Download Global Investment Strategy: Stocks likely to Post Modest Gains with

July-August 2012
By John Praveen, Chief Investment Strategist of Prudential International Investments Advisers, LLC.*
Global Investment Strategy: Stocks likely to Post Modest Gains with Fresh Rate Cuts, Central
Bank Reflation Measures, and Easing of Greek Euro Exit Risk. We Raise Stocks to Modest
Overweight.
Bond Yields Range-bound as Slowing Growth & Eurozone Fears Offset Rich Valuations &
Easing of Greek Euro Exit Risk. Raise Bonds to Neutral
John Praveen’s Global Investment Strategy – July-August 2012 raises stocks to modest overweight as stocks are
likely to post modest gains following fresh central bank rate cuts and reflation measures, and a decrease in the tailrisk of a disorderly Greek Euro exit. However, stock market gains are likely to be limited until global growth fears
ease and/or Eurozone policy makers come up with a game changer to resolve the three year old debt crisis. Hence,
we raise stocks to only a modest overweight.
Global stock markets posted a relief rally as Eurozone dodged a bullet with Greece narrowly voting to stay in the Euro (for
now), thereby diminishing the tail-risk of a disorderly Greek exit from the Euro. Further, Eurozone leaders took some “steps
in the right direction” to tackle the broader Eurozone crisis and Spain‟s problems at the EU summit in late June. However,
Eurozone policy makers continue to take only incremental steps and are yet to come up with a game-changer to
resolve the crisis. Meanwhile, the Spanish crisis continues to deepen despite the bank bailout. Further, stock
markets are facing fresh global growth concerns and earnings uncertainty during the Q2 earnings season. Recent
U.S. economic data has been disappointing leading to sharp downgrade of Q2 GDP expectations, while Eurozone continues
to struggle, and markets continue to fret about China hard landing. These negative factors are likely to offset the fresh
round of interest rate cuts and central bank reflation measures and attractive valuations, limiting equity gains.
Global bond yields are likely to remain range-bound. Risk aversion that gripped financial markets during early Q2
appears to be easing after Greece voted to remain in the Euro and Eurozone policy makers took some concrete steps at the
EU summit to address the Eurozone crisis and the Spanish issues. Further, bond yields have fallen to very low levels in
most major bond markets and are likely to rise further with a sustained decrease in risk aversion. However, financial
markets remain concerned that the EU and ECB continue to take only incremental steps and not a game changer to resolve
the crisis. Further, global GDP growth outlook is weakening while global central banks undertook another round of rate cuts
and stimulus measures in July. This should keep yields contained. Raise bonds to Neutral.
Asset Allocation: Raise Stocks to Modest Overweight, Raise Bonds to Neutral, Reduce Cash to Underweight.
Among global stock markets, we remain Modest Overweight in Emerging Markets & Japan. Raise U.K. to Modest
overweight. Raise Eurozone to Neutral. Reduce U.S. to Underweight.
Among global bond markets we are Modest Overweight in Eurozone bonds and U.K. Gilts, remain Neutral in Emerging
Markets, remain Underweight in Japanese JGBs and U.S. Treasuries.
Among global sectors, we are Overweight on Industrials and Consumer Discretionary, Modest Overweight on Healthcare,
Information Technology and Telecomms. Neutral on Financials, Consumer Staples. Underweight on Energy, Materials and
Utilities.
Investment Strategy: We Raise Stocks to Modest Overweight on Easing of Greek Euro Exit Risk
& Fresh Central Banks Rate Cuts & Reflation Measures. Raise Bonds to Neutral on Slower
Global Growth & Lingering Eurozone Concerns
Asset Allocation: Stocks, Bonds & Cash
Stocks - Raise to Modest Overweight: Stocks are likely to post modest gains after Eurozone dodged a bullet with Greece
narrowly voting to stay in the Euro and Eurozone leaders took some significant steps to tackle the Eurozone crisis.
However, Eurozone policy makers are yet to come up with a “game-changer” to resolve the crisis. Further, stock markets
are facing fresh global growth concerns and earnings uncertainty during the Q2 earnings season. Recent U.S. economic
*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.
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July-August 2012
data has been disappointing leading to a sharp downgrade of Q2 GDP expectations, while Eurozone continues to struggle,
and markets continue to fret about China hard landing. These negative factors are likely to offset renewed central bank
reflation measures and attractive valuations. Hence, further stock market gains are likely to be modest until the
growth fears ease and/or Eurozone policy makers come up with a game changer to resolve the three year old crisis.
Hence we raise stocks to only a modest overweight.
Bonds - Raise to Neutral: Global bond yields are likely to remain range-bound. Risk aversion appears to be easing after
Greece voted to remain in the Euro and Eurozone policy makers took some concrete steps at the EU summit to address the
Eurozone crisis. Further, bond yields have fallen to very low levels in most major bond markets and are likely to rise further
with a sustained decrease in risk aversion. However, financial markets remain concerned that the EU and ECB are
continuing to take incremental steps and not a game changer to resolve the crisis. Further, global GDP growth outlook is
weakening with U.S. Q2 GDP growth expectations revised down while Eurozone continues to struggle. Global central banks
undertook another round of rate cuts and stimulus measures in early Q3 to tackle the global growth slowdown. This should
keep yields contained. Hence we raise bonds to Neutral.
Cash- Reduce to Underweight on decline in tail-risk of disorderly Greek Euro exit.
Investment Strategy with markets:
Among Global Equity Markets:
 Modest Overweight Japan, Emerging Markets & U.K.
 Raise Eurozone to Neutral
 Reduce U.S. to Underweight
Global Bonds
 Remain Overweight Eurozone Bonds & U.K. Gilts
 Remain Underweight U.S. Treasuries & JGB‟s
Global Sectors




