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Second Quarter 2014

Global stocks faltered in January, reacting to the reality of the long-anticipated Fed tapering (the reduction by the U.S. central bank of its bond-buying program) after an extended period of accommodative policy. Continuing economic and political woes across emerging markets and skepticism about the recoveries in Europe and Japan added to the overall decline in global equities in January. Despite political turmoil in several regions, markets rebounded in February and March.

As we went to press, non-U.S. stocks led for the quarter, outperforming those in the U.S. for the first time in several periods. Japan was down slightly for the quarter. Despite this, developed markets continued their dominance over emerging markets, which suffered the largest declines among the components of the world benchmark.

LOOKING BACK

Despite the Fed's announcement in December that it would begin reducing its accommodative program early in 2014, the actuality caused markets to buckle around the globe when implemented in January. As tapering continued into February and March, the markets appeared to accept the move as a sign of confidence in the U.S. economic recovery. World markets rebounded after January more than reversing the first month's losses in early February.

Political turmoil, currency issues, and inflation fears continued to trouble emerging markets, which continued to trail developed markets. Upheaval in Turkey, Thailand, and Ukraine worried global investors. Scenes of Russian tanks rolling into the Crimean peninsula late in the quarter raised questions about Russia's economy should the situation escalate. Such concerns pulled emerging markets into negative territory for the period.

Evidence of economic improvement and corporate earnings growth in the U.S., Europe, and Japan suggested that the global economic recovery was on track for the long term, though additional short-term fluctuations seem likely.

LOOKING FORWARD

Looking ahead, we remain encouraged about the sustainability of the global recovery. The U.S., Japan, and Europe appear to be improving. Emerging markets continue to moderate in response to ongoing currency and political issues. Nonetheless, there are attractive opportunities in select companies in the developing markets that we believe can take advantage of a global recovery. In China, we are seeing opportunities in companies tied to the ballooning internet and social media space as well as in the increasing demand for consumer goods. Central banks should remain focused on quantitative easing in the near term as they continue to monitor deflationary conditions in mature economies.

Eurozone
The European recovery appears to be gaining traction, as evidenced by the fact that eurozone markets gained for the third consecutive quarter. Improving corporate earnings reports helped overcome mixed economic data to extend the rally. Consumer-based companies led the way, benefitting from rising consumer spending and exposure to the U.S. housing and consumer recoveries. Amid mounting concerns about disinflationary tendencies throughout the region, the European Central Bank (ECB) left rates unchanged in March, and gave no indication of plans to take unconventional steps toward increasing inflation toward its 2% target rate. The euro rallied on the news. The ECB appears to believe this combination of lower rates, slight-but-steady economic growth, and favorable corporate earnings results mirrors the one that previously helped pull the U.S. out of its slump.

Going forward, Europe should continue to improve. Government, corporate, and fiscal leaders appear poised to take the necessary steps to keep the recovery on course. Labor flexibility and stimulative fiscal policies remain important components of that turnaround. Earnings are improving, and stock prices still appear to be reasonable in the major markets. Industrials in the larger economies such as France and Germany and consumer-based names across the region continue to benefit from stronger economic activity. Financials appear to be putting their balance sheets in order, with those in northern Europe somewhat farther along in the recovery cycle than their southern counterparts. Peripheral markets, including Greece and Portugal, have also begun to show improvement.

United States
After stumbling in the first month of the year, U.S. stocks recovered, continuing on to record new highs. Corporate revenue and employment data improved in the first quarter, despite some of the worst winter weather the U.S. has experienced in years. Multiple storms in the Midwest, Northeast, and South, combined with lingering frigid temperatures brought on by the "polar vortex," did not deter buyers from buying nor hirers from hiring--the strongest sign we have seen yet that the U.S. recovery is sustainable.

Favorable trends continue. Housing and housing-related industries are strengthening. Corporate earnings remain strong in most sectors, and companies have been able to grow without large increases in payroll costs. Consumers are reaping the benefits of lower oil prices and competitive pressure on brick-and-mortar retail outlets driven by ecommerce.

