Global Investment Strategy – June 2007
By John Praveen,
Chief Investment Strategist, Pramerica International Investment Advisers
For Market Commentary Interviews Contact: Lisa Villareal, 973-367-2503
Financial Market Outlook & Strategy: Summary
John Praveen’s Global Investment Strategy – June 2007 remains overweight on stocks with strong liquidity, stock buybacks and
buyouts, leverage, solid earnings outlooks and attractive valuations driving equity markets in all regions. However, we expect stocks to
struggle in the near-term until the recent anxieties about the US Federal Reserve (Fed) and the European Central Bank (ECB) policy
calm and bond yields recede from their recent spike. The underweight on bonds is reduced, tactically, as yields are likely to pull back
after their recent sharp rise. We increase our underweight position on cash to fund the reduced underweight on bonds.
Within stocks, our strategy remains overweight on stocks in Emerging Markets as growth remains above trend, valuations are attractive
and earnings outlook is positive. We have increased the overweight on Japan as it should benefit from improved global growth, yen
weakness, a new credit cycle and upward earnings revisions. The overweight on Eurozone has been reduced, as Eurozone stocks are
likely to be impacted by further ECB rate hikes and a strong Euro, though macro outlook and valuations remains very supportive for
Eurozone stocks. We have reduced the underweight in U.S. stocks, as they are likely to benefit from the rebound in the second quarter
(Q2 growth), solid non-U.S. growth and the weak dollar.
Within bonds, our strategy is to maintain overweight on U.S. Treasuries as yields are likely to pull back after rising sharply in early
June with the second half of the year (H2) growth likely to remain below trend after the Q2 rebound, and core inflation easing. We have
raised Japanese bonds to overweight from neutral as weak Japanese inflation, around trend growth, and modest rate hikes are likely to
support Japanese Government Bonds (JGBs). We remain underweight on European bonds as stronger European growth and rate
increases are likely to keep European bonds under pressure.
Financial Market Outlook: Interest Rate Uncertainty Clouds Near-term Equity Outlook. Bond Sell-off
Overdone.
Stocks: Likely To Struggle in Near-Term on Growth & Rate Uncertainty. Positive Medium-term Outlook.
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Global equity markets continued to rally in May as leverage and liquidity, buyouts and buybacks (B&B) boosted stocks. However,
stocks posted a sharp sell-off in early June with interest rate disappointments, a sharp rise in bond yields, and rising oil prices.
In the near-term, stocks are likely to struggle as the odds of Fed rate cuts in H2 2007 have receded while the likelihood of additional
rate hikes in Europe have increased. The rise in bond yields is also likely to hurt stocks in the near-term.
However, beyond the near-term correction/uncertainty, the outlook for stocks remains good with strong liquidity, leverage and
attractive valuations driving markets in all regions. In addition, stock buybacks and buyouts and modest earnings growth should
support equities in the U.S. and Europe, while strong earnings should lift stocks in Asia and other Emerging Markets.
Growth & inflation fundamentals are improving further with the recovery in U.S. growth, while non-U.S. growth remains solid.
Inflation remains tame. However, bond and stock markets appear to be reassessing the outlook for interest rates in light of a pickup
in global growth and the lingering inflation concerns voiced by central bankers. We expect these interest rate anxieties to ease over
the summer.
Valuations remain attractive with stocks trading at a discount to long-term averages and cheap relative to bonds.
Earnings growth in 2007 is set to be slower, especially in the U.S., but the impact of softer earnings is likely to be offset by price
earnings (P/E) expansion.
While stocks will likely struggle in the near term due interest rate disappointments and rising bond yields, the medium term
outlook is still positive. Stocks should continue to see support from improving growth, strong liquidity, attractive valuations and
healthy earnings.
Bonds: Yields Likely to Pull Back After Recent Sharp Sell-off.
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Global bond markets sold off in May, suffering the biggest monthly loss in over three years. Yields rose across all markets on signs
of stronger global growth in Q2 led by a U.S. recovery, disappointments about Fed rate cuts and fears over additional European
tightening.
