PRUDENTIAL INTERNATIONAL INVESTMENTS ADVISERS, LLC. Global Investment Outlook May 2014 Stocks to Rebound with Q2 GDP & Earnings Recovery, Fresh ECB (& BoJ) Stimulus, Fed keeping U.S. Rates Low & Easing Emerging Market Uncertainties. However, Stocks Volatile in Near-term with Heightened Ukraine Tensions & Q1 Earnings Uncertainty. Bond Yields Likely to Rise with Q2 GDP Growth Rebounds. Low Inflation, Low U.S. Rates, Fresh ECB Stimulus & Ukraine Risks Cap Rise in Yields. John Praveen, PhD Chief Investment Strategist John Praveen s Global Investment Outlook May 2014 expects stock markets to post further gains with Q2 GDP growth and earnings rebound, favorable interest rate backdrop and reasonable valuations. However, markets are likely to remain volatile in the near-term with Ukraine risks and Q1 earnings uncertainty. Stocks: Global equity markets struggled in early March as the Ukraine crisis escalated but rebounded in late March with the Fed reassuring that U.S. rates will remain low for an extended period. Developed markets declined a modest -0.1% in March for Q1 gains of 0.8%. Emerging markets gained 2.9% in March helping pare Q1 losses to -0.8%. Stocks struggled in early April with weak Q1 GDP data and earnings disappointments. However, stocks recovered in mid-april with increased M&A activity and good earnings reports. Through April 21st, developed markets were flat on the month, while emerging markets rose 1.7%. Looking beyond the near-term volatility, we expect global equity markets to stabilize and post further gains driven by: 1) GDP rebound after the soft Q1; 2) Continued favorable interest rate and liquidity backdrop with fresh ECB stimulus, BoJ likely to expand asset purchases and the Fed keeping U.S. rates low into 2015, well beyond the end of QE; 3) Earnings rebound as GDP growth improves while margins remain healthy; 4) Valuations remain reasonable; and 5) Easing of China concerns and other Emerging Market uncertainties with favorable election outcomes and a potential political solution to the Ukraine crisis. FOR MORE INFORMATION CONTACT: Theresa Miller Phone: 973-802-7455 Email: theresa.miller@ prudential.com Bonds: Developed market bond yields were mixed in March, while EM yields edged down in anticipation of favorable election outcomes in several countries. Looking ahead, bond yields are likely to remain under upward pressure from: 1) Global growth rebound after the soft Q1; 2) The Fed continues gradual QE taper, the ECB and BoJ refraining from providing fresh stimulus for now; 3) Bond valuations remain expensive relative to stocks despite equity gains in 2013; and 4) Easing of Emerging Market uncertainties with favorable election outcomes in several countries. However, the rise in bond yields is likely to be limited by: 1) Inflation remaining low in Eurozone and U.S; 2) The Fed pledging to keep U.S. rates low for an extended period, beyond the end of QE; the ECB likely to cut rates in June/July, and the BoJ likely to be persuaded by Prime Minister Abe to provide fresh stimulus; 3) Safe haven demand with heightened Eastern Ukraine tensions. 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 Rebound with Q2 GDP & Earnings Recovery, Fresh ECB (and BoJ) Stimulus & Fed keeping U.S. Rates Low, Easing Emerging Market Uncertainties & Fair Valuations. However, Stocks Likely to Remain Volatile in Near-term with Ukraine Risks & Q1 Earnings Uncertainty. Bond Yields Likely to Rise with Q2 Growth Rebound & Further Equity Market Gains. Stock Market Outlook (May 2014): Global equity markets struggled in early March as the Ukraine crisis escalated with Russia annexing Crimea and threatening Eastern Ukraine, the U.S. and Europe threatening to impose tougher sanctions, and potential Russian retaliation by cutting off gas supplies to Europe. Fears about China growth and credit defaults also weighed on Markets. However, stocks rebounded in late March following the March Fed meeting where it reassured