Prudential International Investments Advisers
Global Investment Strategy & Market Outlook For 2010
December 30, 2009
By John Praveen, Ph.D, Chief Investment Strategist
For Market Commentary Interviews Contact: Lisa Villareal, 973-367-2503/lisa.villareal@prudential.com
John Praveen’s Global Investment Strategy & Outlook – 2010 expects equity markets to post further gains in
2010, driven by: 1) Solid, sustained GDP growth with growth likely to surprise on the upside; 2) Low headline &
core inflation; 3) Global central banks keeping rates on hold through mid-2010, and liquidity remaining plentiful; 4)
Strong earnings growth with rising revenues, wider margins & improved pricing power. Positive earnings surprises
likely, and 5) Continued stabilization in financial market conditions and risk appetite improving further. Stock
markets were supported in 2009 by the speed of the GDP recovery and breadth of the GDP rebound. During 2010
equity markets are likely to be supported by the sustainability of the GDP recovery and the strength of the earning
rebound. Both GDP growth and corporate earnings are likely to surprise on the upside. We expect the S&P 500 to
rise to 1,350 by 2010 year-end. We expect European and Emerging stock markets to post over 20% gains in 2010.
Bonds are likely to be under pressure during 2010. Bond yields are expected to rise with solid, sustained GDP
growth, a reversal in headline inflation from the 2009 disinflation, and an increase in risk appetite. Rising fiscal
deficits and the resultant increase in bond supply are also likely to put pressure on bond yields. Major central banks
are likely to start draining liquidity earlier in 2010 and eventually raise rates in late 2010, another negative for
bonds. Core inflation is likely to remain low (and negative in Japan) limiting the rise in bond yields. U.S. Treasury
yields are likely to rise to around 4.5% by 2010 year-end.
On Asset Allocation, we are overweight on stocks and underweight on cash and bonds. Among global stock
markets, we are overweight Emerging Markets, Eurozone, and U.K. We are underweight on Japan and the U.S.
Among global government bond markets, we are overweight in Japan, U.K. and Emerging Markets, neutral on
Eurozone bonds, and underweight in U.S. Treasuries. Among global sectors, we are overweight in Industrials,
Materials, Information Technology, and Financials. We have a neutral stance in Consumer Discretionary,
Energy, and Telecomm. We are underweight in Healthcare, Consumer Staples and Utilities.
Macro & Investment Outlook – 2010 Overview
2010 Macro Outlook:
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Growth: Solid, sustained GDP growth in 2010 driven by a substantial fiscal stimulus, low interest rates, inventory
rebuilding and a modest housing recovery. Emerging economies growth is accelerating. GDP growth likely to surprise
on the upside.
Inflation: Headline inflation moves from disinflation to low inflation in 2010 with strength in oil and commodity
prices, base effects and strengthening global growth. Core inflation likely to remain low with excess capacity & high
unemployment.
Interest Rates: Global central banks are expected to start implementing exit strategies in 2010. However, with low
inflation and high unemployment, developed central banks are expected to maintain low rates through mid-2010, but
likely to start draining liquidity earlier in 2010.
Currencies: U.S. dollar expected to gain against the euro, sterling and yen with relatively stronger U.S. GDP growth
and the U.S. rates rise ahead of Europe and Japan. Expect RMB revaluation, and further gains by other EM currencies
and commodity currencies.
2010 Investment Outlook: Stock and Bond Markets
Stocks Post Further Gains in H1 & Consolidate in H2: We expect further stock market gains in H1 driven by:
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Stocks continuing to enjoy the macro sweet spot of sustained GDP growth, low inflation, and low interest rates;
Strong earnings recovery with GDP growth, widening profit margins, and improved pricing power; Positive earnings
surprises likely;
 Stocks still attractively valued relative to bonds, and
 Continued stabilization in financial market conditions and further improvement of risk appetite.
Stocks are likely to consolidate in H2 after solid gains in H1. Increased volatility with the cross currents of strong earnings
and GDP growth versus changing interest rate expectations.
Prudential International Investments Advisers, is a company of Prudential Financial, Inc. (NYSE:PRU)
For Informational Use Only. Not Intended As Investment Advice.