Having risen to the upper end of the recent trading range, bond yields are likely to pull back in the near term. Treasury yields
are likely to pull back after the sharp rise over the past two months. While U.S. growth is showing signs of a rebound in Q2, it is still
likely to remain below trend in H2 with ongoing housing drag. Core inflation continues to move towards the Fed’s comfort zone.
Pramerica International Investments Advisers is a subsidiary of Prudential Financial, Inc. (NYSE:PRU)
For Information Use Only. Not Intended As Investment Advice.
Page 1
Global Investment Strategy – June 2007
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JGB yields are likely to be in a downtrend as growth momentum is slowing from the solid pace in the first quarter (Q1) (and the
fourth (Q4) and inflation continues to remain in negative territory with few signs of ending deflation. The Bank of Japan (BoJ)
tightening is likely to be modest.
In the near-term, Eurozone yields are likely to fall modestly, given the sharp spike over the last month. However, Eurozone yields
are likely to remain under pressure in the medium-term with strong growth momentum and the ECB retaining a tightening bias.
Investment Strategy: Equity Overweight on Positive Macro, Momentum & Earnings Surprise.
ASSET ALLOCATION: Stocks, Bonds, Cash
 Overweight: Stocks. Positive outlook with strong liquidity, leverage and attractive valuations driving markets in all regions. Stock
buybacks and buyouts, solid earnings outlook are further positives. However, in the near-term, stocks are likely to struggle until
interest rate expectations stabilize and bond yields recede.
 Increased Underweight: Cash. Increased underweight due to the expected pullback in bond yields.
 Reduced Underweight: Bonds. Tactically reduced underweight as yields likely to pull back after the recent sharp rise. Improving
growth outlook and revised expectations for rates likely to keep yields under pressure. Bonds expensive relative to stocks, even
after the recent rise in yields.
GLOBAL BONDS
 Overweight: U.S., Japan. Treasury yields likely to pull back after rising sharply in early June with H2 growth likely to remain below
trend after the Q2 rebound, and core inflation easing. JGBs likely to be supported by weak inflation, around trend growth, and
modest rate hikes.
 Underweight: Eurozone, U.K. Above trend growth. Further rate hikes by the ECB & the Bank of England (BoE) likely. Valuations
still expensive.
GLOBAL EQUITIES
 Overweight: Eurozone, Emerging Markets, Japan. Eurozone growth remains above trend. Valuations at discount to U.S. and Japan.
Positive earnings revisions. Macro fundamentals remain positive for Emerging Markets equities. Japan increased to overweight due
to improved global growth, yen weakness and positive earnings revisions.
 Neutral: U.K. Reduced U.K to neutral due to rising interest rates, strong sterling and negative earnings momentum.
 Reduced Underweight: U.S. Q2 growth should rebound from the weak Q1 pace. However, Fed rate cut expectations have been
pushed back and valuations are still relatively expensive.
GLOBAL SECTORS
 Overweight: Energy, Materials, Industrials, Healthcare, and Info. Technology.
 Neutral: Financials, Telecomm.
 Underweight: Consumer Discretionary, Consumer Staples, and Utilities.
CURRENCIES
 Overweight: U.S. dollar. Neutral: Euro, Sterling. Underweight: Yen.
 After falling for three straight months against the euro, we expect the dollar to display strength in the near term with U.S. growth
rebound and pushing out of interest rate expectations. However, the dollar remains in a structural downtrend with large current
account deficit.
Stock Market Outlook & Strategy: Interest Rate Uncertainty Clouds Near-term Equity Outlook.
Liquidity & Leverage, Buyouts & Buybacks Supporting Stocks.
Global equity markets continued to rally in May as leverage and liquidity, buyouts and B&B boosted stocks. The MSCI World Equity
Index gained 3.1 percent in LC, 2.5 percent in US$ with strong gains in the U.S., Japan, Eurozone, Emerging Asia and Latin America.