that U.S. economic conditions may warrant keeping rates low for an extended period. Markets were also relieved that the Ukraine crisis did not escalate into a military conflict between Russia and NATO. The emerging markets outperformed the developed markets in March driven by evidence of China growth stabilization and in anticipation of favorable election outcomes in several countries. Developed markets (MSCI World) declined a modest -0.1% in March after a gain of 4.8% in February. For Q1 2014 the developed markets gained 0.8%. Emerging markets gained 2.9% in March after rising 3.2% in February. This helped the index pare sharp losses from January for a modest quarterly loss of -0.8%. Stocks struggled in early April amidst increased volatility. The ECB again disappointed markets by not providing fresh stimulus despite dovish talk and Eurozone inflation falling further to 0.5%. Markets also appear to be confused with the Fed s communication, especially the increase in the projected federal funds rate path and the change to qualitative rate guidance with a risk of misinterpreting these changes as a signal that tightening could start earlier than expected. In addition, while early Q2 economic data came in solid and points to a Q2 GDP rebound, the weak Q1 GDP data and earnings disappointments weighed on markets. Finally, some of U.S. sectors which had strong performance in 2013 (Biotech and Information Technology) experienced sharp sell-offs, dragging the broader market lower. However, stocks recovered in mid-april with increased M&A activity and good earnings reports. Through April 21st, developed markets were flat on the month, while emerging markets rose 1.7%. Looking beyond the near-term volatility from the Ukraine risks, weak Q1 GDP and earnings uncertainty, we expect global equity markets to post further gains driven by: 1) GDP growth rebound after the soft Q1; 2) Continued favorable interest rate and liquidity backdrop with fresh ECB stimulus, the BoJ likely to expand asset purchases and the Fed keeping U.S. rate low into 2015, well beyond the end of QE; 3) Earnings rebound as GDP growth improves while margins remain healthy; 4) Valuations remain reasonable; and 5) Easing of China concerns and other Emerging Market uncertainties with favorable election outcomes and potential political solution to the Ukraine crisis. 1) Global GDP Growth on Track to Strengthen after the Soft Q1: Solid macro data in early Q2 suggests that global GDP growth remains on track to strengthen after the Q1 soft patch. In the U.S, early Q2 data shows a rebound in industrial production, retail sales and job growth. U.S. Q2 GDP growth is on track to rebound to over 3% from around 1.5% in Q1 with a snapback in consumption and investment spending after being depressed by severe winter storms in Q1. Inventories are also expected to contribute to Q2 growth after being a big drag on Q1 GDP, which was a payback for the strong contributions to growth in H2 2013. 2 For informational use only. Not intended as investment advice.
The Eurozone economy remains in a steady recovery in 2014. Eurozone GDP is expected to strengthen in Q1 to 1.4% QoQ annualized pace after 0.9% in Q4, driven largely by solid German GDP growth and more modest growth in France, Italy and Spain. The ECB continues to see a gradual recovery with GDP growth improving to 1.2% in 2014 (revised from 1.1% in the December forecast). In its semi-annual World Economic Outlook, the IMF also expects Eurozone GDP to grow 1.2% in 2014 and 1.5% in 2015. The U.K. economy remains solid and GDP growth is expected to strengthen to over 3% in Q1 after 2.9% in Q4. The BoE raised its 2014 GDP forecast to 3.2% from 2.4%. Japanese GDP growth is expected to rebound to 3% in Q1 2014 after 0.7% in Q4 2013 with frontloading of consumption spending ahead of the tax hike in early April. However, Q2 GDP growth is expected to contract around -2% due to the impact of the hike in consumption