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Bond Yields Rise: Bond yields expected to rise with solid, sustained GDP growth, a reversal in headline inflation from the
2009 disinflation, and an increase in risk appetite. Major central banks are likely to start draining liquidity earlier in 2010 and
eventually raise rates in late 2010, another negative for bonds. However, phased withdrawal of liquidity and low core inflation
likely to limit the rise in bond yields.
2010 Macro Outlook
GDP Recovery Continues. Disinflation Ends. Rates Remain Low
Growth – The global recovery that began in the middle of 2009 is expected to be sustained in 2010 with a swoosh-shaped
gradual recovery. We do not expect a W-shaped double dip. In fact, growth is likely to surprise on the upside.
GDP growth in the U.S., Europe and Japan is likely to be driven by: a) substantial fiscal stimulus; b) low interest rates; c)
inventory rebuilding (U.S. inventories are at their lowest in 60 years); d) improving global trade and e) a modest recovery in
the housing markets. We expect GDP growth in 2010 to be around 3.3% in the U.S. and around 2% in Europe and Japan. In
contrast to sharp V-shaped rebound from past deep recessions, the current recovery is likely to be a more modest, swooshshaped recovery with the headwinds of high unemployment and continued deleveraging by U.S. households.
GDP growth in China, India, and other Asian Emerging Markets is likely to strengthen further with export recovery and strong
domestic demand boosted by fiscal stimulus. We expect GDP growth to be around 10% in China and around 8% in India.
Emerging Europe and Latin America are likely to benefit from firm oil and commodity prices and recovery in exports.
Inflation - Headline inflation is moving from disinflation in 2009 to low inflation in 2010 with base effects of oil and
commodity prices, and further improvement in global growth. However, both headline and core inflation are likely to remain
low due to the wide output gap, high unemployment and low capacity utilization.
Headline inflation is likely to average around 1.8% in the U.S., around 1.1% in Eurozone and 2.1% in the U.K. However,
Japan is likely to remain in deflation in 2010, around -1%, given the massive output gap.
Core inflation in 2010 is expected to average around 1.5% in the U.S., Eurozone and U.K. However, Japanese core inflation is
likely to remain in negative territory, around -1.5%, with strong domestic deflationary pressures.
Interest Rates & Fiscal Policy - With the global recession ending in the middle of 2009, global central banks are expected to
start implementing exit strategies in 2010. Some of the emerging central banks are likely to start raising rates in H1 2010.
However, with inflation remaining low and unemployment remaining high, the developed central banks are expected to
maintain “crisis-level” low rates through Q3 2010. We expect modest rate hikes (around 25bps) by the Fed, the ECB and BoE
in late 2010 and no increase in Japan However, global central banks are likely to start draining liquidity earlier in 2010. In
fact, the Fed and the ECB have already started debating the timing and speed of unwinding the stimulus.
A significant amount of fiscal stimulus remains in the 2010 pipeline, especially in the U.S. (around $400 billion and China).
Further Japan is likely to inject fresh stimulus.
Currencies – U.S. dollar is likely to stabilize and rise against the euro, sterling and yen in 2010 with relatively stronger U.S.
GDP growth and the Fed raising U.S. interest rates ahead of Europe and Japan. We expect the Chinese RMB to be revalued
and the dollar to fall further against EM currencies.
2010 Investment Outlook
Stocks: Stocks Post Further Gains in H1 & Consolidate in H2
We remain positive on the outlook for stocks with stocks continuing to enjoy the macro sweet spot of sustained GDP growth,
low inflation, and low interest rates. In addition, earnings are expected to rebound strongly.
The macro backdrop for stocks remains very favorable in 2010 with continued solid GDP growth in the developed economies
and strong growth in emerging economies. GDP growth is likely to surprise on the upside. Fiscal stimulus and low interest
rates are expected to support growth. Headline inflation is likely to move from disinflation to low inflation, providing some
pricing power.
Corporate earnings are likely to post a solid rebound in 2010 and likely to surprise on the upside, after declining sharply in
the past two years. Solid GDP growth in developed economies and strong growth in emerging economies are likely to boost
top line revenue growth. Margins are expected to widen with falling unit labor costs and other efficiency gains. Pricing power
is expected to improve with ultra low inventories and disinflation ending.
