PRUDENTIAL INTERNATIONAL INVESTMENTS ADVISERS, LLC. Global Investment Outlook 2014 Year Ahead Outlook January 2014 2014 Year Ahead - Global Investment Outlook Financial Market Outlook: After Strong Gains in 2013, Stocks likely to Post Further Gains in 2014 Fuelled by Strengthening Global Growth, Low Interest Rates & Liquidity Support, Earnings Rebound, Fair Valuations and Easing Global Risks Bond Yields likely to Drift Higher with Strengthening GDP Growth, Fed QE Taper & Easing Global Risks. Low Inflation, Low Rates, Further Easing by ECB & BoJ likely to Limit Rise in Bond Yields John Praveen, PhD Chief Investment Strategist John Praveen s Global Investment Outlook expects global equity markets to post further gains in 2014 fuelled by strengthening global growth, low interest rates and liquidity support, earnings rebound, fair valuations, and easing global risks. Developed Markets are likely to add to their strong gains in 2013, while Emerging Markets are likely to post catch-up gains after struggling in 2013. Stocks: Developed stock markets surged over 20% in 2013 on liquidity (Fed QE buying, BoJ Stimulus and ECB Rate Cut), P/E multiple expansion on fading of global tail risks (U.S. debt default risk, China hard landing, Euro break-up, Cyprus & Italy risks), easing of Syria and other Middle East Tensions. Emerging stock markets struggled and underperformed with growth disappointments, interest rate hikes, Fed QE taper fears and domestic political unrest. Looking ahead to 2014, we expect global equity markets to add to the 2013 gains fuelled by: 1) Continued favorable interest rate backdrop & liquidity support; 2) Strengthening global GDP growth; 3) Earnings rebound; 4) Reasonable valuations; and 5) Easing of global risks and improving risk appetite. We look for double digit gains by global stock markets. Our target for the U.S. S&P500 index is to reach 2014 by 2014 year-end, and 18,100 for the Dow index. During 2014, stock markets have to transition from markets driven by P/E multiple expansion and liquidity in 2013 to markets driven by GDP and earnings rebound. Market volatility is likely to be heightened during the transition until markets get confident and convinced about strengthening GDP growth, earnings rebound and get used to Fed QE taper. FOR MORE INFORMATION CONTACT: Theresa Miller Phone: 973-802-7455 Email: theresa.miller@ prudential.com Bonds: Bond yields are likely to rise further in 2014. Yields are likely to be under upward pressure from: 1) Strengthening global growth with U.S. & U.K. GDP accelerating, Eurozone recovery gaining traction, Japan remaining solid, and stabilizing growth in Emerging Economies; 2) Reduced safe haven demand for bonds with fading of global tail risks (U.S. debt default, China hard landing, Euro break-up) and easing of Middle East tensions; 3) The Fed starts QE Taper in January 2014, and 4) Bond valuations remain 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 deflation; 2) Fed QE taper likely to be gradual and measured and rates remain low through 2014. ECB likely to undertake further easing to tackle deflation. The BoJ could potentially increase asset purchases to achieve its inflation target. 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: After Strong Gains in 2013, Stocks likely to Post Further Gains in 2014 Fuelled by Strengthening Global Growth, Low Interest Rates & Liquidity Support, Earnings Rebound, Fair Valuations and Easing Global Risks Bond Yields Drift Higher with Strengthening GDP Growth, Fed QE Taper & Easing Global Risks. Low Inflation, Low Rates, Further ECB & BoJ Easing likely to Limit Rise in Yields Stock Market Outlook (2014): Developed Stock Markets surged over 20% in 2013 on liquidity (Fed QE buying, BoJ Stimulus, ECB Rate Cut), P/E multiple expansion on fading of global tail risks (U.S. debt default risk, China hard landing, Euro break-up, Cyprus & Italy risks) & easing of Syria and other Middle East tensions. Emerging Stock Markets struggled and underperformed with growth disappointments and interest rate uncertainty, Fed QE taper fear & domestic political unrest. Looking ahead to 2014, developed markets are likely to add to the strong gains in 2013, while Emerging Markets are likely to post catch-up gains after struggling in 2013. While market gains in 2013 were driven by liquidity and P/E expansion, market gains in 2014 are likely to be fuelled by: 1) Strengthening global GDP growth; 2) Earnings rebound; 3) Continued favorable interest rate backdrop & liquidity support; 4) Reasonable valuations; and 5) Easing of global risks and improving risk appetite. Favorable Interest Rate Backdrop & Liquidity Support: The interest rate backdrop remains supportive of stocks. The Fed announced in December that QE taper will start in January (reducing bond buying from $85bln to $75bln) but reassured markets that the taper will be gradual, measured and data-dependent. The Fed also provided additional forward guidance on interest rates, stating that it expects to keep the Fed Funds rate at its current level "well past the time that the unemployment rate declines below 6.5% threshold. In 2014, the Fed under new Chair Janet Yellen is likely to use enhanced forward guidance to reassure markets that the start of taper does not mean the start of tightening and that rates will remain at current low through 2014. In the Eurozone, the ECB is likely to undertake further easing measures to preempt deflationary pressures. The BoJ has pledged to continue asset purchases and expand them if inflation does not reach its 2% target. The