OUTLOOK
2014
BMO Asset Management Inc.
BMO Asset Management Inc.
Outlook 2014
We would like to take this opportunity to provide our capital markets outlook and recommended asset
allocation for 2014. Our asset allocation process is chaired by Paul Taylor, Chief Investment Officer of
Fundamental Canadian Equities, and includes the expertise of a team of seasoned investment
professionals, focused on creating long-term value for our clients.
A Brief Reflection On 2013
Throughout 2013 we maintained our overweight position in equities and in particular U.S. equities,
supported by our expectations of stronger growth prospects in the U.S. versus Canada, coupled with
strengthening business, consumer and investor sentiment south of the border. As 2013 progressed,
our assumptions were validated by an improving global economic environment which resulted in solid
equity returns. The S&P500 Index, the benchmark for the U.S stock market, significantly outperformed
its Canadian counterpart, the S&P/TSX Composite Index. Meanwhile, underperformance of fixed
income since the second quarter of 2013 confirmed our decision to maintain an underweight position
in this asset class.
Outlook For 2014
Overall, we expect a continued rebound in global economic growth in 2014. As Exhibit 1 illustrates,
there has been a significant shift in global growth dynamics over the past 18 months. The Global
Purchasing Manager Index (PMI), gauging manufacturing sentiment and reflecting trend changes in
final demand, points to momentum in economic activity across a number of developed and emerging
markets. PMIs are highly correlated with changes in real GDP and often used as leading indicators of
economic growth due to higher reporting frequency and occasionally providing some lead time for
changes in other economic indicators. As economic growth is one of the key drivers of stock market
performance, PMIs suggest accelerating synchronized global growth in 2014.
Page 1 of 6
BMO Asset Management Inc.
Outlook 2014
Leading Indicators Suggest a Continued Improvement In Economic Backdrop
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Exhibit 1
Global
48.4
48.1
48.8
48.8
49.6
50.1
51.4
50.9
51.1
50.4
50.6
50.6
50.8
51.6
51.8
52.1
53.1
53.3
US
50.5
50.7
51.6
51.7
49.9
50.2
53.1
54.2
51.3
50.7
49.0
50.9
55.4
55.7
56.2
56.4
57.3
57.0
Eurozone
44.0
45.1
46.1
45.4
46.2
46.1
47.9
47.9
46.8
46.7
48.3
48.8
50.3
51.4
51.1
51.3
51.6
52.7
France
43.4
46.0
42.7
43.7
44.5
44.6
42.9
43.9
44.0
44.4
46.4
48.4
49.7
49.7
49.8
49.1
48.4
47.0
Germany
43.0
44.7
47.4
46.0
46.8
46.0
49.8
50.3
49.0
48.1
49.4
48.6
50.7
51.8
51.1
51.7
52.7
54.3
UK
45.2
49.6
48.1
47.3
49.2
51.2
50.5
47.9
48.6
50.2
51.5
52.9
54.8
57.1
56.3
56.5
58.1
57.3
Italy
44.3
43.6
45.7
45.5
45.1
46.7
47.8
45.8
44.5
45.5
47.3
49.1
50.4
51.3
50.8
50.7
51.4
53.3
Norway
48.9
49.0
49.4
49.3
50.6
50.2
50.4
48.3
50.5
48.8
52.3
46.2
48.2
53.1
52.4
53.4
54.1
51.6
China
50.1
49.2
49.8
50.2
50.6
50.6
50.4
50.1
50.9
50.6
50.8
50.1
50.3
51.0
51.1
51.4
51.4
51.0
contraction
neutral
expansion
While the global economy continues to grow below potential and there are some
Canada
persistent headwinds on the domestic front, the Bank of Canada expects the Canadian
economy to reach full capacity by 2016. We expect inflation to remain low despite the recent
depreciation of the Canadian dollar, preserving the purchasing power of Canadian consumers. In fact,
a weaker Canadian dollar should help avoid deflation risks while supporting export-oriented industries.
In addition, low short- and medium-term interest rates should continue to encourage lending,
particularly as fears of a correction in the housing market are starting to ease. At the same time,
businesses anticipate a modest improvement in sales over the next 12 months and plan larger
investment spending.
Page 2 of 6
BMO Asset Management Inc.
Outlook 2014
United
States
Although the most recent employment report indicated somewhat soft conditions in the
labour market in December, it is unlikely that this weakness will persist. Gains in U.S.
employment were solid last October and November, while manufacturing sentiment was up sharply
in the latter part of 2013 pointing to strengthening business sentiment on a trend basis. Meanwhile,
solid Q3 and Q4 growth – amid strong consumption demand – suggests that the recovery in the U.S.
is gaining traction, which should be further supported as fiscal headwinds fade. Overall, gradually
improving labour and housing market conditions in the U.S., combined with solid equity returns in
2013, continued to strengthen households’ balance sheets and should contribute to higher levels of
consumer confidence and spending in 2014. At the same time, cash-rich businesses are now more
likely to engage in higher capital spending amid a stronger economic outlook. As a result, we expect
above-consensus real GDP growth in the U.S. (3.2% year-over-year) and a rebound in the equity
market after soft performance in January.
