. Quarterly growth was 2.8% annualized after 3.6% in Q2. Full details are not yet available. Japanese GDP fell, unexpectedly, contracting -1.6% annualized in Q3 after a sharp -7.1% decline in Q2 driven by a decline in business investment spending while recovery in consumption spending was modest. Following the unexpected decline in Q3 GDP, PM Abe called for snap elections to the Lower House to seek a fresh mandate for 3 For informational use only. Not intended as investment advice.
Abenomics and to push back the second round of tax increase scheduled in 2015. PM Abe announced a delay in the second increase in consumption tax scheduled for October 2015 to 2017. This is expected to help support consumption growth over 2015. Further, the government is considering fresh fiscal stimulus with a supplementary budget of 2-3 tr (0.5% of GDP) to boost the economy. Japanese GDP growth is expected to recover to around 1.5% in Q4. 3) Strong Q3 Earnings, Solid Earnings Outlook: Global earnings are expected to rise around 10% in 2015 after rising around 8% in 2014 driven by improving global GDP growth and solid margins. U.S. Q3 earnings results are coming out stronger than expected with earnings growth tracking 9.3% with 363 of the S&P 500 companies reporting and 76% of the companies beating expectations. After the Q3 earnings upside surprises, 2014 full-year earnings are tracking 8% and expected to accelerate to over 10% in 2015. Eurozone earnings are expected to strengthen to around 14% in 2015 after an 8% rise in 2014. Japanese earnings growth is tracking around 12% in 2015 and expected to grow over 10% in 2015. However, earnings expectations are likely to be revised lower after GDP growth contraction in Q3 and expectations are for modest growth in coming quarters. U.K. earnings remain lackluster with 3% growth in 2014 and 5% in 2015. Emerging Market earnings growth is expected to improve modestly to around 8% in 2015 after 7% in 2014. EM earnings growth is driven by solid earnings growth in EM Asia while earnings in Latin America and EMEA have lagged. 4) Stock Valuations remain Reasonable despite Modest Rise in P/Es on October Gains: Stock market P/E multiples rose in October with global markets posting gains amidst extreme intra month volatility. The P/E multiple for developed markets (DM) rose modestly to 18.1X in October from 17.9X in September, but remains well below the long term average of 21.2X. U.S. (S&P 500) trailing P/E multiple rose to 17.9X at the end of October from 17.5X at the end of September. The U.S. trailing P/E multiple still remains below the 2014 high of 18.1X in August and the long-term average of 19.3X. The P/E for Japanese stocks (TOPIX) was unchanged at 15.6X at the end of October, while the P/E for Eurozone stocks (STOXX 600) fell to 20.5X from 20.9X in September. Emerging Market (EM) P/E multiples rose slightly to 12.9X from 12.7X in September as EM stocks rose 1.3% during the month. Bottom-line: Stock markets rebounded from the early October sell-off as the Ebola pandemic fears eased and Q3 earnings were stronger-than-expected. Stock markets continued to rally in November with a fresh liquidity boost from the BoJ and ECB, and rate cut in China. The rally lifted the U.S. S&P 500 to a new all time high (2070). Through November 28, developed markets are up 1.8% to take YTD returns to 4.7%. Emerging markets declined -1.1% in November, dragged lower by a sharp decline in Emerging Eastern Europe (-7.8%). Emerging markets are up 0.2% YTD. Looking ahead, we expect the global equity rally to continue into year-end fueled by: 1) Fresh Stimulus in Japan, Eurozone & China. The BoJ announced fresh stimulus, aggressively expanding its balance sheet, while the ECB has started to lay the ground work to undertake full-fledged QE. China delivered a surprise rate cut in November after targeted, mini stimulus in recent months. The Fed ended QE in October with no Taper Tantrums and reassured that the first rate hike is unlikely until mid-2015. Several Emerging central banks have been cutting rates and likely to undertake easing measures in early 2015; 2) Global growth remains on track to modest H2 recovery with around 3% growth in the U.S. & U.K. Eurozone appears to be stabilizing with the Core economies posting modest growth in Q3 while the Periphery remains healthy. Japan GDP contracted in Q3 but is likely to recover in Q4 with fresh BoJ stimulus, another fiscal stimulus package and postponement of the 2015 tax hike. China GDP growth remains stable in the 7-7.5% range and growth continues to improve in India, Taiwan, Korea, Turkey and Mexico; 3) Strong Q3 Earnings, Solid Earnings Outlook with Improving GDP Growth: The Q3 earnings results were strong in the U.S. and Europe and earnings outlook remains solid with improving GDP growth. Global earnings are expected to rise over 8% in 2014 and improve to 10% in 2015 driven by solid earnings growth in the U.S. (11%), Japan (12%), Emerging Markets (8%) and Eurozone (14%); 4) Fair Valuations: Stock market P/E multiples rose in October with markets posting gains amidst extreme intra 4 For informational use only. Not intended as investment advice.