The strong gains in May and earlier in April pushed YTD gains for the World Equity Index to 8.2 percent in local currency (LC) and 8.9
percent in US$. However, stocks posted a sharp sell-off in early June with interest rate disappointments, a sharp rise in bond yields and
high oil prices. Bond yields spiked higher in the U.S., Europe, and Japan in late May/early June with markets beginning to price out Fed
rate cuts and price in additional tightening in Europe.
On the macro front, the rise in bond yields and changing interest rate expectations are causing uncertainty for stocks. However, the
growth and inflation backdrop remains favorable for stocks. Global growth has picked up with a rebound in the U.S., while Europe
remains solid, Japan healthy, China and India strong. Inflationary pressures remain largely subdued, despite central bank rhetoric.
Strong liquidity and leverage is fuelling the stock rally. Despite rate hikes by central banks, money supply growth remains solid, running
at 10.4 percent in Eurozone (M3), at 12.7 percent in the U.K. and 17.3 percent in China. Money growth is running at 6.6 percent in the
U.S. Corporate liquidity is high with cash on corporate balance sheets currently around 14 percent, the highest level since 1985. The
record high levels of cash are funding M&A activity and share buybacks.
Pramerica International Investments Advisers is a subsidiary of Prudential Financial, Inc. (NYSE:PRU)
For Information Use Only. Not Intended As Investment Advice.
Page 2
Global Investment Strategy – June 2007
Bottom-line: In the near-term, stocks are likely to struggle as Fed rate cuts have been pushed out (and even priced out), while the
likelihood of additional rate hikes in Europe has increased. The rise in bond yields is also likely to keep stocks volatile in the nearterm.
However, beyond the near-term correction/uncertainty, the outlook for stocks remains good with strong liquidity, leverage and
attractive valuations driving markets in all regions. In addition, stock buybacks and buyouts, and modest earnings should support
equities in the U.S. and Europe, while strong earnings should lift stocks in Japan and Emerging Markets.
Regional Equity Strategy
Emerging Markets: Our model remains overweight on Emerging Market equities. Relative valuations are positive and earnings growth
outlook remains strong. Macro fundamentals remain positive. Growth remains solid, although slowing modestly. Inflation remains well
contained. Rising interest rates and tightening measures are negatives. Overweight Emerging Markets.
Japan: Japan should benefit from the pickup in global growth in Q2. Yen weakness is a positive for earnings, while interest rates remain
accommodative, and a new credit cycle is underway. Earnings growth is also supported by wider margins from reduced spare capacity
and lower input costs. Potential for upward earnings revision due to conservative initial estimates by firms. Japanese gross domestic
product (GDP) growth remains around trend pace in Q2 from 3.3 percent in Q1 and 5.4 percent in Q4. Valuations are expensive relative
to other markets. Given recent underperformance, we are increasing our overweight in Japan. Increased Overweight.
Eurozone: Growth momentum remains strong with Q2 growth likely to come in above trend, around 2.8 percent year-on-year (YoY).
Valuations – current and historical – are at a discount to the U.S. and Japan. Relative earnings outlook is good. Recent earnings
revisions have been positive. ECB likely to hike rates beyond 4 percent. Strong euro is another negative. Hence, trimming the
overweight. Reduced Overweight Eurozone.
U.K.: Q2 GDP growth likely to remain above trend at 2.8 percent YoY after 2.8 percent in Q1. Inflation eases to 2.8 percent, but
remains above target. BoE rate hikes and strong sterling are negatives. Sector effect is unfavorable due to high financials exposure.
Valuations attractive relative to other markets. Relative earnings outlook is less positive with negative earnings momentum. Neutral.