Overweight: Industrials & Consumer Discretionary
Modest Overweight: Healthcare, Telecomm & Information Technology
Neutral: Financials & Consumer Staples
Underweight: Energy, Materials & Utilities
Currencies


Overweight: U.S. Dollar;
Neutral: EM Currencies & Yen; Underweight: Euro & Sterling
The U.S. Dollar is likely to remain firm against the euro and sterling but range-bound against the yen. The euro has
regained some of its losses after the EU summit, but there are still risks facing the Eurozone which are likely to put
downward pressure on the euro in the near term. The sterling is likely to remain under pressure with BoE‟s additional asset
purchases and its correlation with the euro. The yen is likely to remain range-bound with relatively stronger fundamentals
and lingering risk aversion, but offset by BoJ easing and risk of currency intervention. The outlook for EM currencies is also
neutral with a solid growth outlook, but risks arise from investor„s risk aversion.
Global Equity Strategy
Emerging Markets (EM): Emerging Markets have underperformed Developed Markets during Q2 due to the spike in risk
aversion due to Eurozone debt crisis. Concerns about Eurozone crisis and global growth slowdown are expected to be
negatives for EM stocks. However, GDP growth is likely to have bottomed in Q2 and appears on track to improve in H2 in
response to interest rate cuts and relief to consumers from lower oil prices. Further, EM central banks are easing policy with
the Chinese central bank (PBC) cutting rates for the second time in a month and taking steps to further liberalize rates.
Other emerging economies such as Brazil and South Korea also cut rates to cushion the impact of a global growth
slowdown. EM earnings remain supported by domestic demand while valuations have improved significantly after the
decline in Q2. Any decline in risk aversion should be a positive for EM stocks. Remain Modest Overweight.
For Informational Use Only. Not Intended As Investment Advice.
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July-August 2012
Japan: Japanese stocks have posted solid gains in June after declining sharply in the previous two months. Valuations still
remain attractive. The macro outlook remains positive with Japanese GDP growth expected to remain solid around 2% in
Q2 after a stronger than expected Q1 rebound driven by public and private investment spending growth. While the BoJ kept
interest rates at 0% and retained the scale of asset purchase program in July, it is expected to ease further in coming
months to support the ongoing recovery. While Japanese Q1 earnings results were not as strong as expected, the
improvement in valuations after the declines in early Q2 are a support for Japanese stocks. However, Japanese stocks will
still remain pressured by global growth fears and the elevated yen. Remain Modest Overweight.
U.K.: U.K. economy continues to struggle with Q2 GDP contracting again after relapsing to a recession in the past two
quarters. While the BoE kept rates unchanged at 0.5% in July, the bank expanded their asset purchase program to ₤375bn
and is likely cut rates again following the Q2 GDP contraction. The recent easing in risk aversion in Eurozone is a positive
for U.K. stocks. Energy and Commodity prices have declined recently and an easing in risk aversion could benefit U.K.
given its big exposure to these sectors. Upgrade to Modest Overweight.
Eurozone: Eurozone stocks rallied after Eurozone avoided its worst case scenario of a Euro break up following the victory
of the pro Euro parties in the Greek re-election and after the EU summit in late June resulted in more significant than
expected action to tackle the issues facing Spain. While the ease in risk aversion will be a positive for Eurozone stocks, the
ongoing debt crisis and the inability of Eurozone policymakers to come up with a game changer to resolve the crisis, and the
deepening recession in the Periphery are likely to keep economic activity depressed in the region as a whole. Eurozone
GDP is likely to have contracted around -0.5% in Q2. Earnings growth expectations for 2012 are expected around 2% but
still carry the risk of further negative revisions. The ECB cut rates to a record low 0.75% in July but appears to feel no
particular urgency to act more aggressively. Upgrade to Neutral.
U.S.: U.S. stocks underperformed in June when risk appetite increased after the positive developments in Greece. U.S.
stocks are likely to underperform if risk aversion eases further. In addition, the macro backdrop is weakening recently. The
U.S. growth outlook has weakened as a string of disappointing economic data points to increased downside risks to Q2
