Global Investment Outlook - February 2007

Global Investment Outlook - February 2007

By John Praveen

Chief Investment Strategist, Pramerica International Investment Advisers, LLC.

For Market Commentary Interviews Contact: Lisa Villareal, 973-367-2503

Summary

John Praveen’sGlobal Investment Outlook – February 2007 expects equity markets to trend higher with lower oil prices, falling inflation and stable interest rates, attractive valuation and price/earnings (P/E) multiple expansion. Earnings downgrades for the first quarter (Q1) pose near-term risks for stocks. Market volatility is likely to remain high with cross currents of moderating earnings, changing interest rate expectations, lower inflation and oil price swings. Bond yields are likely to be under pressure in Japan and Europe with the Bank of Japan (BoJ) likely to raise rates and continued tightening by the European Central Bank (ECB) and Bank of England (BoE). However, tame inflation is likely to provide some support to Eurozone and Japanese bonds.

Global growth likely to slow in Q1 with the U.S. slowing below trend pace, Japan easing to below trend and European growth remains well above trend in Q1. Headline inflation is likely to fall further in the U.S. and Europe with lower oil prices in January. Core inflation is likely to trend lower in the U.S. and is well contained in Eurozone and the U.K. The U.S. Federal Reserve (Fed) remains on hold in January, and is likely to remain on hold in H1. The ECB paused in February and has signaled a rate hike in March. The odds of a BoJ hike in Q1 have increased with the strong the fourth quarter (Q4) rebound.

Macro Outlook

Fourth Quarter Gross Domestic Product Rebound. Inflation Tame. Fed on Hold. E CB March Hike. BoJ Likely to Hike inQ1

Growth: Stronger global growth in Q4 with a gross domestic product (GDP) rebound in the U.S. (3.5 percent) and Japan (4.8 percent) and stronger than expected growth in Eurozone (3.3 percent) and U.K. (3 percent). Strong growth momentum continues in China and India. Global growth expected to moderate in Q1 with GDP growth slowing to below trend pace in the U.S. and trend pace in Japan as oil prices firm and the warm winter effect fades. German VAT increase and strong Euro likely to dampen Eurozone growth.

Inflation:Headline inflation in the U.S. and Europe remains tame and is expected to fall further in early 2007 with the sharp drop in oil prices in January. Eurozone headline inflation is stable at 1.9% despite the German VAT increase.

U.S. core inflation ended 2006 at 2.6 percent and continues to trend lower towards the Fed’s comfort zone. The 3-month rate of change in core CPI inflation is now at 1.8 percent, down from the high of 3.5 percent in June. Japanese core inflation is still struggling to stay above zero. Core inflation remains contained in Eurozone (1.5 percent) and the U.K. (1.6 percent).

Interest Rates:Fed on hold in January and expresses confidence that the U.S. economy is headed for a soft landing. The Fed also acknowledged progress on inflation. The Fed is likely to remain on hold through the first half of the year (H1). ECB pauses in February after December hike to 3.5 percent. Signals March hike. ECB downplays improvements in inflation, setting stage for further rate hikes. BoE pauses in February after January hike to 5.25 percent. BoJ was on hold in January after sending signals about a possible rate hike. The BoJ remains confident about the growth and inflation outlook, hence, appears inclined to raise rates, modestly.

Global Investment Outlook - February 2007

Currency:U.S. dollar gains 1.4 percent against the Euro and 1.5 percent against the Yen in January on signs of a rebound in U.S. Q4 growth. Strong capital flows likely to support the dollar, near-term. However, dollar remains in a secular downtrend with narrowing of rate gap with ECB and BoE hikes and the Fed on hold, and stronger growth momentum in Europe.

Investment Outlook

Stocks: Falling Inflation, Lower Oil, Steady Rates & P/E Expansion Underpin Stocks

Stocks made a solid start to 2007 gaining 1.7 percent in local currency (LC), 1.2 percent in US$ in a volatile January. Stocks gained on lower oil prices, benign inflation, a solid growth rebound, the Fed, BoJ and ECB on hold and a respectable Q4 earnings season. Stock markets were also very volatile during January with wild swings in oil prices and changing interest rate expectations.

The macro data continues to be equity-friendly with a growth rebound, benign inflation, lower oil prices and rates on hold. The favorable macro backdrop and attractive equity valuations provide scope for P/E multiple expansion. Earnings in Q1 2007 are being downgraded and pose some risks to stocks. However, the impact of softer earnings is likely to be offset by P/E multiple expansion. This should support stocks.