tax and the payback for the front-loading of spending in Q1. GDP growth in the emerging economies remained soft in Q1 2014 as severe winter storms depressed export demand from developed economies, while China data was soft. A rebound in developed economies GDP growth after the soft Q1 could jump-start EM exports and boost GDP growth. China s GDP growth slowed in Q1 to 7.4% YoY from 7.7% in Q4 2013, slightly higher than market expectations of 7.3% growth. The Q1 growth pace is not too far from the official GDP target for 2014 of 7.5% and should allay fears of a hand landing. Chinese policymakers appear comfortable with the current pace of growth and Premier Li Keqiang ruled out major stimulus in early April. China s GDP growth is expected to slow further in Q2 to 7.2% but rebound to above 7.5% in H2 with a mini-fiscal stimulus, modest monetary stimulus and the weakening Renminbi providing a boost to exports. Among other economies, GDP growth appears to be stabilizing in Q1 2014 in Taiwan (2.7%), Korea (3.7%), Brazil (2%), Mexico (2.5%), India (4.8%) and other emerging economies. 2) Continued Favorable Interest Rate Backdrop & Liquidity Support: The interest rate backdrop remains supportive of stocks with the ECB (and possibly the BoJ) likely to provide fresh stimulus over the next few months, the Fed keeping U.S. rates low into 2015, well beyond the end of QE, and Emerging central banks close to ending their tightening cycle. The U.S. Federal Reserve continued its gradual, measured taper, cutting asset purchases by another $10bn to $55bn from $65bn at the March meeting. However, the Fed continued to reassure that QE taper is not on auto-pilot or a preset course but will be data-dependent and will continue in measured steps. The minutes of the March meeting reaffirmed the Fed s commitment to keeping U.S. rates low for an extended period, well beyond the end of QE. The ECB once again left policy unchanged in April with rates at 0.25% and no fresh stimulus. However, with Eurozone headline inflation down to 0.5% in March, the ECB s tone was markedly dovish with President Draghi assuring that the ECB will act forcefully including using QE if inflation does not recover to the ECB's forecast path. Draghi also noted that the ECB was prepared to lower both the refi and deposit rates further. The ECB s view is that the March drop in inflation is a temporary distortion due to the late Easter holidays. While the April reading is likely to show a snap back in inflation, the March low is likely to be re-tested in late Q2, prompting the ECB to act in June/July, with a rate cut and even a modified QE. The Bank of Japan (BoJ) left policy unchanged in April. The bank is likely to remain on hold in the near term to assess the impact of the consumption tax hike on the economy but is likely to implement further easing measures in H2. Governor Kuroda reiterated that the BoJ still has a number of options to ease further if downside risks rise and will not hesitate to take action if necessary. Prime Minister Abe is scheduled to meet BoJ Governor Kuroda soon and is likely to persuade the BoJ to undertake fresh stimulus to offset the impact of the April tax hike. 3 For informational use only. Not intended as investment advice.
The Bank of England (BoE) left U.K. policy unchanged in April with policy rates at 0.5% and asset purchases at 375bn. With U.K. inflation now below the BoE s 2% target, there is less pressure on the BoE to tighten policy. Thus, despite continued solid GDP growth, current expectations are that the BoE will keep rates at current lows through 2014. Among Emerging Central Banks, Brazil, Russia, Turkey & South Africa remain in tightening mode. India and China are on hold but the People s Bank of China (PBoC) is likely to provide modest stimulus with GDP growth below the official 7.5% target. However, the PBoC wants to be cautious and does not want to lower guard against the risk of high leverage in the corporate sector." Hence any China stimulus is likely to be modest. Other emerging central banks remain on hold in Asia (Taiwan, Korea), Eastern Europe (Poland, Hungary and Czech Republic) and Latin America (Mexico). Brazil s central bank continues to raise rates but has slowed the pace of rate hikes (to 25 bps). 