As we head into the artificial investing horizon of year-end, sell-side research is compelled to offer its best-guess at what will be key for the year ahead. We certainly head into 2012 with considerable potential downside risks - US recession?, breakup of the Euro?, hard-landing in China? - and BofA Merrill Lynch's RIC Report bears these in mind as it suggests investors position for these ten key macro themes (some positive, some negative) from slower global growth to a weakening US consumer and QE in US and Europe. Starting from a neutral equities, long gold (target $1200), long US corporate bonds, they favor growth, quality, and yield in one of the more complete summaries of expectations we have read.
10 key macro themes for 2012
Heading into 2012 the RIC believes investors should position for the following 10 macro themes:
1. Slower global economic growth
Co-heads of Global Economics Ethan Harris and Alberto Ades forecast that global GDP growth will slow modestly to 3.5% in 2012. The US economy will expand by 1.9% in 2012 but will weaken in the second half. In Europe, our base case is for a mild recession, and we expect EM growth to slow to 5-6%.
How to play it: Neutral equities until lead indicators trough; overweight Growth versus Value and large versus small cap stocks; reduce Treasury allocations in the spring as our fixed income strategists expect a trough in Treasury yields by early 2Q12.
2. The US consumer will weaken again
Our economics group expects the recent momentum from US consumer spending to subside in coming quarters, in the absence of much stronger jobs creation or wage growth.
How to play it: Weaker US consumption growth means portfolios should be tilted toward defensives in the US in early 2012 (Chart 3). Within defensives, US Equity and Quantitative Strategist Savita Subramanian’s favored sector is Consumer Staples.
3. A soft landing in China
China is vulnerable to a US and European recession, but a healthy balance sheet, a huge current account surplus and massive foreign reserves mean China can ease aggressively if necessary. Economist Ting Lu expects China to avert a hard-landing, and forecasts GDP growth of 8-9% in 2012.
How to play it: As inflation risks fade in 2012, look for Chinese policies to turn increasingly pro-growth. Maintain exposure to commodities and begin to look for opportunities in other EM assets as more EMs join the easing cycle.
4. Quantitative easing in the US and Europe
Tighter fiscal policies in the US, Europe and Japan are likely to be offset by accommodative monetary policies around the world, aided by lower inflation. Importantly, our economists expect fresh rounds of quantitative easing by mid 2012 in both the US and Europe. This will prove to be an important inflection point for risk assets (Chart 4).
How to play it: Buy gold and gold stocks. Commodity Strategist Francisco Blanch has a 12-month gold price target of $2000/oz.
5. Negative returns for holders of US Treasuries
Treasury returns were one of the biggest surprises in 2011. Next year, US Rates Strategist Priya Misra expects 10-year Treasury yields will fall to 1.6% by early 2Q (before the Fed launches QE3), before rising to 2.4% by year-end. This would imply a total return of -0.7% for the year. While Treasuries are likely to remain a safe-haven asset, the downside and upside on yields will be limited.
How to play it: Underweight Treasuries and overweight corporate and Emerging Market bonds, which offer a more attractive risk-reward profile.
6. Yield and income will remain paramount
This will be another year of low rates and scarce yield, and investors will continue to seek assets that provide quality income. Credit Strategists Hans Mikkelson and Oleg Melentyev are bullish on corporate credit. They expect credit spreads to significantly tighten by the end of 2012 and forecast total returns of 4.8% and 13.9% from US IG and HY bonds, respectively.
How to play it: Within corporate bonds, favor the US over Europe, and overweight IG Financials. Within equities, favor high quality and high dividend yielding companies, US Staples and Tobacco stocks, REITs and MLPs.
7. Modest upside for equities
Equities should offer roughly 10% upside in 2012. Our year-end targets for equities are 330 for the MSCI ACWI and 1350 for the S&P 500. Deleveraging and slower earnings growth will limit upside, but quantitative easing, valuation and positioning will limit downside. We remain convinced that the true equity bull market is in stocks and sectors that provide high growth, high quality and high yields.
How to play it: 2012 portfolios should continue to be tilted toward Creditors over Debtors, Growth over Value, large over small, quality over junk, US over Europe and EM over Japan. Select US sectors (Consumer Staples, Tech) and themes that offer a combination of high quality and strong secular growth.
8. Large-caps should outperform small-caps
The RIC expects large-caps to continue to outperform small-caps in 2012, as earnings growth and valuations are better up the market cap spectrum. The heightened volatility and macro uncertainty offsets the clean balance sheets and potential for more M&A within small-caps.
How to play it: Avoid small-cap ETFs. Within small-caps, look for size and quality to outperform along with secular growth stocks. Small-cap Strategist Steven DeSanctis’ favored sectors are Energy, Health Care and Tech, and his least-favored are Financials and Materials.
9. EM rate cuts support EM assets and commodities
Our economists expect Emerging Markets to continue to be the engine of global growth in 2012. EM government debt-to-GDP ratios are well below those in DMs, leaving room for increased public spending. And as recent policy easing in Brazil, Russia, Turkey and Indonesia suggest, EM central banks will be pre-emptive in supporting growth.
How to play it: Aggressive EM easing is positive for EM bonds and equities, although the upside to EM currencies will be constrained. Asian easing should be positive for commodity prices.
10. Stock picking opportunities likely to emerge
A decline in correlation and volatility is very likely from the current unprecedented levels and should engender higher returns from active fund management in 2012. The growth of high frequency program trading and widening use of ETFs has simultaneously increased correlations and inefficient pricing of individual stocks. Correlations are likely to drop once a macro solution is forced upon Europe.
How to play it: This can be exploited with a buy-and-hold strategy for the best companies and aggressive stock pair trades, as well as favoring active fund management.
The good news is investor sentiment is more defensive today than 12 months ago, and central banks are once again demonstrating they will do everything they can to prevent systemic financial market turmoil. The BofAML base case is that policymakers will once again succeed in avoiding the abyss in 2012. As a result, the RIC believes 2012 offers many investment opportunities, as well as threats.