The long awaited earnings slowdown appears to be materializing. The Q4 earnings season in the U.S. has been respectable with earnings tracking around 10 percent, slowing from the 21 percent earning per share (EPS) growth in Q3. With 68 percent of S&P 500 companies reporting, 64 percent beat expectations and 20 percent missed expectations. However, earnings expectations for Q1 and Q2 2007 are being scaled down to around 6 percent EPS growth. For full year 2007, consensus expectations are for 8 percent EPS growth in the U.S. (revised down from 10 percent) with below-trend U.S. GDP growth and an uptick in unit labor costs causing the earnings slowdown. Consensus expectations for 2007 global earnings are currently around 9.5 percent, down from 12.8 percent in December. This follows earnings growth of 14.5 percent in 2006. Slower earnings pose risks to stocks.

Consensus expectations for 2007 earnings growth in Eurozone have been revised down to 9 percent and down to 7 percent in the U.K. Strong currencies and policy rate hikes are negatives for European earnings. In Japan, consensus expects 14 percent earnings growth, supported by margin expansion due to the continued decline in labor costs and improving corporate pricing power.

Equity valuations remain attractive despite the modest uptick in January. The trailing P/E multiple for the MSCI World Index rose to 17.1X in January from 16.8X at the end of 2006. However, the P/E multiple is well below the multiple of 17.9X in January 2006 as the 15 percent earnings growth outpaced the 13 percent price gains during 2006. Valuations are hovering around the lowest levels since August 1990. The current low level of P/E multiples provides room for multiple expansion in 2007. A more friendly macro backdrop with benign inflation, lower oil prices and stable interest rates are likely to lead to P/E multiple expansion. Stocks are also cheap relative to bonds but less so than in December given the rise in bond yields during January.

Bottom-line: Equity markets are likely to grind higher with lower oil prices, falling inflation and stable interest rates, attractive valuation and P/E multiple expansion. Earnings downgrades for Q1 pose near-term risks for stocks. Market volatility is likely to remain high with cross currents of moderating earnings, changing interest rate expectations, lower inflation and oil price swings.

Bonds: Growth Rebound, Rate Hikes Pressure Bond Yields

Global bond markets fell in January on evidence of a Q4 growth rebound in the U.S. and Japan, strong growth momentum in Europe and changing interest rate expectations. Yields rose in all markets during January. Bonds began 2007 on a weak note with the JP Morgan Global bond index down –0.2 percent in local currency and –1.2 percent in US$.

Global Investment Outlook - February 2007

In the near-term, Treasury yields are likely to be range bound having moved to a high of 4.9 percent. Positives for Treasuries include softer Q1 GDP growth after the strong Q4 rebound, tame headline inflation and continued pension fund demand. Headline inflation remains subdued with lower oil prices and favorable base effects. Core inflation continues to trend lower as rents stabilize, but still above the Fed’s comfort zone. Other negatives include the Fed unlikely to cut rates in the near-term and the inverted yield curve.

Japan yields are likely to come under pressure with a strong Q4 GDP rebound to 4.8 percent annual rate from the anemic 0.4 percent growth in Q3, and likely BoJ rate hike. Low inflation is a positive for JGBs. The BoJ remains confident about the growth and inflation outlook and appears inclined to raise rates in February/March give the strong Q4 growth rebound.

Eurozone yields are likely to remain under pressure with strong growth momentum and further ECB tightening. Eurozone Q4 GDP accelerated to 3.3 percent. Q1 growth is likely to be slower but still remain above trend at around 2.5 percent. Fears of a jump in Eurozone inflation following the German VAT increase did not materialize. January headline inflation was stable at 1.9 percent with the combined impact of lower oil prices and a smaller pass-through of the VAT increase. The ECB left rates unchanged at 3.5 percent in February but signaled a rate increase in March. While the ECB is likely to pause after March, further rate hikes appear likely with the ECB confident of the growth outlook and concerned about money supply and credit growth.

U.K. yields are likely to remain under pressure with growth well above trend, inflation well above BoE target, and the BoE likely to tighten further. Also, though U.K. headline inflation eased to 2.7 percent in January from 3 percent, it still remains well above the BoE’s 2 percent target and unlikely to come down significantly in the near-term.

Disclosure:

Pramerica International Investments Advisers, LLC, (PIIA) is the trading name of Prudential International Investments Advisers, LLC, a company incorporated in Delaware, U.S.A. and an investment adviser registered with the Securities and Exchange Commission of the United States. PIIA is a subsidiary of Prudential Financial, Inc (PFI) of the United States, both of which are not affiliated with Prudential plc of the United Kingdom. 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 as of the date of writing, and are subject to change at any time without notice. There can be no assurance that any forecast made herein will be actually realized.

The data presented is for informational purposes only. 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 regarding economic trends and conditions or investment process and may or may not be held by accounts managed by PIIA affiliates. The strategies and asset allocations discussed do not refer to any Pramerica service or product. Nothing herein should be viewed as advice, as a recommendation, as a solicitation or an offer to buy or sell any securities, as an offer with respect to the provision of investment advisory services, or as a proposal to adopt any investment.

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