MARKETS BRACE FOR LOWER RETURNS AND HIGHER VOLATILITYMARKETSBRACEFORLOWERRETURNSANDHIGHERVOLATILITY

U.S. stocks soared in 2021, but equity returns around the globe were mixed. Equities rose by double digits in Europe, the U.K., and many emerging markets. However, poor performance in China, driven by government regulatory crackdowns and property sector woes, dragged down emerging markets overall, while Japanese stocks were essentially flat. U.S. real estate investment trusts (REITs) and commodities were particularly strong performers as inflation surged. Bonds mostly posted negative returns in 2021 as yields fluctuated, but generally they ended the year at higher levels.

Stocks typically perform well in the early stages of Fed rate hikes, which seem likely to begin next year. The real damage from higher rates tends to occur later in the cycle when tighter policy flattens or inverts the yield curve. We are still not at that point.

Equity valuations improved in 2021, with profit growth far outpacing stock market gains. Multiples are still elevated in certain markets, especially in the U.S. Outside of the U.S., valuations remain much more favorable, which could fuel outperformance of non-U.S. stocks in 2022. However, this condition has existed for several years, and price momentum still favors the premium-priced and higher-quality U.S. market. Similarly, valuation, higher rates, and elevated inflation should favor value and small-cap stocks over large-cap and growth equities in the U.S. However, these conditions were also in place in 2020, and value and small-cap investments delivered mixed results. We are currently neutral on style and market-cap positioning in the U.S. but could eventually favor small-cap and value stocks if we see more definitive signs that market sentiment is moving in their direction.

CAUTIOUSLY PLAY THE RECOVERY

Bloomberg Commodity Index is composed of futures contracts and reflects the returns on a fully collateralized investment in the BCOM. This combines the returns of the BCOM with the returns on cash collateral invested in 13-week (3-month) U.S. Treasury bills. Bloomberg U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade, fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. Bloomberg U.S. Corporate High Yield Index covers the USD-denominated, non-investment grade, fixed rate, taxable corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. A small number of unrated bonds are included in the index. The index excludes emerging markets debt. FTSE World Government Bond Index (WGBI) measures the performance of fixed-rate, local currency, investment-grade sovereign bonds. FTSE Non-USD WGBI includes all WGBI markets except the United States and is stated in USD terms includes all WGBI markets except the United States and is stated in USD terms. JP Morgan EMBI Plus Index tracks total returns for traded external debt instruments (external meaning foreign currency denominated fixed income) in the emerging markets. MSCI China is designed to measure the performance of the large- and mid-cap segments with H shares, B shares, red chips, P chips and foreign listings (e.g., ADRs) of Chinese stocks. MSCI Emerging Markets Index is an equity index covering 23 countries representing 10% of world market capitalization. MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia, and the Far East, excluding the U.S. and Canada. Nasdaq Composite Index is the market capitalization-weighted index of over 2,500 common equities listed on the Nasdaq stock exchange. Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index. Russell 3000 Growth Index measures the performance of Russell 3000 companies (growth segment of the U.S. equity universe) with higher price-to-book ratios and higher forecasted growth values. Russell 3000 Value Index measures the performance of Russell 3000 companies (value segment of the U.S. equity universe) with lower price-to-book ratios and lower forecasted growth values. S&P 500 Index is an unmanaged index of 500 common stocks of large U.S. companies, weighted by market capitalization. S&P Global Ex-U.S. REIT Index defines and measures the investable universe of publicly traded property companies domiciled in developed and emerging markets excluding the U.S. S&P United States REIT Index defines and measures the investable universe of publicly traded real estate investment trusts domiciled in the United States. Indices are unmanaged and are provided for informational purposes only. Investors cannot directly invest in an index.

Risks—Investing involves risks. Some investments are riskier than others. The investment return and principal value will fluctuate, and shares, when sold, may be worth more or less than the original cost. Fixed income investments are subject to interest rate risk, and their value will decline as interest rates rise. Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes, and political and economic uncertainties. Investing in emerging markets is very risky due to the additional political, economic, and currency risks associated with these underdeveloped geographic areas. Investments in growth stocks may be especially volatile. Value investing involves the risk that undervalued securities may not appreciate as anticipated. It may take a substantial period of time to realize a gain on an investment in a small or midsized company, if any gain is realized at all. Real estate investment trusts (REITs) may not be suitable for all investors. There is no guarantee a REIT will pay distributions given the inherent risks associated with the market. A REIT may fail to qualify as a REIT as defined in the Tax Code, which could affect operations and negatively impact the ability to make distributions. There is no guarantee a REIT’s investment objectives will be achieved. Diversification and asset allocation do not guarantee profit or protect against loss.

The views expressed herein are those of investment professionals at PGIM Quantitative Solutions at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. This commentary is not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services. This commentary does not constitute investment advice and should not be used as the basis for any investment decision. This commentary does not purport to provide any legal, tax, or accounting advice. PGIM Investments LLC is a registered investment advisor with the U.S. Securities and Exchange Commission. PGIM Custom Harvest does not provide tax, legal, or accounting advice. This material is for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.

Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information, nor do we make any express or implied warranties or representations as to the completeness or accuracy. Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated, based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.

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1056362-00001-00  Ed. 1/2022