According to the Russell Investments Strategists' Global Outlook 2014, several trends and conflicting factors caused a rather sluggish start to the year and stock markets are still waiting for fundamentals to confirm the good results of 2013.
Among the various factors, one must consider the impact on economic data of an exceptionally cold winter in the United States, fears over the Chinese debt, the increase in consumption taxes in Japan, as well as the tensions in Crimea and the deadlock in the East China Sea. However, given that the US economy is experiencing good growth rates, Russell's Strategists maintain a slight preference globally for equities over fixed income.
Strategists estimate that an average of 215.000 new jobs will be created in the US per month over the next nine months and that a Federal Reserve interest rate hike will be delayed until mid-2015. way to challenge us and the challenge right now is the combination of late-cycle valuations for asset classes like credit and US equities and mid-cycle dynamics in developed economies,” says Thomas Schneider, Director Southern Europe and Head for Russell's Italy.
“We believe the economic cycle will get the better of us and investors should therefore maintain their equity exposure. The temperature in the markets, however, is rising. It could be a hot summer for the northern hemisphere, not just for vacationers, but for investors as well."
To update market forecasts, Russell's Strategists use a "three prongs" process - value, cycle, sentiment - which combines qualitative views and quantitative elements. Valuations, market cycle and sentiment on each geographic area are weighted to define the suggested final exposure to investors' multi-asset portfolios. Based on this process, Russell's current forecasts for global markets estimate:
. Value: Equity valuations still high, especially in the US
Equity valuations in developed markets appear stretched compared to late 2013. With price-to-books hovering around 2,7x and a cyclically adjusted price-to-earnings (P/E) ratio above 20x, the equity market American, as measured by the Russell 1000 Index® as of 31 March 2014, is at levels not seen since 2007, levels the team estimates are overpriced. Eurozone equities are also slightly expensive, while Japan's P/E at 13x and a P/B of 1,3x, as measured by the Russell Japan Index, show valuations close to what we consider appropriate levels. Russell's strategists believe emerging markets are adequately valued, at a 30%-40% discount to developed markets, according to the Russell Emerging Markets Index and the Russell Developed Index.
. Economic cycle: forecasts of economic improvement in the Eurozone are growing, albeit with greater downside risks; the United States is regaining its footing
The moderate recovery continues in the Eurozone led by business and consumer confidence. However, the recent inaction by the European Central Bank has given way to deflationary forces, increasing the risk of an economic downside. The United States should continue its recovery after the February frost and return to the anticipated trend of moderate growth and low inflation. “The price multiples recorded on US equities in 2013 were based on the assumed strengthening of the economy in 2014,” says Luca Gianelle, client portfolio manager of Russell's multi-asset team. "Although the macroeconomic data at the beginning of the quarter was disappointing, our forecasts indicate that as the weather warms up, something under the snow will start to grow." The Strategists have a positive outlook on Japan's business cycle as earnings per share are revised higher and a fiscal stimulus package is currently underway. However, the team believes that Japan will experience lower growth this year than in 2013 as a result of the consumption tax hike that took place in April 2014. In emerging markets, the business cycle continues to face several challenges such as tightening credit in China, falling demand for raw materials and, more generally, rising inflation and the aftermath of currency devaluation.
. Sentiment: the positive phase continues for developed equity markets
Overall, fund flows, investor sentiment, risk appetite and technicals all appear neutral. As a result, sentiment interpretations are predominantly driven by momentum, which currently offers a positive driver for developed equity markets. The US market leads other developed markets globally in terms of sentiment, as strong 2014 economic data expectations offset Fed plans for moderate-speed tapering. Japan is close behind, as it hit new highs on a number of economic indicators, such as growth in the monetary base, inflation, job growth and corporate profits. Eurozone sentiment improved on capital inflows and the outperformance of risky assets. Conversely, the team believes that emerging markets generally have negative sentiment, with negative momentum and no indicators signaling change.
Market Outlook Update and Positioning Advice Russell's Strategists have provided an update on the outlook and related exposures across geographies and asset classes since the 2014 Global Outlook released in December.
. Japan – Focus on equity exposure, as it represents one of the best positioned markets for 2014, with full currency hedging.
. United States – Retention of previous equity exposure, as end-2014 targets for Russell 1000® (1.060) and S&P 500® (1.900) Index have not changed. Even on fixed income, try to maintain exposure to credit, as well as for corporate bonds.
. Eurozone – Lower equity exposure, close to neutral or on benchmark levels. Peripheral country bonds rallied sharply in 2014, but with yields tightening and risk rising, you need to watch your exposure.
. Emerging markets - Caution on short-term equity exposure. Although this segment of the market is relatively cheap from the point of view of valuations, investment in the area requires a medium-long time horizon.
