Merrill Lynch Wealth Management predicts a great rotation out of bonds and into equities in 2013 and beyond – a suggestion that the cult of the equity could return.
Merrill Lynch Wealth Management chief investment officer (CIO) for EMEA Bill O’Neill said a full cyclical rotation away from fixed-income and into equities is on its way.
O’Neill said he would favour higher-income equities to the overweighed bond positions as part of the private bank’s three year strategy, "Portfolio 2015".
"It’s a good year for equities. It will go green," he added.
O’Neill pointed out that equities have been trading at their most attractive level relative to high-grade credit in over two decades, with equity risk premium relative to credit valuation gap at over 4%, the highest in over 25 years, compared to less than 1% in 2010 alone.
"The structural case for higher returns to equities is strong," he said, "[and] 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."
BofA Merrill Lynch Global Research chief investment strategist Michael Hartnett also agreed, adding investors had already started positioning their portfolios for the next "great rotation".
Asia-Pacific driver of middle-class trends
O’Neill advised investors to keep in mind emerging economies, where consumer’s power is blossoming, citing Asia-Pacific as a key investment location in the next two to three years.
According to Merrill Lynch Wealth Management data, Asia-Pacific already offers a considerable growth in the emerging middle-class, with 28% of the global middle-class located in the region.
An estimated 54% and 66% of the global middle-class will be located in Asia-Pacific in 2020 and 2050 respectively.
China as allocation centre in 2012
China’s is forecast to have a "better year" for its economy in 2013. The country’s increasing number of young people driving a rebalance from investment and exports towards a consumer class economy, and a newly elected leadership under Xi Jinping, are behind China’s forecasted GDP growth of 8.1% in 2013 from 7.7% estimated in 2012.
India is also expected to do far better, according to O’Neill, with its GDP to grow by 6.9% in 2013 from 5.6% in 2012, after a "problematic year for investors" in 2012.
"Global trade is picking up," stated O’Neill, who said that although Brazil still had positive view for its GDP growth in H1 in 2013, it would not exceed 5% in 2013 but keep set at 4.6%, from 1.7% in 2012.
US bipartisan solution to "fiscal cliff" issue
BofA Merrill Lynch Global Research co-head of global economics research Ethan Harris said an eleventh hour compromise on the US fiscal cliff will likely be followed by cuts of $250bn to $320bn.
The fiscal cliff refers to a series of President Bush-era tax breaks that are due to expire at the end of 2012 and whose combined impact, mainly the introduction of tax increases and spending cuts, could push the US economy back into recession.
The cuts will represent an estimated 1.6% to 2% of the US GDP, BofA research predicted.
O’Neill who agreed a last minute bipartisan agreement would be the best result, says a political compromise that contains a sustainable combination of entitlement and Bush tax cuts reform would keep cuts at a lower $200bn, or 1.3% of expected US GDP.
"We view bipartisan agreement as a likely consequence of a second-term president and a weakened opposition," says O’Neill.
Negative interest rates: economic "painkillers"
Although the reality of slow growth continues to disappoint hopes for a full sustained recovery, O’Neill predicted a slump in the US economy in 2013, with GDP growth of around 1.5% in 2013, from 2.1% in 2012.
Merrilll Lynch Wealth Management predicted the US economy would pick up later in 2013. Increased evidence of the US Federal Reserve’s progress in rekindling the US economy (maintaining ample liquidity and delivering negative interest rates of -1% in 2012 for example), and 2013’s dip in GDP growth where referred to as a "disguise" by O’Neill, who forecasts better performance in the last two quarters of 2013.
"Low interest rates… this painkiller, or inoculation, is a key to the post-financial crisis," said O’Neill as long as the fiscal cliff issue is tackled by the authorities.