month volatility. However, P/E multiples remain below long term averages. Stocks are cheap relative to bonds given the decline in bond yields. We expect favorable macro, earnings and valuation fundamentals to fuel the equity rally to year-end. However, stocks face several uncertainties including ECB disappointing again on full-fledged QE, weak growth in Eurozone and Japan, another round of destabilizing Washington dysfunction and geo-political tensions. Further, while the Fed has assured that U.S. rates will remain on hold for a considerable period, there is likely to be increased uncertainty about Fed exit strategy and timing of first rate hike. While these uncertainties are likely to keep markets volatile, we expect stock markets to rally into year-end fuelled by liquidity & low interest rates, improved H2 GDP growth, solid earnings and fair valuations. We expect U.S. stocks to reach and surpass our 2014 year-end target of 2100 for the S&P 500 index and 18,000 for the Dow Jones Industrial Average (DJIA). Bond Market Outlook: Yields Likely to Rise with Improved H2 GDP Growth, Expensive Valuation & Fed Rate Uncertainty Bond yields plunged in early October as weak Eurozone growth, deflation fears and Ebola pandemic scare triggered a sharp sell-off in equity markets leading to safe haven demand for bonds. Yields rose in late October as equity markets rebounded. Looking ahead, bond yields are likely to rise with; 1) Solid GDP growth in the U.S. and U.K., while Eurozone appears to be stabilizing. Japan GDP contracted in Q3 but is likely to recover in Q4; 2) The Fed ended QE in October and while the Fed has assured that U.S. rates will remain on hold for a considerable period, there is likely to be increased uncertainty about Fed exit strategy; 3) Bond valuations are very expensive relative to stocks. However, the rise in bond yields is likely to be limited by: 1) Low inflation in the developed economies with the risk of Eurozone sliding into deflation; 2) The BoJ announcing fresh stimulus, while the ECB is laying the ground work to undertake full-fledged QE; 3) Lingering geopolitical tensions and risk. Investment Strategy: Asset Allocation: Stocks vs. Bonds - Increase Equity Overweight as Stocks to Rally into Year-end with BoJ, ECB & China Stimulus, Fed on Hold, Improved H2 Growth, Solid Earnings & Fair Valuations Stocks Increase overweight as stocks rebound from early October sell-off and likely to rally into year-end fueled by fresh BoJ stimulus, ECB undertaking full fledged QE, Fed on hold, China rate cut & mini stimulus, rate cuts & easing measures by other Emerging central banks, improved H2 GDP growth, solid earnings & fair valuations. Bonds Remain modest underweight as bond yields likely to rise with solid GDP growth in the U.S. & U.K., Eurozone stabilizing, expensive valuations & Fed rate hike uncertainty. Low inflation, ECB QE, BoJ stimulus and lingering geopolitical tensions are likely to limit the rise in yields. Global Equity Strategy: Modest Overweight in Emerging Asia, Japan & Eurozone; Downgrade U.S. to Modest Underweight; Underweight U.K., Latin America & Emerging Europe. Emerging Markets: Modest Overweight in Emerging Asia with China rate cut & mini stimulus, India reforms & rate cuts likely; Underweight in Latin America & EM Europe: Weak GDP growth in Brazil, rate hikes & reforms unlikely under Dilma II. Russia recession, rate hikes & Ukraine tensions persist. Japan: Raise to Modest Overweight with BoJ expanding stimulus, reforms likely to gets a jump start after snap election. Eurozone: Raise to Modest Overweight with ECB preparing to launch full fledged QE, expand balance sheet by 1trn, Eurozone growth stabilizing. 5 For informational use only. Not intended as investment advice.
