Europe took center stage for the 2012 analysis. BofA Merrill Lynch Global Research’s macro analysts forecast global economic growth of approximately 3.5% during 2012. The team anticipates credit and commodities will outperform equities in the first half of 2012, and recommends investors overweight corporate and emerging market bonds.
“The global economy can weather a normal size recession in Europe, in our opinion,” said Ethan Harris, co-head of Global Economics Research. “The U.S. faces its own challenges, with gradual fiscal tightening and considerable uncertainty around policy after the election. As a result, while we expect solid 3% GDP growth in the current quarter, we look for growth to slow to just 1% by the end of 2012.”
At a press briefing in New York, Harris addressed the severity of the situation for Greece. He said the European Central Bank (ECB) is “asking for too much austerity,” adding Greece “needs to be on a sustainable path to reduce its debt and create growth. We need to focus more on reform and not just austerity. The people of Greece may think things can’t get worse, when they really can.”
If Greece were to exit the Euro-zone, the problem wouldn’t be so much in the exit itself, but in the collateral damage, Harris noted. The exit would also have to be a controlled one, not chaotic; if there is a chaotic exit from the Euro-zone, it would “create many shocks in the markets. It’s easy to get married and hard to get divorced – and they have 17 kids to think about,” he concluded
Political and financial concerns in the U.S. will also play a vital role in 2012.
“The very real risk of policy mistakes causing a recession in the U.S. or a hard landing in China means that investors should conservatively allocate assets in 2012. Despite our short-term caution, however, we anticipate that global equities could rally by 10% next year from current levels, aided by liquidity, modest earnings growth and cheap valuations. In a bullish scenario, 2012 could represent the beginning of the end of the great bear market in equities,” said Michael Hartnett, chief Global Equity Strategist and chairman of the BofA Merrill Lynch Research Investment Committee (RIC).
RIC recommends investors approach the U.S. markets tactically and with caution next year.
Savita Subramanian, head of U.S. Equity and Quant Strategy, forecasts the S&P 500 will end 2012 near the highs of its two-year trading range, with a year-end target of 1350. “Asset correlations and volatility could remain high next year, while U.S. corporate profit growth will decelerate,” said Subramanian. “To navigate this market, investors should focus on stocks and sectors that have differentiated performance, and on secular, rather than cyclical, growth opportunities. Companies that deploy cash through dividends and buybacks rewarded investors in 2011, and that trend will continue in 2012.”
BofA produced five tactical ideas to navigate the U.S. markets in 2012:
• Corporate bonds issued by large U.S. banks and high yield companies: Despite slow economic growth and low rates, large U.S. banks are expected to continue to benefit improving credit fundamentals, wide spreads and systemic support. U.S. high-yield companies are attractively priced as spreads more than adequately compensate for adverse economic risks.
• High-quality, high-yielding municipal bonds and “kicker bonds”: Tighter U.S. fiscal policies on the federal, state and local government levels will be positive for bonds of high-quality municipal issuers. Within high yield, head of Municipal Research John Hallacy favors AA-rated hospital system bonds, Airport General Aviation revenue bonds and Dedicated Sales Tax or other special tax Transportation bonds, as well as “kicker bonds” (high coupon bonds with short calls).
• Quality, Growth and Yield should benefit. According to Subramanian, high volatility and slowing earnings growth both suggest quality and growth will continue to outperform. She recommends U.S. equity overweights in consumer staples and technology and underweights in materials and financials.
• U.S. technology companies: U.S. technology companies have the highest cash levels of any sector in the S&P 500 and are more likely to grow dividends, buy back stock and increase capital expenditures. Additionally, companies in this sector have high earnings stability and attractive valuations – over 80% are trading below their five-year average price-to-earnings valuations. Internet Software & Services and Computers have the strongest secular growth prospects.
• Watch the technicals: As long as asset prices remain in trading ranges, technical analysis will be relevant, said Mary Ann Bartels, head of U.S. Technical and Market Analysis. “The best entry point into U.S. equities is at the 1,074 – 1,100 level on the S&P 500 index, and profits can be taken on the S&P 500 in the 1,300 – 1,350 range,” she said.
In the absence of global economic expansion, BofA Merrill Lynch Global Research recommends investors should stay defensively positioned and look to add alpha through secular trades in high-growth, high-quality and high-yielding assets.
“The two key assumptions behind our central scenario are that the situation in Europe will have to get worse to force policymakers to move irrevocably toward closer fiscal integration, and that the global economy will struggle to decouple from the first round of U.S. fiscal tightening. We expect these two themes to collide in the first quarter of 2012, which will lead to outperformance of the USD and U.S. Treasuries. Visibility beyond that point is low, but we are concerned that the recession in Europe will undermine the political support for reforms and the euro,” said David Woo, head of Global Rates and Currencies Research.
The team provided five tactical ideas to navigate the global markets in 2012:
• Gold: Commodity strategist Francisco Blanch set a 12-month gold price target of $2,000 per ounce, implying a 16% price gain from current levels. Monetary easing by central banks around the globe in 2012 should benefit the precious metal and help investors to mitigate the negative impact of debt deleveraging. In addition, David Woo expects this should cause gold to outperform most currencies.
• Emerging market debt denominated in local currencies: The global Emerging Markets Fixed Income Strategy team forecasts a 2012 target return of 10.4% for emerging market local currency debt. Broad exposure can be accessed via bond funds, but investors looking for more specific exposure should consider long-duration Mexican bonds, yielding above 7% in a currency (MXN) that is the most undervalued relative to the U.S. dollar.
• High-yielding international equities: International dividend-paying stocks are expected to offer exceptionally attractive, high-quality income streams. Examples include: Australian banks (7%) and Eurozone Telecoms (10%), liquefied natural gas (LNG) and crude oil infrastructure MLPs, REITs in the self-storage, datacenter and high quality/infill retail sectors.
• “The best and the distressed” in Europe: European stocks are the most oversold they have been relative to U.S. equities in 20 years, and European companies have as much cash on their balance sheet as U.S. companies. The RIC recommends high-quality European equities with strong earnings, healthy balance sheets and solid margins, and anticipates that bank deleveraging should create distressed asset bargains.
• Hedge risk: In a risk-on/risk-off world, many asset prices move together when a tail risk strikes. According to head of Global Equity Derivatives Research Ben Bowler, tail risk hedging remains better value in emerging markets where options are priced more optimistically. Value can also be found in sector and country indices away from the mainstream hedging markets, which can become crowded.
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