Sluggish start to 2013, but global economy to pick up steam

December 2012

After a dip in the first quarter, the global economy will stabilise and begin a gradual recovery in the second half of 2013, predicts BofA Merrill Lynch Global Research.

A cloud of uncertainty is likely to overhang the global markets in 1Q13 through a painful and protracted resolution of the US fiscal cliff. However, global economic growth is expected to improve in the second half of the year, ultimately pushing the S&P 500 Index to 1600, a new all-time high, according to BofA Merrill Lynch Global Research in its 2013 Year Ahead market outlook.

BofA Merrill Lynch analysts expect the resolution of fiscal policy issues, another year of accommodative central bank actions and improving corporate profits to skew the macro and market risks to the upside. They believe that the year ahead could be “lucky 13” for cautious investors, as the beginning stages of a “great rotation” in the markets from bonds to equities create opportunities for cyclical and undervalued asset classes poised for recovery.

BofA Merrill Lynch Global Research outlined 10 macro calls on which it is basing its 2013 outlook:

1. The global economy is expected to grow 3.2%, gradually improving through the year, led by China and the US. Resolution of the fiscal cliff in the US and successful negotiation of aid to Spain, combined with high liquidity and low commodity prices, should support a gradual improvement in global business and consumer spending through the year. By the end of 2013, growth is expected to rise to 2.5% in the US and 8% in China.
   
2. Monetary easing may not be enough to offset fiscal contraction in the first part of the year. Fiscal austerity in Europe and in the US – the latter by as much as 2% of GDP – is likely to be a drag on growth. Analysts expect the Federal Reserve to implement another round of quantitative easing following “Operation Twist”.
   
3. The US housing recovery builds momentum. US home prices are expected to rise another 3% in 2013, adding to the 5% gain in 2012.
   
4. With support to Spain from the European Central Bank (ECB), the European economy should stabilise as the year progresses. Despite a series of episodic flare-ups of the on-going crisis in Europe, the big tail risk of a Eurozone breakup has likely passed.
   
5. Against a backdrop of subdued growth in developed markets, GDP growth in emerging markets is expected to recover to 5.2%, led by the BRIC economies, particularly China. However, rising inflation could leave emerging market policymakers with little room to ease, particularly Turkey and central and eastern Europe.
   
6. Global equities should be the best-performing asset class. Powerful policy support, reasonable valuations and receding tail risks should help make global equities the best performing asset class in 2013. The US, European and Asian equity markets could see gains of 10% to 16% next year, with the MSCI AWI reaching 370 and the S&P 500 Index reaching a new all-time high of 1600 by year-end.
   
7. The US dollar and euro could rally on the global recovery and greater fiscal clarity, pushing the yen lower and emerging market currencies higher.
   
8. High yield and emerging market bonds should outperform corporate credit. On the heels of record-low yields in 2012, US investment-grade corporate bonds are likely to offer scant returns of 1.6% in the year ahead, but high yield bonds could return up to 7.0% and emerging market bonds could return 10.1%.
   
9. Government bond yields should rise modestly. G3 central banks are expected to maintain their zero-interest rate policies. Government bond yields in the US, UK and Germany are expected to rise modestly to 2.0%, 2.5% and 1.5%, respectively, translating into total returns for major government bond markets of roughly -3% to +2%.
   
10. Gold could rise to $2,000 per ounce. Large-scale policy easing by the US Federal Reserve and ECB positions gold as a useful hedge against global macro and inflation risks.
    

The corporate “rotation trade”

Accommodative monetary policy has driven debt costs far below equity costs for many companies. Next year, according to BofA Merrill Lynch Global Research report “Global Credit Strategy Year Ahead”, companies around the globe will remain incentivised to use cheap debt to please shareholders.

With low interest rates and high levels of corporate cash, M&A activity is also expected to increase. The emerging markets will benefit most, particularly Russia which will see a disproportionate amount of M&As. US companies look like they are further into the releveraging cycle than their European or Asian counterparts. For example, US M&A volumes are significantly up from the 2009 lows and the jump has been much more than for either Europe or Asia.

First published on www.treasurytoday.com