Further financial market stabilization and capital market activity are likely to be positives both for the Financials sector as well
as non-Financials getting access to credit. Firm oil and commodity prices will be positives for Energy & Materials earnings.
Prudential International Investments Advisers, is a company of Prudential Financial, Inc. (NYSE:PRU)
For Informational Use Only. Not Intended As Investment Advice.
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Global equity valuations are less compelling with P/E multiples having risen to multi-year highs from decade-low levels in
early 2009 as stocks rallied sharply while earnings plunged with the global recession and financial crisis. Thus valuations are
unlikely to be a driver of market gains. However, P/E multiples are expected to improve during 2010 with earnings on track to
rise sharply. While markets look expensive on trailing P/E basis, stocks are still cheap on adjusted earnings basis. Further,
stocks are still cheap compared to bonds with stock yield higher than bond yields.
Stocks are likely to post most of their gains in H1 and consolidate in H2. Hence, we remain overweight in stocks in H1 and
reduce the overweight in H2 with stocks range bound with the cross currents of strong earnings and GDP growth versus
changing interest rate expectations.
Stock market volatility is likely to remain high in 2010 with: 1) Market concerns about the sustainability of the GDP
recovery and fears about a double-dip; 2) Uncertainty about central bank exit strategies and 3) The fallout from potential
aftershocks of the financial crisis, such as the recent Dubai World debt episode.
2010
Year-end Stock Market Targets
USA - S&P 500: 1350; Japan - Nikkei: 12,000; Eurozone – STOXX50: 3750; U.K. – FTSE100: 6600;
China – Shanghai Composite: 4100; India – Sensex: 22,000; Taiwan – TWSE: 9900;
Korea – KOSPI: 1860; Brazil – Bovespa: 81,000; Mexico – Bolsa: 37,000
Bonds: Bond Yields Rise Further
Bonds are likely to be under pressure during 2010. Bond yields are expected to rise with solid, sustained GDP growth, a
reversal in headline inflation from the 2009 disinflation, and an increase in risk appetite. Rising fiscal deficits and the resultant
increase in bond supply are also likely to put pressure on bond yields. Major central banks are likely to start draining liquidity
earlier in 2010 and eventually raise rates in late 2010, another negative for bonds. However, central banks are likely to
withdraw liquidity in a phased manner so as not to cause a spike in yields. Core inflation is likely to remain low (and negative
in Japan) limiting the rise in bond yields.
Bond yields are likely to rise further in H1 with sustained GDP recovery, headline inflation moving from negative to low
positive readings, rising fiscal deficits, central banks unwinding asset purchases and interest rate normalization and
increasing risk appetite. Bonds are likely to rise modestly in H2, supported to some extent by the slower withdrawal of
liquidity by central banks, slower rise in inflation and stocks coming under pressure.
Investment Strategy
Asset Allocation: Stocks vs. Bonds:
H1 2010: Stocks – Overweight. Bonds & Cash – Underweight.
H2 2010: Stocks – Modest Overweight. Bonds & Cash – Modest Underweight.
Global Equity Strategy:
Emerging Markets: Overweight. The Emerging Market recovery is on track to accelerate in 2010 after the strong rebound in
2009. Exports and the massive fiscal stimulus packages continue to drive robust GDP growth in Asia. In China investment
spending remains strong. The recovery in trade should drive strong growth in Korea and Taiwan. Meanwhile, the recovery in
oil and commodity prices is positive for Latin America and Emerging Europe. EM earnings expectations for 2010 were revised
up further to 26%. EM Asia earnings expected to rise 30% in 2010 with China’s earnings growth continue to be revised up to
28% in 2010. However, EM now trades at a premium to DM on some valuation measures, though EM stocks still have a lower
trailing P/E. Further, Currency appreciation is a further negative for EM stocks.