U.S.: Our model has increased the weight on the U.S., reducing the underweight relative to other markets. Growth is likely to rebound to
over 3 percent in Q2 after the weak 0.6 percent pace in Q1. Fed rate cuts have been pushed out, given the Q2 rebound. The weak dollar
and strong overseas demand continue to be positives for U.S. earnings with around 30 percent of S&P earnings coming directly from
foreign operations. Valuations remain expensive relative to other equity markets, but at a discount to own 10-year history. Reduced
Underweight.
Bond Market Outlook & Strategy
Global bond markets sold off in May, suffering the biggest monthly loss in over three years. Yields rose across all markets on signs of
stronger than expected global growth in Q2 led by a U.S. recovery, disappointments about Fed rate cuts and fears over additional
European tightening. Yields were also pressured by solid equity market performance. The JP Morgan Global Bond Index fell –0.9
percent in May in local currency and a steeper –2 percent in US$ as the dollar rebounded. Having risen to the upper end of the recent
trading range, bond yields are likely to pull back in the near term. The ongoing decline in U.S. core inflation, fears about the U.S.
sub-prime problem and uncertainty about U.S. growth beyond the Q2 rebound are likely to support bonds. Bonds are also likely to
get support from contained inflation expectations.
USA: Treasury yields are likely to pull back after the recent sharp rise. While U.S. growth is showing signs of a rebound in Q2, growth
is still likely to fall below trend in H2. Further, inflation data has been encouraging with the core consumer price index (CPI) dropping to
a one year low of 2.3 percent and the core PCE falling to 2 percent in April, within the Fed’s comfort zone. After the steep 50 bps climb
in 10-year Treasuries in May-early June, further upside is limited and yields are likely to pull back. Remain Overweight Treasuries.
Japan: JGB yields are likely to be in a downtrend as growth momentum is slowing from the solid pace in Q1 and Q4. Inflation continues
to remain in negative territory with few signs of deflation ending. The BOJ retains its positive assessment of the economy, and is
satisfied that growth “is expanding moderately” and is eager to continue normalizing interest rates. However, further tightening is likely
to be modest and is expected only later in H2 with deflationary pressures persisting and the Upper house elections in July. Upgraded to
Overweight from Neutral.
Emerging Markets: Macro outlook remains solid with inflation remaining under control, adequate Forex reserves and comfortable
external debt positions. Low volatility and continued support from the carry trade are positives for these bonds. Tightening measures in
Emerging Markets remain a risk. With liquidity remaining strong and economic fundamentals solid, we expect Emerging Market bonds
to gain in the near term. Modest Overweight.
Global Investment Strategy – June 2007
Pramerica International Investments Advisers is a subsidiary of Prudential Financial, Inc. (NYSE:PRU)
For Information Use Only. Not Intended As Investment Advice.
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Eurozone: Eurozone yields spiked with Q1 GDP coming in stronger than expected and with the ECB suggesting additional tightening
beyond 4 percent. In the near-term, Eurozone yields are likely to fall modestly, given the sharp spike over the last month. However,
Eurozone yields are likely to remain under pressure in the medium-term with strong growth momentum and the ECB retaining a
tightening bias. Remain Underweight Eurozone Bonds.
U.K.: U.K. Gilts are likely to remain under pressure with Q2 growth likely to remain above trend at 2.8 percent YoY after the 2.8
percent growth in Q1. Headline inflation, at 2.8 percent, remains above BoE’s target. The BoE kept rates on hold in June, but is likely to
hike rates further with continued above trend GDP growth, robust money growth, and inflation above target. Remain Underweight
U.K. Gilts.
Global Sector Strategy
Our global sector model ranks sectors on a comparative basis using macro factors, valuation, earnings and risk measures.
 Energy: Attractive valuations. Oil prices remain firm, rising above $65 in early June with growth recovering in the U.S. and tight
supply-demand balance with onset of U.S. summer driving season. Oil prices likely to remain firm with strong hurricane season. U.S.
Energy attractive due to equipment and services exposure and weak dollar. Earnings outlook negative, but likely to be revised up.
Overweight.