U.S.: Reduce Overweight on profit taking after strong run, Fed rate hike uncertainty, risk of Washington dysfunction. Dollar strength poses risks to U.S. growth & earnings. Easing risk aversion reduces safe haven appeal of U.S. stocks. U.K.: Remain Underweight with BoE set to hike rates but growth momentum slowing with slower Eurozone GDP growth. Global Bond Market Strategy: Yields likely to Rise with Improved GDP, Fed Rate Hike Uncertainty. Low Inflation, BoJ Stimulus & ECB QE likely to Cap Rise in Yields Eurozone: Remain Overweight with weak GDP growth, low inflation and ECB preparing to undertake full fledged QE. EM Bonds: Modest Overweight with growth stabilizing, China rate cuts & mini stimulus, rate cuts by other banks, easing political uncertainties. Japan JGBs: Raise to Neutral with BoJ stimulus & fresh Abe reforms likely after snap elections. GPIF AA shift to risky assets a negative. U.S. Treasuries: Remain Modest Underweight as yields likely to rise with solid H2 GDP growth, uncertainty about Fed s exit strategy & timing of first rate hike, expensive valuations. Reduced safe haven demand with easing geopolitical tensions. U.K. Gilts: Remain Underweight as yields under pressure with solid GDP growth and BoE starts rate hikes in 2015. Global Sector Strategy: Overweight: Info. Tech & Healthcare; Modest Overweight: Industrials & Financials; Neutral: Materials, Consumer Discretionary, Telecomms; Underweight: Energy, Consumer Staples & Utilities. Currency Strategy: Overweight: U.S. Dollar (solid GDP growth & Fed ends QE) Neutral: Emerging Market Currencies (improving GDP growth, easing political uncertainties) & Pound Sterling (solid GDP growth but BoE rate hikes pushed out into 2015); Underweight: Euro & Yen (weak GDP growth in Eurozone & Japan, ECB set to undertake full-fledged QE, & BoJ expands stimulus). Follow us on Twitter: www.twitter.com/prustrategist Disclosures: Prudential International Investments Advisers, LLC. (PIIA), a Prudential Financial, Inc. (PFI) company, is an investment adviser registered with the Securities and Exchange Commission of the United States. Pramerica is a trade name used by PFI and its affiliated companies in select countries outside of the United States. PFI, a company incorporated and with its principal place of business in the United States of America is not affiliated in any manner with Prudential plc, a company headquartered in the United Kingdom. The commentary presented is for informational purposes only, and is not intended as investment advice. This material has been prepared by PIIA on the basis of publicly available information, internally developed data and other third party sources believed to be reliable. However, no assurances are provided regarding the reliability of such information. All opinions and views constitute judgments of PIIA as of the date of this writing, and are subject to change at any time without notice. There can be no assurance that any forecast made herein will be realized. Distribution of this information to any person other than the person to whom it was originally delivered and to such person s advisers is unauthorized and no part of this material may be reproduced or distributed further without the written approval of PIIA. These materials are not intended for distribution to, or use by, any person in any jurisdiction where such distribution would be contrary to local law or regulation. The companies, securities, sectors and/or markets referenced herein are included solely for illustrative purposes to highlight the economic trends, conditions, and the investment process, but may or may not be held by accounts actually managed by PIIA. The strategies and asset allocations discussed do not refer to any service or product offered by PIIA or by its affiliates The global asset and strategy allocation models presented are hypothetical allocation models shown for illustrative purposes only, and do not necessarily reflect the management of any actual account. Following the allocation recommendations presented will not necessarily result in profitable investments. Past performance is not an assurance of future results. Nothing herein should be viewed as investment advice to adopt any investment strategy, nor should it be considered an offer to provide investment advisory or other allocation services. 2014 Prudential Financial, Inc. and it related entities. Prudential, the Prudential logo and the Rock symbol are service marks of Prudential Financial, Inc. and it related entities, registered in many jurisdictions worldwide. 6 For informational use only. Not intended as investment advice.