As economic data in Europe continues to improve and conditions in the credit market
Europe
have become more stable, the region – and in particular developed Europe – offers a
compelling investment opportunity. Credit spreads in the periphery, reflecting perceived riskiness of
local bonds, declined substantially in 2013, easing borrowing costs and improving liquidity conditions
while providing a better environment for economic expansion in 2014. In addition, progress toward a
banking union should help support investor sentiment.
Accommodative monetary policy lifted Japanese equities in 2013 and should provide
Japan
continued support in 2014. However, a new consumption tax that will be implemented
in early Q2 could potentially limit the benefits of the Bank of Japan’s bond-buying program.
We expect China’s real GDP growth around 7.5-8% in 2014, supporting demand for
China
commodities. This should reflect the government’s efforts to support gradually deceler-
ating growth and recent reforms that should boost consumer spending.
Page 3 of 6
BMO Asset Management Inc.
Outlook 2014
Emerging
Markets
As we expect long-term interest rates in the U.S. to continue to rise modestly and the
U.S. dollar to strengthen relative to emerging market (EM) currencies, EM assets
denominated in local currencies could continue to witness outflows. As foreign portfolio investment is
an important source of financing for many developing economies, this will likely translate into a higher
degree of divergence in economic growth amongst emerging markets. However, export-oriented
emerging markets should benefit from weaker local currencies, which should partially offset the impact
of lower capital inflows or outright outflows.
Valuation
As the global economic recovery continues to gain traction since the great financial crisis, investor
sentiment remains on an upward trajectory, resulting in the current multi-year equity bull market.
Moreover, as fixed income began to underperform in 2013, owing to rising longer-term interest rates,
the bond sell-off provided a tailwind for inflows into stocks and raised concerns over equity valuation.
However, we believe that fears of overvalued North American stocks will likely subside as improving
consumer and business sentiment should result in increased spending on goods and services and
support corporate earnings. Our technical valuation analysis shows that the trailing 12-month
S&P500’s P/E multiple is well within its historical norm (Exhibit 2). This suggests that despite the
strong equity rally in North America in recent years and particularly in 2013, there is little evidence of
overheating in the stock market, offering more upside potential.
Page 4 of 6
BMO Asset Management Inc.
Outlook 2014
U.S. Equities Appear To Be Fairly Valued
Exhibit 2
S&P500: Historical PE
35
30
25
20
15
10
5
0
Jan-55
Jan-62
Jan-69
PE ratio
Jan-76
Jan-83
Hist average
Jan-90
Jan-97
Jan-04
Jan-11
hist avg +/- rolling 5yr stand. deviation
Source: BMO AM Inc., Bloomberg
On the European front, equities continue to be attractive from a valuation perspective as they have
not fully benefitted from the global economic recovery due to the Eurozone debt crisis. However, in
the latter part of 2013, economic growth began to gain momentum while leading indicators suggest a
continued, albeit gradual, economic rebound in early 2014, which should lift local equity prices.
Investment Strategy
Exhibit 3 demonstrates our investment strategy with respect to various geographic regions and asset
classes. Our model portfolio reflects our preference for equities over fixed income in 2014. Our largest
overweight continues to be in U.S. equities, followed by non-North American developed countries,
with the remainder in Canadian stocks owing to our expectations of relative economic and equity
Page 5 of 6
BMO Asset Management Inc.
Outlook 2014
performance in these regions. We continue to focus on higher quality companies with solid growth
prospects and reasonable valuations which should continue to generate attractive risk-adjusted
returns.
While we maintain an underweight position in fixed income due to our expectations of gradually rising
longer-term interest rates, we recommend a higher allocation to corporate bonds. In addition to
providing diversification benefits to our model portfolio, we expect Canadian credit spreads to narrow
in 2014, suggesting outperformance of this asset class relative to government bonds.
Exhibit 3
BMO AM Inc. Balanced Model Portfolio Positioning
Cash
Fixed Income
International Equity
US Equity
Canadian Equity
% 0
5
10
15
20
BMO AM Inc. Balanced Model Portfolio
Page 6 of 6
25
30
35
Blended Benchmark
40
45
50
We wish our clients, partners and prospects all the best for 2014 and
thank you for your continued support!
For more information about our line-up of Equity, Fixed Income, Currency and ETF solutions, please contact:
Marija Finney
Senior Vice President, Head of Institutional Sales & Service
Tel: (416) 359-5003 marija.finney@bmo.com
Disclosure/Disclaimer
TM/® Trade-marks/registered trade-marks of Bank of Montreal, used under licence
The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell
securities nor should the information be relied upon as investment advice. Past performance is no
guarantee of future results.
All Rights Reserved. The information contained herein: (1) is confidential and proprietary to BMO Asset
Management Inc. (“BMO AM”); (2) may not be reproduced or distributed without the prior written consent
of BMO AM; and (3) has been obtained from third party sources believed to be reliable but which have
not been independently verified. BMO AM and its affiliates do not warrant or make any representations
regarding the use or the results of the information contained herein in terms of its correctness, accuracy,
timeliness, reliability or otherwise, and do not accept any responsibility for any loss or damage that
results from its use.
® Registered trade-mark/trade-marks of Bank of Montreal, used under license.