The U.S. employment picture continues to improve, and in March, new jobless claims were reported at a three-month low. Jobless numbers are decreasing among all major demographic groups as well as in the ranks of the long-term unemployed, defined by the U.S. Bureau of Labor Statistics (BLS) as 27 weeks or longer. More than 1.1 million people (or 23%) left this group in the past year, according to the BLS.

Positive news on the employment, earnings, and housing fronts has helped buoy confidence widely. Both consumer and purchasing manager confidence indices were up sharply. Consumer discretionary, staples and retail stocks rallied accordingly.

Considering these trends, economists predict that ongoing encouraging data should further boost consumer confidence, which, when combined with higher savings and real wage growth, should lead to greater consumer activity. This is good news for companies in the industrials, consumer discretionary, consumer staples, and financials sectors. Concurrently, equities here appear attractively priced, with earnings multiples still significantly below levels seen during previous bull market runs.

Japan
The situation in Japan continues to improve, though at a modest pace. Corporate earnings are improving amid stimulative fiscal and monetary policies, albeit against favorable comparisons due to the country's long economic slump. Export- and industrial-based companies remain the primary beneficiaries of a weakening currency and government policies to stimulate inflation.

While Prime Minister Shinzo Abe's efforts to jumpstart the economy are keeping the economic rebound afloat, we are keeping our eyes on the potential effects of the new consumption tax to be implemented in April. Retail sales have clearly spiked as consumers move to make major purchases before the tax takes effect. Spending changes after the tax will be an important factor in our outlook for Japan going forward. The government may need to institute another supplementary budget to offset the effects of that tax and earnings growth at the company level may or may not continue to rebound. We continue to monitor this situation closely.

Emerging Markets
After two consecutive quarters of positive performance, emerging markets slipped back into negative territory in the first quarter. Emerging Markets continued to lag developed markets due to concerns about U.S. Fed tapering, inflation, and currency troubles. Political turmoil in Venezuela, Thailand, Turkey, and Ukraine exacerbated the fears of investors.

China also suffered as signs of weakness in the housing and manufacturing industries hinted at a slower economy there. The one bright spot was China-focused internet, broadband, online, and social media companies, which are benefiting from the rapid growth of adoption of these technologies and services in world's second-largest economy.

The big question for China remains: as China transforms from an investment- and industrial-based to a service-based economy, how will the central committee's new plenary directives affect growth? This is another ongoing situation we are watching closely.

While we continue to find opportunities through our bottom-up fundamental research process, we remain aware that rising inflation and currency weakness will continue to challenge many emerging market economies, especially those carrying current account deficits versus the U.S. in a stronger-dollar environment.

Longer-term, Asia's developing economies are likely to rebound relative to developed markets, despite recent performance headwinds, which, in our view, are the result of several short-term factors. China's slower infrastructure spending has hurt commodity- and materials-based names, but they should rebound along with greater economic activity in China, Europe, and the U.S. We would also expect to see manufacturers and exporters, especially those tied to global growth, benefit as economic conditions strengthen in China and the developed markets.

CONCLUSION

As dedicated bottom-up stock pickers, we are committed to keeping short-term market trends in perspective as we maintain our disciplined investment approach. Though optimistic after several consecutive quarters of growth, many investors remain cautious about fixed income, U.S., Europe, Japan, and emerging markets investments alike. We believe that by analyzing opportunities on a company-by-company basis, regardless of short-term market conditions, we will be able to uncover attractive stocks that can offer the earnings acceleration potential that is the cornerstone of our investment process.

International investing involves special risks, such as political instability and currency fluctuations. Investing in emerging markets may accentuate these risks.

The opinions expressed are those of Mark Kopinski and are no guarantee of the future performance of any American Century Investments fund. This information is for educational purposes only and is not intended as investment advice.

For a detailed description terms referenced above, refer to our Glossary.

MSCI World Index: A free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

Source: MSCI. Morgan Stanley Capital International (MSCI) makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used to create indices or financial products. This report is not approved or produced by MSCI.