growth. U.S. Q2 GDP growth is currently tracking around 1.5% from around 2.5% in early Q2. The Fed announced an
extension of the “Operation Twist” program by $267bn through the end of 2012 but has not announced additional QE. The
Q2 earnings kicked off in mid July and there are concerns that results might surprise negatively. However, valuations have
improved sharply in Q2. Any sharp deterioration in the global financial markets or economy would prompt additional easing
by the Fed, a support for U.S. stocks. Downgrade to Underweight.
Global Bond Strategy
Eurozone: The outlook for Eurozone bonds remains positive. Core Eurozone bond yields have fallen to record lows
recently, giving them little room to fall further. While risk aversion has eased in the past few weeks following the Greek reelections and the EU summit, Spanish and Italian bond yields remain under upward pressure. Continued risks to periphery
bonds could keep safe haven demand in place for the core bonds. Further, fundamentals are supportive for Eurozone bonds
with Eurozone economy continuing to struggle with the ongoing debt crisis, elevated funding costs and credit markets still
shut. Inflation is falling with the decline in energy prices. Eurozone bonds are also supported by ECB rate cuts. While the
ECB did not announce any additional asset purchases in July, it is likely to be forced to take additional liquidity measures
and bond purchase increases. Remain Overweight Eurozone Bonds.
U.K.: The outlook for U.K. Gilts remains positive. U.K. GDP growth is expected to rise a modest 0.1% in Q2 after
relapsing into a recession in the past two quarters, but there are still risks that GDP growth is either flat or negative. The
BoE has expanded asset purchase programs further in early July, which will likely keep downward pressure on yields.
Further, U.K. yields are relatively higher than U.S. and Eurozone yields, giving them more room to decline in the event of an
increase in investor risk aversion. There has been a decline in inflation, which will likely keep downward pressure on yields.
Remain Overweight U.K. Gilts.
Emerging Markets: The near-term outlook for Emerging Market bonds has improved modestly, but remains risky.
The decline in investor risk appetites had led to portfolio shifts away from risky EM assets earlier in the year. While there
was some improvement in June, the risks to EM bonds remain due to still remaining concerns about the Eurozone crisis.
Further, there are also concerns about EM GDP growth which slowed in H1. In response, with EM inflation falling, EM
central banks are easing monetary policy. EM rate cuts are expected to provide support to GDP growth and prevent a major
For Informational Use Only. Not Intended As Investment Advice.
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July-August 2012
spike in yields. Nevertheless, the near term outlook for EM bonds remains conditional on global risk appetite. Remain
Neutral EM Bonds.
Japan: The outlook for JGBs is relatively less favorable. Macro fundamentals are negative for Japanese yields.
Japanese GDP growth is likely to remain solid in the coming quarters after the strong Q1 rebound, which should put upward
pressure on yields. However, inflation remains low and is unlikely to accelerate. Further, given the depressed level of JGB
yields and the BoJ maintaining its asset purchase program through the end of the year, JGB yields are likely to rise more
slowly than other markets if global yields rise. However, there is less scope for gains in Japanese bonds if an increase in
equity market volatility puts downward pressure on global yields. Remain Underweight JGBs.
U.S.: The outlook for U.S. Treasuries is relatively less favorable. U.S. growth outlook has weakened as a string of
recent disappointing economic data points to increased downside risks to Q2 growth, which is currently tracking around
1.5%. While Treasuries have benefited from the rise in risk aversion in Q2 due to the Eurozone debt crisis, risk aversion is
easing. Renewed worries could still put downward pressure on yields. While the expansion of Operation Twist will likely
keep long-term yields contained in the event that risk appetites strengthen further, the Fed has not announced any
additional QE measures. However, yields are already at low levels, giving less room for yields to decline. Remain
Underweight U.S. Treasuries.
Global Sector Strategy
We are Overweight Industrials and Consumer Discretionary, Modest Overweight in Healthcare, Information
Technology and Telecomms, Neutral in Financial and Consumer Staples and Underweight in Energy, Materials and
Utilities.

