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Top 10 global economic themes and tips for 2012

Top 10 global economic themes and tips for 2012

If it wasn’t clear to you yet, nobody on earth will has illusions of grandeur for the global economy situation. But here’s Merrill Lynch’s handy guide to navigating through 2012.

December 20, 2011 10:42 by

…this will prove to be an important inflection point for risk assets and could support commodity prices in the second half of 2012.

• US Treasuries to remain the safe-haven asset of choice. Head of US Rates Strategy Research Priya Misra expects the Fed to communicate a much longer on-hold policy. She expects 10-year Treasury yields to fall to 1.6 percent early in the year due to risks from Europe, triggering policy response which should help rates increase to 2.4 percent by year end. While Treasuries are likely to remain a safe-haven asset, the downside and upside on yields are expected to be limited.

• Yield and income will remain paramount. The year 2012 will likely be another environment of low rates and scarce yield, and investors will continue to seek assets that provide attractive yields. US Credit Strategist Hans Mikkelsen is bullish on corporate credit and expects credit spreads to tighten significantly by the end of 2012. The credit strategy team forecasts total returns of 4.8 percent and 13.9 percent from US investment-grade and high-yield bonds, respectively.

• Modest upside for equities. Equities should offer roughly 10 percent upside in 2012. Deleveraging and slower earnings growth are expected to limit the upside, while quantitative easing, valuation and positioning limit the downside. The Global Equities team recommends focusing on sectors that provide high growth, high quality and high yields. The equity strategy teams’ 2012 year-end targets are 330 for MSCI All Country World Index and 1,350 for the S&P 500.

• Large-cap equities will outperform small-cap equities. Head of US Small-Cap Strategy Steven DeSanctis expects large caps to continue to outperform small caps in 2012 as earnings growth and valuations are better for larger companies. Heightened volatility and macro uncertainty offset the clean balance sheets and potential for M&A within small caps.

• Stock picking opportunities likely to emerge. Correlation and volatility are likely to decline in 2012, once a macro solution for Europe’s debt problems is implemented. This environment favors active fund management in the year ahead.

• Emerging market interest rate cuts support risk assets and commodities. Despite risks, the Global Economics team expects emerging markets to continue to be the engine of global growth in 2012. Emerging market government debt-to-GDP ratios are well below those in developed markets, leaving room for increased public spending. And as recent monetary policy easing in Brazil, Russia and Indonesia suggest, emerging market central banks are likely to be pre-emptive in supporting growth.

Top global ideas for 2012
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.

Francisco Blanch, head of Global Commodities and Multi-Asset Strategy, said, “Politics, policy and geo-political events will remain key drivers of commodity prices in 2012. That said, we see limited upside to oil prices in 2012 and forecast that Brent Crude and West Texas Intermediate will not rise above $108 and $101 per barrel, respectively, absent a shock to the global economy. Gold prices, in contrast, could rally during the second half of 2012, given the turmoil in Europe, which is fueling demand for safe-haven assets.”

Hans Mikkelsen, US Credit strategist, and Barnaby Martin, European Credit strategist, remarked, “We see a better risk reward proposition in US credits than in European credits, where we do not predict a quick fix for the region’s debt problems.” One thing is certain, according to Martin: “As European credit fundamentals clash with policy, spread volatility will remain extreme, and investors should prepare for a trading market in European credit again, including a small overweight in European high-grade bonds early in the year.”

David Woo, head of Global Rates and Currencies Research, said: “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 US fiscal tightening. We expect these two themes to collide in the first quarter of 2012, which will lead to outperformance of the USD and US 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.”

Below are five specific 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 percent 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 that 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 percent 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 percent in a currency (MXN) that is the most undervalued relative to the US dollar.

• High-yielding international equities: International dividend-paying stocks are expected to offer exceptionally attractive, high-quality income streams. Examples include: Australian banks (7 percent) and Eurozone Telecoms (10 percent), 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 US equities in 20 years and European companies have as much cash on their balance sheet as US 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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