3) Stock Valuations Improve in March: Stock market P/E multiples improved in March to levels seen at the beginning of the year. The P/E multiple for developed markets eased to 17.5X in March after rising to 17.9X in February from 17.4X in January. Developed markets remain reasonably valued, with P/E multiples well below their historical long term average of 21.2X. Emerging Market stock valuations rose modestly to 12.3X in March from 11.9X in February and 11.6X in January. Emerging market valuations remain cheap well below P/E levels of 12.8X seen in early 2013. 4) Q1 Earnings Uncertainty but on Track to Rebound in Q2: Global earnings outlook continue to be revised lower to reflect weak Q1 with earnings growth for full year 2014 now expected around 9%, revised lower from 11% in early 2014. In the past month, the downward revision in earnings outlook has been mostly driven by downgrades in Japan. Japanese earnings growth for full year 2014 is now expected around 10% down from earlier expectations of 13% as the negative impact of the consumption tax hike, the lack of further BoJ stimulus and yen strength are factored into expectations. In the U.S. while there is a risk of Q1 earnings disappointments, the earnings outlook beyond the weak Q1 remains solid. U.S. Q1 earnings season has just begun with earnings expectations revised down to around 1% from 6.5% in January to reflect weak Q1 GDP growth. U.S. earnings growth is expected to improve to around 8% in Q2 and further strengthen to 11% in H2 2014 with GDP growth expected to rebound to over 3%. Eurozone earnings are expected to grow 12% in 2014 driven by modest GDP growth. European earnings growth for Q1 2013 are tracking 5% but expected to strengthen with improving GDP growth. Emerging Markets earnings are expected to rise around 10% in 2014 after just 4% in 2013 with improving GDP growth. Bottom-line: In the near-term, markets are likely to remain volatile with heightened Ukraine tensions, weak Q1 GDP and potential earnings disappointments. Markets are likely to remain volatile until there is clear evidence of strengthening GDP growth and earnings rebound, are convinced that Fed will keep U.S. rates low for an extended period, beyond the end of QE taper, and there is a political solution to the Ukraine crisis. Looking beyond the near-term volatility from the Ukraine risks, weak Q1 GDP and earnings uncertainty, we expect global equity markets to post further gains driven by: 1) GDP rebound after the soft Q1: U.S. GDP growth on track to rebound to over 3% after the weak Q1. The Eurozone remains in a steady recovery with around 1.4% GDP growth in Q1 lead by Germany. U.K. GDP growth expected to strengthen to over 3% in H1. Japan s GDP is expected to rebound in Q1 with frontloading of spending ahead of the April tax hike. China hard landing fears ease with Q1 GDP growth at 7.4%, and GDP growth in other emerging economies is stabilizing; 2) Continued favorable interest rate and liquidity backdrop with the ECB (and possibly the BoJ) likely to provide fresh stimulus over the next few months, the Fed keeping policy accommodative well into 2015, beyond the end of QE. Emerging central banks ending their tightening cycle; 3) Earnings rebound after the weak Q1 as GDP growth strengthens while margins remain healthy; 4) Valuations remain reasonable as P/E multiples remain below long term average in both developed and emerging markets; 5) Easing of China concerns and other Emerging Market uncertainties with favorable election outcomes, and potential political solution to the Ukraine crisis. 4 For informational use only. Not intended as investment advice.