Consumer Discretionary U.S. consumer spending is expected to recover with recent weakness in employment offset
by lower energy prices. The pace of contraction in European retail sales has slowed. Valuations remain fairly attractive
with the sector trading at a discount to both its long term forward as well as trailing P/E. Remain Overweight.

Industrials Imports of capital goods were soft in H1 and an improving growth outlook in emerging economies on the
back of central bank easing is likely to boost demand in H2. Global sector valuations are attractive and 2012 earnings
growth is expected around 16%. Remain Overweight.

Information Technology Enterprise demand has weakened due to the debt crisis in Europe, slowing U.S. and
Chinese economies and due to concerns in the U.S. related to the December “Fiscal Cliff”. Consumer electronics sales
remain strong. The sector trades at a discount to both trailing as well as forward P/E. Earnings are expected to grow
14% in 2012. Reduce to Modest Overweight.

Healthcare The outlook for healthcare is modestly positive given the increased risk aversion in global financial
markets. Valuations remain attractive and the high dividend yield is a positive. However, earnings growths for the
sector are unimpressive at around 3%. Upgrade to Modest Overweight.

Telecomm Services Increase risk aversion in financial markets is a positive for the sector. The high dividend yield for
the sector is also attractive. However, earnings growth for the sector remains weak with growth expected to remain flat
in 2012. Companies within the sector continue to incur high costs on infrastructure investments. Upgrade to Modest
Overweight.

Financials The macro environment for global banks remains difficult with the Eurozone crisis unresolved, continued
regulatory constraints and constant shifts in global risk appetite. The Q2 earnings season is likely to put further strain
on fundamentals, especially on capital markets activity. Remain Neutral.

Consumer Staples Commodity price declines are a positive for the sector as it could lead to an improvement in
margins. Strong balance sheets and share repurchases and healthy dividend payments should continue to help the
sector. Valuations remain expensive due to its outperformance in 2011. Remain Neutral.

Energy Oil demand is expected to grow 0.8mn bpd in 2012 to 89.9mn bpd according to the IEA. The IEA continues to
expect a recovery in economic growth later in the year, though they acknowledge the weakness in OECD growth.
Valuations are attractive following steep losses in Q2. The sector remains attractive on both trailing P/E as well as P/B
ratios. Reduce to Underweight.

Materials Commodity prices have been on a downtrend since May and still remain sluggish. This is chiefly due to the
concerns around the European debt crisis, slowing growth in China and weak U.S. macro data. Investors may wait and
For Informational Use Only. Not Intended As Investment Advice.
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July-August 2012
see if economic growth deteriorates further and policy responses are taken before investing in basic materials. Remain
Underweight.

Utilities The sector remains unattractive on both a forward as well as trailing P/E basis. Unusually warm weather in the
U.S. is a negative for U.S. Utilities. Increased input cost is likely to cut into margins and earnings. Rising risk aversion
and high dividend yield of the sector are positives. Remain Underweight.
Investment Strategy Summary:
Asset Allocation: Raise Stocks to Modest Overweight; Raise Bonds to Neutral; Reduce Cash to Underweight.
Global Equities: Remain Modest Overweight Emerging Markets and Japan; Raise U.K. to Modest Overweight; Raise
Eurozone to Neutral; Reduce U.S. to Underweight
Bonds: Remain Overweight Eurozone & U.K.; Remain Underweight JGB‟s and U.S. Treasuries
Sectors: Overweight: Industrials, Consumer Discretionary; Modest Overweight: Healthcare, Information Technology and
Telecomms; Neutral: Financials, Consumer Staples; Underweight: Energy, Materials, Utilities.
Currencies: Overweight: U.S. Dollar; Neutral: EM Currencies, Yen; Underweight: Euro, Sterling
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For more information contact: Lisa Villareal: 973-367-2503, [email protected]
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
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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
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allocation services.
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For Informational Use Only. Not Intended As Investment Advice.
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