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Prudential sees late-cycle equity value

18 January 2017


A re-acceleration in business activity late in the economic cycle favours cyclical equity markets, with emphasis on Japan

The strength of earnings growth late in the cycle will be one of the key investment themes in 2017, according to Prudential Portfolio Management Group (PPMG), but the benefits will not be spread evenly around the world.

Japan was highlighted as market where Prudential expects an earnings recovery expected to come through late in the cycle.

David Shairpe, head of research, said: "The late-cycle reacceleration tends to favour the more cyclical equity markets – those that will see a jump in earnings in response to a pickup in activity and in response in a pickup in their top lines."

The US is at the other end of the spectrum after its rapid rise over the last 12 months. The investment environment in the US is mature, said Shairpe: "In terms of valuations, they are very stressed."

"Our view is that the US is pretty fully-priced. US equities are richly priced and that comes through fairly consistently." Shairpe added that the case for the US, if there even is one, is a turn in the earning cycle. But in his view, there is not a "compelling enough case."

The US equity risk premium has fallen to 3%, which is the lowest on this series since July 2004. "We don’t see a massive amount of value," Shairpe said. 

The outlook is for 2017 is brighter than it has been in recent years largely due to the expectation for expansionary fiscal policy. While Prudential expects fiscal easing to materialise, it does not expect it in the first half of the year.

In Japan the central bank’s monetary policy becoming less effective so the government may be forced to turn to more expansionary fiscal policy to boost demand. The same situation exists in the eurozone.

"Monetary policy cannot be the only spur for economic growth," said Leila Butt, senior economist at Prudential. "It must be in tandem with fiscal policy and structural reform."

Eurozone growth has been more tepid than in the US and the UK. "Accommodative monetary policy, less restrictive fiscal policy and an improving labour market will act to sure up eurozone growth such that it pushes growth by 1.5% this year," said Butt.

Meanwhile,in the US, on the back of the incoming Republican administration, expectations for more fiscal policy have already resulted in a late-cycle spurt to growth. Conditional on the actual fiscal stimulus, Prudential expects the Fed to tighten monetary policy with three 25 basis points (bps) hike rates this year.


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