U.K.: Overweight. U.K. GDP growth likely to lag other countries in 2010. However, valuations and sector composition remain
positives for U.K. stocks. The BoE is likely to keep the U.K. bank rate on hold at 0.5% for most of 2010, but will begin to
withdraw liquidity measures later in order to prepare the market for rate hikes. Valuations are attractive both on a historical and
current basis. Expected Sterling weakness against the U.S. dollar is another positive for U.K. stocks.
Eurozone: Overweight. The Eurozone recession ended in H2 2009 and GDP growth is expected to consolidate in 2010. The
ECB is likely to remain on hold at its record low rate of 1% through mid-2010. Eurozone earnings expected to rise sharply in
coming quarters and grow 27% in 2010 with solid GDP growth and improved margins. Earnings expectations for Eurozone
companies are likely to be revised higher after turning positive in October for the first time in 23 months. Eurozone stocks still
attractively valued and trading at a discount to the U.S., Japan and Emerging Markets.
Japan: Underweight The Japanese GDP recovery is expected to continue in 2010, though GDP is estimated to rise just 1.6%
as consumer fundamentals remain weak. Japanese earnings are expected to recover in 2010 with the global recovery boosting
Japanese exports. However, yen strength is a headwind for Japan’s export recovery and earnings. Further, valuations remain
expensive relative to U.S., Europe, and Emerging Markets.
Prudential International Investments Advisers, is a company of Prudential Financial, Inc. (NYSE:PRU)
For Informational Use Only. Not Intended As Investment Advice.
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USA: Underweight. U.S. GDP growth expected to be solid in 2010. The Fed is expected to maintain rates at current low levels
through late 2010. Strong earnings growth with solid top-line revenue growth, widening margins, improved pricing power and
significant exposure. However, the U.S. stock market also remains relatively expensive. During past equity market rallies, the
U.S. has underperformed international markets due to its defensive characteristics. Thus, even though we expect U.S. stocks to
post solid gains in 2010, we expect even stronger gains in higher beta Emerging Markets and Europe and to outperform the
U.S. in H1 2010.
Overweight: Emerging Markets, U.K. and Eurozone. Underweight: Japan and U.S.
Global Bond Strategy:
Government Bonds versus Corporate Bonds. Corporate bonds are likely to outperform government bonds given the increase in
risk appetite, further stabilization in credit markets and solid, sustained GDP growth. However, gains will be weaker than those
in 2009. With risk aversion waning, government bond yields are likely to rise as investors continue to move to riskier assets.
Further, ballooning fiscal deficits should increase the supply of government bonds, putting pressure on yields in the
intermediate-term.
USA: Underweight. Solid U.S. GDP, a reversal in headline inflation from negative inflation in 2009 to positive inflation in
2010, Fed draining liquidity and eventually raising rates are likely to put upward pressure on Treasury yields in 2010. The
stabilization of financial markets and the increase in risk appetite also reduces the safe haven appeal of Treasuries. The
ballooning U.S. budget deficit is another negative for Treasury yields.
Eurozone: Neutral. European bond yields are expected to rise modestly in 2010 with the rebound in Eurozone growth,
especially in Germany and France. In addition, inflation is set to rise back close to ECB target. Further, there is a possibility
that the ECB begins to raise rates ahead of market expectations and unwinds non-traditional policy measures.
UK: Overweight. U.K. Gilts have a relatively favorable outlook with weaker U.K. GDP lagging the rebound in the U.S., Japan,
and Eurozone. In addition, the BoE has a relatively dovish stance. After expanding their QE program in late 2009, the Bank is
likely to be slower in unwinding their monetary expansion.
Japan: Overweight. Japanese bonds are likely to benefit from deflation persisting through most of 2010. In addition, the BoJ
is expected to keep rates on hold until 2011, which should keep bond yields contained. However, yields could be under
pressure with a stronger than expected GDP rebound and further expansion of the fiscal deficit with the DPJ government
expected to enact another stimulus package in 2010.
Emerging Markets: Overweight. EM spreads should narrow further given rising risk appetite, solid commodity prices and
strong GDP growth in emerging economies. Spreads are still above levels before the financial crisis, leaving room to fall
further. Commodity prices are expected to remain firm in 2010, putting downward pressure on yields. However, EM central
banks are likely to begin removing the monetary stimulus, which is a negative.
