MERRILL LYNCH’S BULLISH 2010 INVESTMENT OUTLOOK – A BUBBLE IN PESSIMISM
We are just about finished wrapping up our series on 2010 outlooks. In this article we’ll outline Bank of America Merrill Lynch. Bank of America Merrill Lynch is very bullish heading into 2010 (an outlook similar to RBC). They see many of the trends of 2009 continuing into 2010 and driving equity markets around the world higher by double digits (see JP Morgan’s bullish emerging market outlook here). Ethan Harris, head of North American economics summarized the Merrill outlook:
“We believe the global economy will gather momentum in 2010. We think that the unprecedented mix of near-zero interest rates and high budget deficits will engineer an economic recovery that is real and sustainable. We aren’t forecasting a swift return to robust growth. In fact, the recovery will likely lag behind those of previous recessions – but we believe that the world economy will perform far better than the economic consensus would indicate.”
This macro outlook is underpinned by a number of variables:
- Global growth will be 4.4%, Chinese growth will be 10.1% and U.S. growth will be 3.2% – all above 2010 consensus estimates.
- Inflation will remain benign.
- U.S. stocks will rise 15% led by strong growth in global cyclical sectors – tech, energy, industrials and materials. Financials are also expected to perform well as the yield curve remains conducive to strong earnings.
- The MSCI All-Country World Index will rise 20 percent.
- Gold and oil will both continue to rally as strong demand from foreign investors remains the primary driver. Gold will breach $1,500 and oil will surpass $100.
- Government bonds will perform poorly.
- The Dollar & Yen will rally against the Euro.
Merrill also notes 10 key investment themes for 2010. From PR Newswire:
10 Investment Themes for 2010
- Government Balance Sheet Risk: The soaring U.S. budget deficit and a Chinese currency revaluation will drive 10-year U.S. Treasury yields above 4 percent by year-end 2010. Shorter-duration Treasuries and U.S. investment-grade corporate credit are less susceptible to such risks.
- Rising Taxation: The soaring U.S. budget deficit, looming U.S. healthcare reform and a likely second stimulus package will need to be funded through higher tax rates. Opportunities include essential purpose revenue and general obligation municipal bonds, and municipal bond exchange-traded funds.
- Alternative Dividend Yield Strategies: Dividend taxes are likely to rise in 2011, and as the prospect of higher taxes erodes the popularity of traditional dividend yield-oriented strategies, tax-advantaged or tax-deferred strategies will benefit.
- Financial Sector Rehabilitation: Steepening yield curves around the world, increased M&A activity and the still-underestimated normalized earnings power of financials should foster their returns surprise on the upside. Opportunities can be found in best-of-breed mega-cap global financials.
- Corporate Cash Flow Beneficiaries: High cash balances will translate into strategic M&A, a term describing non-speculative, non-private equity mergers. In addition, companies will increase capital spending and possibly dividends. We expect the beneficiaries of capital spending to include the industrial sector and temporary staffing companies as production expands.
- Rising Global Growth: The global policy stimulus seen in 2009 will continue to support global growth led by emerging markets, while in the U.S. an inventory restocking cycle and higher capex converge to push global growth well above 4 percent. Opportunities include best-of-breed mega-cap multinationals based in developed markets with a large presence in emerging markets.
- The Emerging Market Consumer: The emerging market consumer is at the beginning, not the end, of the credit cycle. Opportunities include emerging market currencies versus the U.S. dollar and, in equities, U.S. energy stocks, global energy majors and mega-cap multinationals.
- Commodity Price Inflation: Supply constraints are likely to resurface in the year ahead as commodity demand outpaces the productive capacity of current resources. Investment opportunities include long positions in gold and global energy stocks.
- Alternative Energy: Truly economical renewables may be years away, but investment in alternative energy is an important secular theme that will continue to gain ground. Alternative energy ETFs offer exposure to the burgeoning industry while providing important diversification across multiple technologies and business models. Old technology energy equities such as utilities will be a source of, not a beneficiary of, alternative energy investment.
- The Return of Active Management: Volatility has come down in 2009, especially since central banks began their critical quantitative easing in March. Lower volatility leads to lower correlation, resulting in greater differentiation in asset price performance. The trend favors active over passive management. Such a stock-picking environment should result in high-quality, best-of-breed stocks outperforming in 2010.
“Poor returns from the equities markets over the past decade, particularly from large cap equities, have created a pessimism bubble among investors,” said Bianco. “We believe the S&P 500 is now undervalued, which could create many investment opportunities in the year ahead. Given our expectations for global growth led by emerging economies, a slow but steady U.S. recovery, and healthy S&P 500 EPS growth, we think that the pessimism bubble will finally burst in 2010.”
Interesting outlook indeed. A bursting in the pessimism bubble will likely mean a very real asset bubble - which should come as a surprise to Ben Bernanke and co.
Within the 10 investment themes, I find his second bullet point, calling for buying muni G.O.’s and essential service revs to be borderline nuts.
Municipal finances are a catastrophe and getting worse. Any rising taxation they somehow can pull off will just allow then to tread water where they are as sales taxes, income taxes, and even property related transaction taxes and direct property levies continue to collapse.
If you get an overall rsiing rate environment you could lose on two fronts.
