Economies Thaw from a Cold Winter and Valuations Heat Up– Strategists maintain preference for equities over fixed income globally
– Team sees moderately stronger growth in the U.S., a resilient Japanese economy and signs that China is stabilizing
April 17, 2014 8:02 am (est)- SEATTLE–(BUSINESS WIRE)–Russell Investments’ released its Strategists’ 2014 Global Outlook – Second Quarter Update, reflecting the most recent guidance from Russell’s global team of investment strategists.
In the report, the team notes that a variety of market crosscurrents have led to a lackluster start to 2014 and equity markets are still waiting for the fundamentals to validate their 2013 gains. These crosscurrents included the chilling winter impact on U.S. economic data, concerns around China’s debt and Japan’s consumption tax hike as well as tensions in Crimea and the stand-off in the East China Sea. But, as the U.S. economy finally heats up, Russell’s strategists maintain a modest preference for equities over fixed income globally. They predict monthly gains in U.S. non-farm jobs to average 215,000 over the next nine months and the U.S. Federal Reserve’s (the FED) interest rate hikes to be held off until mid-2015.
“Markets always find new ways to challenge us, and currently this challenge comes from the combination of late-cycle valuations for asset classes like credit and U.S. equities, and mid-cycle dynamics in developed economies,” said Russell’s Global Head of Investment Strategy, Andrew Pease. “We believe that the economic cycle will win out, and investors should maintain equity market exposure. However, the temperature is rising. It could be a warm northern hemisphere summer, not just for vacationers, but for investors as well.”
To update their market forecasts amid a changing market environment, Russell’s strategists use a three-pronged “value, cycle, sentiment” investment strategy process, which combines qualitative views and quantitative inputs. The valuations, business cycle and sentiment assessments for each region are then weighed into final exposure recommendations for client’s multi-asset portfolios.
Based on this process, Russell’s current global market perspectives are as follows:
- Value: U.S. and Eurozone equity valuations still expensive
Equity valuations in developed markets appear stretched relative to the end of 2013. With a price-to-book (PB) floating near 2.7x and a cyclically adjusted price-to-earnings (P/E) ratio over 20x, the U.S. equity market, as measured by the Russell 1000® Index as of March 31, 2014, is valued at levels not seen since late 2007, which the team finds to be expensive.
Eurozone equities are also slightly expensive, the strategists note, while Japan’s P/E ratio of 13x and P/B of 1.3x, as measured by the Russell Japan Index, indicate valuations which are close to what they consider fair.
The strategists find that emerging markets are currently relatively favorably valued, with about a 30% to 40% undervaluation relative to developed markets, as measured by the Russell Emerging Markets Index and Russell Developed Index.
- Cycle: Eurozone growth expectations improving, but with increasing downside risk; U.S. regains its footing
The team sees moderate economic recovery in the Eurozone continuing, primarily driven by producer and consumer confidence. However, the strategists suspect that recent inaction by the European Central Bank has allowed deflationary forces to take hold, leading to heightened downside economic risk.
In the U.S., the strategists expect the economy to continue recovering from the February freeze and return to the anticipated track of moderate, low-inflation growth.
“The price multiple mapped onto U.S. equities through 2013 was based on an assumed strengthening economy in 2014,” said Doug Gordon, Russell’s Senior Investment Strategist, North America. “While the macroeconomic data at the start of the quarter was disappointing, our forecasts indicate that when the weather effect thaws, there will be organic sources of improvement beneath the snow.”
Japan, on the other hand, is seen by the strategists to have a positive business cycle outlook, as earnings-per-share are being revised higher and additional fiscal stimulus is underway. Still, the team suspects that Japan will have lower growth this year than in 2013 as a result of the April (2014) consumption tax rise.
As for emerging markets, the business cycle there continues to face challenges as a result of China’s tighter credit conditions and slowing commodity demand, and more generally from rising inflation and the after effects of currency devaluations.
- Sentiment: Positive momentum continues for developed equity markets
Overall, the strategists find that their records of fund flows, investor confidence, risk appetite and technical data, which encompass their sentiment views, appear neutral globally. Accordingly, sentiment readings are mainly pushed by momentum, which currently offers a positive driver for developed equity markets.
The U.S. market leads other developed markets globally in terms of sentiment as strong forecasts for economic data in 2014 balance out the Fed’s plans to continue a moderately paced tapering of its asset purchasing program. Japan comes next, having recently reached new highs in a wide range of economic indicators, including base money growth, CPI inflation, employment growth, and corporate profit margins. Eurozone sentiment also has improved due to capital inflows and outperforming risk assets.
On the other side of the spectrum, the team finds that emerging markets generally have a negative sentiment with negative momentum and no indicators signaling a shift in momentum.
Updated Market Forecasts and Exposure Recommendations
Based on market shifts since the 2014 Annual Global Outlook was published in December, the strategists have expressed updated forecasts and exposure recommendations across regions and asset classes, which help guide the firm’s multi-asset portfolio and services.
- Japan – Focus on equity exposure, as it is among the better positioned equity markets, from a fully hedged perspective, in 2014.
U.S. – Maintain previous equity exposure, as the 2014 year-end targets for the Russell 1000® Index (1,060) and the S&P 500® Index (1,900) have not shifted. For fixed income, look to maintain credit exposure, such as with corporate bonds.
- Eurozone – Lower equity exposure back to neutral or benchmark levels. Peripheral bonds had a great run thus far in 2014, but with tightening yields and increased risk, guard against exposure.
- Emerging Markets – Be cautious on equity exposure. Although this market segment is relatively cheap from a valuation perspective it places last in overall qualitative attractiveness.
For more detailed information, please see the Strategists’ 2014 Global Outlook – Second Quarter Update as well as the Global Outlook Infographic.
About Russell Investments
Russell Investments (Russell) is a global asset manager and one of only a few firms that offers actively managed multi-asset portfolios and services that include advice, investments and implementation. Russell stands with institutional investors, financial advisors and individuals working with their advisors—using the firm’s core capabilities that extend across capital market insights, manager research, portfolio construction, portfolio implementation and indexes to help each achieve their desired investment outcomes.
Russell has more than $259 billion in assets under management (as of 3/31/2014) and works with over 2,500 institutional clients, independent distribution partners and individual investors globally. As a consultant to some of the largest pools of capital in the world, Russell has $2.4 trillion in assets under advisement (as of 6/30/2013). It has four decades of experience researching and selecting investment managers and meets annually with more than 2,200 managers around the world. Russell traded more than $1.4 trillion in 2012 through its implementation services business. Russell also calculates approximately 700,000 benchmarks daily covering 98% of the investable market globally, including more than 80 countries and more than 10,000 securities. Approximately $5.2 trillion in assets are benchmarked to the Russell Indexes, which have provided investors with 30 years of smarter beta.