Overweight: Corporate Bonds. Underweight: Government Bonds.
Overweight: Emerging Markets, U.K. and Japan. Neutral: Eurozone. Underweight: U.S.
Global Sector Strategy
Industrials: Overweight. Industrial activity is expected to post solid gains in 2010 with solid GDP growth in developed
economies with emerging economies growth accelerating. Further, the strong rise in business confidence points to rebound in
capital spending. Machinery and Equipment companies expected to benefit from fiscal stimulus and the improvement in
business spending. Defense/ Aerospace spending is relatively weaker but still solid.
Materials: Overweight. Commodity prices expected to rise further in 2010 with the GDP recovery in developed economies and
emerging economies growth accelerating. Increased government spending, particularly in infrastructure, will boost materials
demand. Agricultural prices firm up due to supply constraints in many key producers.
Info. Technology: Overweight. Solid demand for global tech product continues, especially in EM. Strong Tech infrastructure
spending and upgrades following the release of Windows 7. Telecomm equipment demand and productivity improvements will
be by driven stronger business spending. Gradual improvement in consumer spending over the course of the year.
Financials: Overweight. Earnings outlook improves further. Financial market stabilization and improvement in capital market
activity support Diversified Financials. Banks benefit as the GDP recovery improves the outlook for both businesses and
consumers. Central banks likely to keep accommodative policies through late 2010 and hike rates modestly. Risks for U.S.
commercial banks from problems in commercial real estate.
Consumer Discretionary: Neutral. Consumer spending is likely to improve gradually during 2010. Consumer credit
rebounding, stabilization of unemployment, and modest income growth should boost Consumer Discretionary earnings.
Valuations are attractive. In addition, fiscal stimulus in several markets should provide some support for consumers.
Prudential International Investments Advisers, is a company of Prudential Financial, Inc. (NYSE:PRU)
For Informational Use Only. Not Intended As Investment Advice.
Page 4
Energy: Neutral. Oil prices expected to rise to $90 due to the continued recovery in global GDP growth. OPEC likely to be
slow in bringing back excess capacity into production, unless prices stay above $90. Apart from Oil producers, alternative
energy companies such as nuclear are likely to benefit from rising energy prices. Valuations are expensive.
Telecomm Services: Neutral. Strong case for Telecomm M&A given the relatively low funding costs, cost synergy
opportunities, and strategic rationale. However, slower earnings relative to other sectors. Business investment spending is slow
currently, but might pick up later in the year. Stabilization in payrolls will be a positive for Wireless.
Healthcare: Underweight. Rising risk appetite is negative for sector. U.S. healthcare reform and regulatory legislative
uncertainties are further negatives. Slower negative product news flow, stable pricing, and firms addressing pipeline issues are
positives.
Consumer Staples: Underweight. Stronger risk appetite is a negative. Sector is not leveraged to cyclical improvements in
payrolls and the broader economy. Higher input costs are likely to be a drag on earnings. Tobacco has stronger growth
prospects and solid margins. Beverages benefit from strong international growth.
Utilities: Underweight. Investors focus on cyclically leveraged sectors given the ongoing GDP growth recovery. Independent
Power Producers more geared to the GDP recovery will outperform than the broader Utilities sector. U.S. and Japanese
Utilities relatively attractive compared to Europe.
Investment Strategy Summary
Asset Allocation:
H1 2010: Stocks – Overweight. Bonds & Cash – Underweight.
H2 2010: Stocks – Modest Overweight. Bonds & Cash – Modest Underweight.
Global Equities:
Overweight: Emerging Markets, U.K. and Eurozone. Underweight: Japan and U.S.
Global Bonds:
Overweight: Corporate Bonds. Underweight: Government Bonds.
Overweight: Emerging Markets, U.K. and Japan. Neutral: Eurozone. Underweight: U.S.
Global Sectors:
Overweight: Industrials, Materials, Info Technology and Financials. Neutral: Consumer Discretionary, Energy and
Telecomm. Underweight: Healthcare, Consumer Staples and Utilities.
Disclosure:
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Commission of the United States. 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
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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
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