The 2013 Year Ahead, Merrill Lynch Wealth Management
Investors should position for the ‘great rotation’ out of fixed income and into equities that is likely to begin in 2013, according to Johannes Jooste, Head of Strategy for Europe, Middle East and Africa (EMEA) at Merrill Lynch Wealth Management. Drawing from the resources of BofA Merrill Lynch Global Research, the #1 Institutional Investor ranked team, with approximately 700 analysts in more than 20 countries, Mr Jooste outlines below the key forecasts investors should focus on for 2013.
The economic and market outlook for the coming year is brighter than in 2012, believes Mr Jooste. He sees increased evidence of the Federal Reserve’s progress in rekindling the U.S. economy and even a gradual eurozone recovery in prospect during the second half. In addition, in China GDP growth is forecast to improve slightly. BofA Merrill Lynch Global Research is projecting Chinese GDP growth to pick up, from 7.7 percent in 2012 to 8.1 percent in 2013.
“Growth should begin taking over from policy as the key focus for investors next year,” Mr Jooste says. “This leads us to favour equities over bonds in 2013. The notable valuation gap between the two asset classes, now at its most favourable level for stocks in over 25 years, adds to our conviction here.”
Stimulus supporting stronger economic performance
Even with a greater emphasis on growth, policy and politics will remain vital factors in the investment environment of 2013, Mr Jooste believes. Central banks underpinned the advances in 2012 by maintaining ample liquidity and a constructive interest rate environment. These measures should provide a supportive backdrop to next year’s better equities performance.
While the recent elections have brought some clarity in the U.S., resolution of the ‘fiscal cliff’ issue must now follow. “We view bipartisan agreement as a likely consequence of a second-term president and a weakened opposition,” says Mr Jooste.
Demand and corporate earnings should pick up in 2013 as stimulus measures take effect. China’s growth will tick upwards as recent policy stimulus measures gain traction. India too should fare better next year, with GDP growth expected to jump to 6.9 percent next year, from a forecast of 5.6 percent for 2012.
The U.S. offers potential for a positive macroeconomic surprise, but fiscal retrenchment is likely to weigh on GDP growth during the first half of 2013. BofA Merrill Lynch Global Research expects a modest 1.4 percent increase in GDP, but growth is likely to pick up later in the year. The core of the eurozone could face a difficult first half of 2013, but Mr Jooste expects growth to return in the second half.
Central bank accommodation, political impetus
Mr Jooste anticipates that the U.S. Federal Reserve will pursue its open-ended quantitative easing (QE) programme through next year and into 2014, while the European Central Bank (ECB) will eventually engage in purchases of short-term sovereign bonds. These measures are unlikely to add to inflationary risk in 2013, he believes.
As both sides are now incentivised to compromise, Mr Jooste expects a bipartisan solution to the U.S. ‘fiscal cliff’ issue. As Ethan Harris, BofA Merrill Lynch Global Research Co-Head of Global Economics Research, predicts, an 11th hour compromise will likely be followed by cuts of $250bn to $320bn (1.6 percent to 2 percent of U.S. GDP).
At present, opinion polls suggest that the CDU-CSU coalition will remain the dominant group in German politics after next autumn’s federal elections. Mr Jooste believes this should be positive for the eurozone by removing political uncertainty. However, he also acknowledges a risk of heightened volatility in the region during H1 2013 if Spain continues to resist pressure to seek external support, as he expects, and Italian national elections lead to political instability.
Politics will also be an increasingly important component of the emerging markets’ landscape in 2013, Mr Jooste expects. Legitimacy and risk are likely to weigh more heavily, with credible leaderships attracting investor support and weak ones having to rely on stimulus measures alone. As it seeks to manage its major social and governance challenges, China is likely to fall between the two.
Turning towards equities
Mr Jooste expects equities to outperform fixed-income investments in 2013. In line with the view articulated by BofA Merrill Lynch Global Research Chief Investment Strategist Michael Hartnett, he thinks investors already have adequate grounds to begin reversing their overweight bond positions and underweights in equities. The time for a full cyclical rotation away from bonds may not yet have arrived, but equities are now trading at their most attractive level relative to high-grade credit in over two decades.
As an initial step, Mr Jooste favours higher-income equities. However, as suggested by BofA Merrill Lynch Global Research Chief U.S. Strategist Savita Subramanian, he prefers companies with proven track records of dividend growth over those that offer the highest current yields, as the latter are mostly in sectors likely to underperform. With macroeconomic weakness and disappointing earnings more than adequately priced into European stocks, he favours the region’s equity markets. Moreover, due to relative valuation, he sees better scope for multiple expansion in Europe than in the U.S. Elsewhere, he prefers emerging markets, with allocation tilted towards China and India due to better GDP growth than in 2012.
The outlook remains negative on sovereign debt and investors should have less appetite for investment-grade bonds than in 2012, although there is still strong income potential in the high-yield sector. The U.S. dollar should outperform other major currencies in 2013, especially the euro but also the Japanese yen, reflecting better economic fundamentals in the U.S.
2015 and beyond: The great rotation out of bonds and into equities
Merrill Lynch Wealth Management and BofA Merrill Lynch Global Research foresee an eventual ‘great rotation’ out of fixed income and into equities.
“The combination of over-investment, excessive optimism and low levels of income generation in fixed-income markets all seem to point to the end of the bull market in bonds,” says Mr Jooste. “Meanwhile, the structural case for higher returns in equities is strong. Healthier, more robust companies are emerging from this drawn-out crisis. They have leaner balance sheets and a growing global demand base.”
Merrill Lynch Wealth Management EMEA will focus on four main ideas driving portfolio performance over the next three years (‘Portfolio 2015’): First, new sources of income form a pressing need with money market interest rates so low. Second, consumer power is blossoming in emerging economies. Third, some unloved assets, such as European equities, have been oversold during the financial crisis and could return to favour as solutions to the European crisis emerge. Finally, improvements in technology and in energy and labour costs will support multi-year growth themes. For example, a more competitive labour force is ready to drive a U.S. manufacturing revival much further.