Stock markets are likely to stabilize and post further gains with GDP growth and earnings rebound after the soft Q1, continued favorable interest rate and liquidity backdrop with Fed keeping U.S. rates low, fresh ECB (and possibly BoJ) stimulus, reasonable valuations, easing of Emerging Market election uncertainties and improving risk appetite as the Ukraine crisis is resolved. However, in the near-term stocks are likely to remain volatile with Q1 earnings uncertainty and potential disappointments and lingering Ukraine risks. Bond Market Outlook: Bong Yields Likely to Rise with GDP Growth Rebound & Equity Market Gains. Developed market bond yields were mixed in March with U.S. and Japanese yields range-bound while Eurozone yields declined steadily. Emerging Market yields edged down in anticipation of favorable election outcomes in several countries. Looking ahead, bond yields are likely to remain under upward pressure from: 1) Global growth rebound with GDP growth expected to be solid in the U.S. and U.K. (over 3%), steady in Eurozone (1.4%), stabilizing in China (at 7.4%) and other Emerging economies; 2) The Fed continues gradual QE taper, the ECB and BoJ refraining from providing fresh stimulus for now; 3) Bond valuations remain expensive relative to stocks despite equity gains in 2013; and 4) Easing of Emerging Market uncertainties with favorable election outcomes in several countries. However, the rise in bond yields is likely to be limited by: 1) Inflation remaining low in Eurozone (0.5%) and U.S (1.5%); 2) The Fed pledging to keep U.S. rates low for an extended period, beyond the end of QE; the ECB likely to cut rates in June, and the BoJ likely to be persuaded by Prime Minister Abe to provide fresh stimulus; 3) Safe haven demand with heightened Eastern Ukraine tensions. Investment Strategy: Stocks Volatile in Near-term with Ukraine Tensions & Q1 Earnings Risks. Stocks to Rebound with Q2 GDP & Earnings Recovery, Fresh ECB (and BoJ) Stimulus & Easing Emerging Market Uncertainties. Asset Allocation: Stocks vs. Bonds Remain Overweight in Stocks but keep Modest Overweight with Q1 Earnings Risks & Ukraine Tensions. Stocks Looking beyond the near-term volatility, we expect global equity markets to post further gains with GDP growth and earnings rebound, continued favorable interest rate and liquidity backdrop with fresh ECB (and BoJ) stimulus, reasonable valuations, and easing of emerging market election uncertainties. However, we keep a modest overweight in stocks due to Ukraine risks & Q1 earnings uncertainty. Bonds Keep bonds at modest underweight as yields likely to rise with global GDP growth on track to rebound after the soft Q1, the Fed continues QE taper, no fresh stimulus from the ECB and BoJ for now, and bond valuations remain expensive relative to stocks. Global Equity Market Strategy: Reverse Tactical Bets and Raise Eurozone & U.K. to Modest Overweight, lower U.S. to Underweight. Eurozone: Raise to modest overweight with ECB easing likely, steady GDP growth, earnings rebound, and potential resolution of Ukraine crisis. U.K.: Raise to modest overweight with solid growth outlook, attractive valuations & potential resolution of Ukraine crisis. Japan: Raise to Neutral as Prime Minister Abe likely to persuade BoJ to provide fresh stimulus to offset drag from April tax hike and solid Q1 GDP with frontloading of spending. Emerging Markets: Raise to Neutral with GDP growth stabilizing and easing of uncertainties in anticipation of favorable election outcomes. U.S.: Lower U.S. to underweight with weak Q1 earnings, reduced safe haven appeal with easing of EM uncertainties and limited scope for further P/E expansion. 5 For informational use only. Not intended as investment advice.
Global Bond Market Strategy: Yields likely to Rise as Global Growth Rebounds after Q1 Soft Patch & No Fresh ECB Stimulus for Now. Eurozone: Remain Overweight with low inflation, modest GDP growth and ECB likely to ease in June. EM Bonds: Raise to Modest Overweight as uncertainties have eased in anticipation of favorable election outcomes. Improving global growth also positive. Japan JGBs: Neutral with BoJ on hold & Q1 GDP rebound with front loading of spending ahead of April tax hike. Weak Q2 GDP & likely BoJ stimulus are positives. U.S. Treasuries: Neutral with solid GDP rebound after soft Q1 and Fed continuing QE taper, but offset by low inflation and Ukraine safe haven demand. U.K. Gilts: Remain Underweight as yields under pressure from solid GDP growth and further BoE stimulus unlikely. Global Sector Strategy: Overweight: Industrials & Information Technology; Modest Overweight: Financials, Healthcare & Energy; Neutral: Telecommunication Services, Healthcare, Materials; Underweight: Consumer Discretionary, Consumer Staples & Utilities. Currency Strategy: Overweight: U.S. Dollar & Sterling; Neutral: Emerging Market Currencies; Underweight: Yen & Euro. 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.