BoE is expected to keep rates unchanged. Emerging Central banks are likely to remain steady, with some rate cuts and unwinding of 2013 tightening measures. Strengthening Global GDP Growth: Global growth is on track to improve with stronger GDP growth in the U.S. and the U.K. GDP growth in the U.S. is on track to accelerate to around 2.8% (from 1.8% in 2013) with a smaller fiscal drag, consumption & business spending strengthening while housing remains solid. The Eurozone recovery gains traction as Germany strengthens and recession ends in the Periphery. Growth in Japan remains solid as the impact of the sales tax hike is offset by fiscal stimulus and boost to exports from weak yen, while GDP growth is stabilizing in China and other Emerging Economies. Earnings Rebound: Global earnings growth recovered modestly in 2013 after the 2012 decline. Earnings growth is expected to further rebound in 2014 with strengthening GDP growth in all regions. Current expectations are for earnings to rebound to around 11% globally in 2014 with double digit earnings in the U.S. (11%), Eurozone (15%), U.K. (10%) and Emerging Markets (11%). Earnings in Japan are expected to be solid at 9% but low compared to the double digit earnings in 2013. Reasonable Valuations: P/E Multiple expansion was a big driver of stock market gains in 2013, especially in the U.S. and to a lesser extent in Eurozone. Stock markets were re-rated in 2013 with fading of global tail risks (U.S. debt default, China hard landing, Euro break-up, Cyprus & Italy Risks), QE Taper delay, and easing of Middle East tensions. Given the P/E expansion in 2013, there is limited scope for further P/E expansion in the U.S. However, there is scope for P/E 2 For informational use only. Not intended as investment advice.
multiple expansion in the Eurozone, Japan and Emerging Markets. Further, despite the market gains in 2013 by the developed markets, valuations are not yet stretched as P/E multiples still remain below long-term averages. Emerging market valuations are attractive given their underperformance in 2013. Easing Global Risks & Improving Risk Appetite: Many of risks that cast shadow on stocks in 2013 have eased. Despite Washington dysfunction, the bipartisan budget agreement to fund the U.S. government removes the risk of another destabilizing government shutdown and the specter of debt default. Middle East tensions have eased with the Iran nuclear deal and a diplomatic solution in Syria. Eurozone continues to stabilize with financial conditions improving while the Peripheral countries are expected to emerge from recession. The easing of these global risks should improve risk appetite and boost stocks. While equity markets are expected to post further gains, there are several risks & challenges that are likely to keep stock markets volatile in 2014: Fed QE Taper and Interest Rate Anxiety: Global stock markets reacted positively to the Fed announcing the start of QE taper in December 2013. However, markets are likely to face increased jitters if strong data stokes fresh fears that the Fed may accelerate QE taper during 2014 or even start tightening rates earlier than currently expected. Markets may throw another Taper Tantrum as they did in May-June 2013. Eurozone Deflation Risk & Slow/Inadequate ECB Response: Eurozone emerged from recession in mid-2013 and GDP growth is on track to strengthen as recession ends in most Periphery countries. However, Eurozone faces the risk of deflation with headline inflation now under 1%. The ECB downgraded its 2014 inflation forecast to 1.1% and expects a "prolonged period of low inflation. This suggests that the ECB needs to undertake further aggressive easing measures to prevent deflation from taking hold. However, if the ECB dithers and is slow to ease, deflation pressures could snowball and precipitate another leg of the Eurozone crisis. Further, France could potentially become the new ground zero of the Eurozone debt crisis as French fiscal and debt problems snowball into another full-fledged crisis. Potential GDP Growth and Earnings Disappointment: GDP growth is expected to strengthen in 2014 leading to stronger earnings growth. However, potential growth and earnings disappointment (as in 2013) due to continued U.S. fiscal drag, or yen strength in Japan, ECB slow to ease and further rate hikes (in some Emerging Economies) are likely to lead to a market sell-off. Fresh Geo-Political Tensions: While Middle East tensions have eased, there is risk for fresh tensions in Asia, between China and North Korea versus Japan and South Korea. Further, there is risk of fresh tension in Syria and the Iran nuclear deal breaking down. Bottom-line: We expect global equity markets to post further gains in 2014 driven by: 1) Continued favorable interest rate backdrop and liquidity support; 2) Strengthening global GDP growth; 3) Earnings Rebound; 4) Reasonable valuations; and 5) Easing of global risks and improving risk appetite. The developed markets are likely to add to the strong gains in 2013, while Emerging Markets are likely to post catch-up gains after struggling and underperforming in 2013. During 2014, stock markets have to transition from markets driven by P/E multiple expansion and liquidity in 2013 to markets driven by GDP growth & earnings rebound. Market volatility is likely to be heightened during the transition until markets get confident and convinced about strengthening GDP growth & earnings rebound, and get used to Fed QE taper. 3 For informational use only. Not intended as investment advice.