 Materials: Continued firm commodity prices due to a pickup in global growth are a positive. Strong earnings revisions and positive
earnings outlook. Solid Emerging Markets demand, weak dollar and tight supply are positives. Valuations rich. Overweight.
 Industrials: Macro outlook positive with firm production in Europe and Emerging Markets. Recovering U.S. growth is a positive
for U.S. Industrials. Japanese Industrials supported by positive capex outlook and solid earnings outlook. Aerospace and Defense
supported by international orders and defense spending. We prefer Industrials with Emerging Market exposure. Overweight.
 Healthcare: Sector valuations are attractive, while earnings revisions are very positive. Pharma outlook is positive with improving
fundamentals, restructuring, dollar weakness and dividend yield. Pharma and Biotech likely to benefit from style shifts to large cap and
growth stocks, respectively. Negative news-flow remains a risk. Overweight.
 Information Technology: Macro outlook positive with solid demand offset by pricing pressures. Earnings outlook is positive,
while relative sector valuations are neutral. Telecomm and corporate infrastructure positive with low inventory build-up and solid
demand. Overweight.
 Telecomm Services: Relative sector earnings outlook is negative, while valuations are a modest positive. However, sector has a
high dividend yield. Sector benefiting from restructuring efforts, cost reduction and pricing power from consolidation. Neutral.
 Financials: U.S. and European Financials suffer from Fed rate cuts being pushed out and additional tightening in Europe, U.S.
housing slowdown and sub-prime problems. Strong capital market activity and abundant liquidity are positives. Japanese Financials
likely to benefit from new credit cycle, still accommodative interest rates and rising property prices. Neutral.
 Consumer Discretionary: Valuations are negative, while earnings revisions are positive. Eurozone and Japan are attractive with
strong labor market and wage improvements. Ongoing U.S. housing slowdown and sub-prime problems are negatives. Underweight.
 Consumer Staples: Relative sector valuations are negative. Earnings outlook and revisions are negative. Prefer Staples (Beverages
and Tobacco positive) with pricing power and Emerging Market exposure. Underweight.
 Utilities: Sector valuations are expensive. Earnings outlook is neutral. Higher energy costs are a negative. U.S. and Japanese
Utilities are relatively attractive as European valuations are relatively expensive. Underweight.
Strategy Summary: Reduced Equity Overweight with Increased Risk Aversion.
Asset Allocation – Overweight: Stocks. Increased Underweight: Cash. Reduced Underweight: Bonds.
Global Bonds - Overweight: U.S., Japan. Underweight: Eurozone and U.K.
Global Equities - Overweight: Eurozone, Emg. Markets, Japan. Neutral: U.K. Underweight: U.S.
Global Sectors - Overweight: Energy, Materials, Industrials, Healthcare, and Info. Technology. Neutral: Telecomm and Financials.
Underweight: Consumer Discretionary, Consumer Staples and Utilities.
Currencies - Overweight: U.S. dollar. Neutral: Euro and Sterling. Underweight: Yen.
Pramerica International Investments Advisers is a subsidiary of Prudential Financial, Inc. (NYSE:PRU)
For Information Use Only. Not Intended As Investment Advice.
Page 4
Disclosure:
Pramerica International Investments Advisers (“the Company”) an investment adviser registered with the SEC of the United States, under the name of Prudential
International Investments Advisers, LLC., is a subsidiary of Prudential Financial, Inc. (U.S.A.). Pramerica is a trade name used by both companies in select countries
outside the United States. None of these companies are affiliated in any manner with Prudential plc, a company incorporated 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 the Company 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 the Company 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.
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accounts managed by the Company or by its affiliates. The strategies and asset allocations discussed do not refer to any service or product offered by the Company or by
its affiliates. The global asset and strategy allocation models presented are hypothetical allocation models shown for illustrative purposes only, and does 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 or as a recommendation, solicitation, or an offer to buy/sell any
security, or to adopt any investment strategy, nor should it be considered an offer to provide investment advisory or other allocation services.
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For Information Use Only. Not Intended As Investment Advice.
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