The call to buy munis because rates are going up has been reflexive for as long as there have been tax free bonds, but things are not what they have always been in muni land. People need to consider the size and scope of outstanding muni issuance before they just casually think the U.S. government can just bail them all out. And, if that happened they would likely lose their Federal exemption. (If this scenario were to play out, you would be better off buying crap like CA G.O.’s because losing the Federal exemption would be more than off set by the massive upgrade in credit quality. You actually could make money if CA defaulted and the U.S. bailed them out. No?)
TPC,
Is there one investment house out there not predicting a bullish outlook for 2010? With everyone so bullish, it makes me think a contrarian view should be considered. The only thing holding me back is that big money now control the market. They will take it where they want. The market may be flat-ish for the remainder of this year but a big move is coming.
TPC Reply:
December 15th, 2009 at 8:49 AM
Gray,
Both MS and CS are calling for difficult years. Both are, in my opinion, the best of the best.
http://pragcap.com/morgan-stanley-stocks-are-set-to-decline-in-2010
http://pragcap.com/credit-suisse-equities
BGray Reply:
December 15th, 2009 at 9:13 AM
Even so, they both see 1st half with robust growth.
TPC Reply:
December 15th, 2009 at 8:50 AM
I should add. I kind of like there theme of a bubble in pessimism. It may not be true, but it’s an interesting thought. Are investors so turned off after the credit crisis that a slowly melting higher market will sucker them all back in?
TPC Reply:
December 15th, 2009 at 8:51 AM
their theme….
BGray Reply:
December 15th, 2009 at 9:04 AM
True. There are still lots of bears out there. Retail mom and pops haven’t come in. I’m not sure that they will either though but that’s how markets top. Who has money left to invest after 1) they supposedly sold at the low 2) any savings they have has to be used to pay down debt 3) if somebody lost their job in the family they invariably will need to cut into savings 4) healthcare, education, gas prices all up.
Perhaps all those foreclosures are good for something. Rents have come down and those who have forgone their homes no longer need to pay huge mortgages. They can start saving.
TPC Reply:
December 15th, 2009 at 9:17 AM
First half is unanimously bullish from what I’ve seen. I’d say this was a contrarian sign if I didn’t know that the banks are controlling the trading.
VCC Reply:
December 15th, 2009 at 11:24 AM
The banks that are now controlling trading were the same ones that were in free fall for much of the last two years. Huh?
Not a big fan of these bullish bank reports. These guys were dead center in the crisis that they never saw coming, and they’re now telling us the sky is clear again, dollar will go up, stocks will go up, everything will go up up up up up. I can’t help but think of Blankfein in summer 2008 when he said “we’re in the seventh innning of the crisis.” And now we’re to believe these clowns as they gorge themselves at the government trough??
I find the guru outlooks much more helpful. Those guys don’t have the same upward directional bias as the major banks. A double-dip and falling market are pretty bad for business, hence their need to put lipstick on the pig that is the bloated s&p.
Rob Reply:
December 15th, 2009 at 2:00 PM
These are the same banks that all put sell rating on their peers just weeks before the March bottom. That sounded like blatent manipulation to me at the time. “Look out below, sell all your bank shares… to me.”
How many fund manager’s beat the market consistently year after year? Very few. How many analysts and strategists get their market calls correct constistently year after year. Very few, not even at Goldman Sachs. Often not even in the right direction.
How many who get the macro trends right can get the timing right? The tech bubble was obvious to anyone with a brain, ditto the housing bubble, but it went on and on and on until the doubters were no longer listened to. That is when the bubble finally pops. This time it is the liquidity bubble(s).
VCC Reply:
December 15th, 2009 at 2:33 PM
Rob, that’s because the paradigm thru which they view the markets is horribly flawed. I would be stumbling around too if my glasses were fogged over and all I knew was the general destination was historically up, save a few steep cliffs along the way. Let’s not kid ourselves and say these cats make huge macro calls and that’s where the profit comes from. Much of their business involves making money from everything a healthy, upwards moving market creates.
But the idea that we were saved b/c savvy old Ben and sagely Tim printed enough money to get us out by our chinny chin chins is absolutely nuts. The biggest question is what happens when these banks need another bailout? There will be no stomach to give them more public funds after they wash themselves in cash this bonus season. Where will the next round of capital come from and at what price? But for now I’m left thinking about Roger’s quote to tech ticker a couple days ago: “The idea you can solve a problem of too much debt and too much consumption with more consumption and more debt defies belief. I cannot believe that grownups would stand there and say that.”
What if the following happens: participants in the real economies of the Western world remain stubbornly pessimistic due to a high debt load, no jobs and higher gas/oil/food prices. This depresses their consumption, increases savings further and decreases political stability by popularizing radical and populist politicians. In the developing world, consumption increases, but cannot offset the decrease in the west. Moreover, because of the previous point, exports lag expectations in Asia. This would create a different climate for stocks and especially safe haven investments like treasuries. Just a thought to counter the rosy outlooks of the previous reports. What I find interesting is that the consensus forecast among the big brokerage houses seems to be that since “everybody” (I’m assuming general populace) is pessimistic, we should be optimistic. But since this is the consensus, I remain skeptical. Where was this optimism at the end of February, or March???
Looks like everything is going up — where are my darts
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