Also contributing to market volatility is continued political bickering and dysfunction in Washington DC over Obamacare despite the December agreement to fund the U.S. government and avoid a shut-down, Japan tax hike and potential policy disappointments (Abe s third arrow), the ECB is slow to respond to Eurozone deflation risk, growth and interest rate uncertainty in the Emerging Markets. Strengthening GDP growth and earnings rebound, continued favorable interest rate and liquidity backdrop, reasonable valuations, easing of global risks and improving risk appetite are likely to lift stock markets higher during 2014. We look for double digit gains by global stock markets. Our target for the U.S. S&P 500 index is to reach 2014 by year-end 2014 and 18,100 for the Dow index. Bonds: Bond Yields likely to Drift Higher with Strengthening GDP Growth, Fed QE Taper & Easing Global Risks. Low Inflation, Low Rates, Further ECB & BoJ Easing Likely to Limit Rise in Yields Bond yields are likely to rise further in 2014. Yields are likely to be under upward pressure from: 1) Strengthening global growth with U.S. GDP accelerating to 2.8% in 2014 from under 2% in 2013, Eurozone recovery gaining traction, U.K. and Japan remaining solid, and stabilizing growth in Emerging Economies; 2) Reduced safe haven demand for bonds with fading of global tail risks (U.S. debt default, China hard landing, Euro break-up) and easing of Middle East tensions; 3) The Fed starts QE Taper in January, and 4) Bond valuations remain 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 deflation; 2) Fed QE taper likely to be gradual, measured and data-dependent, and rates remain low through 2014. The ECB likely to undertake further easing to tackle Eurozone deflation. The BoJ could increase asset purchases to achieve its inflation target. Investment Strategy: Remain Overweight Stocks with Further Gains likely in 2014. Underweight Bonds with Yields likely to Rise Further Asset Allocation: Stocks vs. Bonds Remain Overweight Stocks Stocks Remain Overweight as stocks likely to add to 2013 gains with strengthening global GDP growth and earnings rebound, continued favorable interest rate and liquidity backdrop, reasonable valuations, easing of global risks and improving risk appetite. We look for double digit gains by global stock markets. Bonds Keep bonds at Modest Underweight as yields likely to drift higher with strengthening global GDP growth led by the U.S. and U.K., reduced safe haven demand with fading of global tail risks and easing of Middle East tensions, the Fed starts QE Taper, and bond valuations remain expensive relative to stocks. Global Equity Markets Overweight in Eurozone. Modest Overweight Japan & Emerging Markets. Underweight in U.S. & U.K. Eurozone: Overweight as Eurozone stocks are likely to outperform in 2014 with Eurozone in the macro sweet spot of modest GDP growth and further ECB easing. Eurozone gains are also likely to be driven by solid earnings rebound and P/E expansion as easing of risks in the Periphery and improving financial condition should lead to market re-rating. Japan: Modest Overweight as Japanese stocks are likely to post further gains in 2014 with continued solid GDP growth, BoJ stimulus and the Abe administration launching the third arrow, structural reforms. Emerging Markets: Modest Overweight as Emerging Market stocks are likely to post solid gains in 2014 with GDP growth improving, earnings rebound, EM central banks unwinding the tightening measures undertaken in 2013, improving risk appetite and P/E multiple expansion. UK: Underweight as U.K. stocks likely to underperform with the BoE is unlikely to ease further and U.K. earnings growth expected to lag earnings growth in other markets in 2014. 4 For informational use only. Not intended as investment advice.
U.S.: Underweight as U.S. stocks are expected to post more modest gains in 2014, around 10%, after 25% gains in 2013. The 2014 gains are likely to be driven by low rates and gradual Fed taper, GDP growth strengthening and solid earnings growth. However, U.S. stocks are unlikely to be supported by P/E expansion which was a big driver of 2013 gains. Our target for the S&P500 index is to reach 2014 at 2014 year-end, and 18,100 for the Dow index. Global Bonds: Eurozone Bonds & Emerging Market Debt Likely to Outperform U.S. Treasuries, U.K. Gilts & Japanese JGBs Eurozone bonds: Overweight as the outlook for Eurozone bonds remains positive with modest GDP growth, further ECB easing, low inflation bordering on deflation, and further financial stabilization. Emerging Markets Debt: Overweight on increased risk appetite and EM central banks unwinding tightening measures undertaken in 2013 to defend currencies and fight inflation. Japan JGBs: Neutral The outlook for JGBs is neutral as BoJ asset purchases are likely to offset continued solid GDP growth and improving inflation outlook. US Treasuries: Underweight as the outlook for U.S. Treasuries is relatively negative in 2014 with U.S. GDP growth on track to strengthen, the Fed starting QE taper in January 2014, and reduced safe haven demand with easing global risks. U.K. Gilts: Underweight as the outlook for U.K. Gilts remains negative with solid GDP growth, relatively high inflation and the BoE on hold with tightening bias. Global Sectors: Overweight: Industrials, Info. Technology Modest Overweight: Financials Neutral: Consumer Discretionary, Materials, Healthcare, Energy & Telecommunication Services Underweight: Consumer Staples & Utilities Currencies: Overweight: U.S. Dollar Neutral: EM Currencies Underweight: Euro, Japanese Yen 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.