Merrill Lynch Wealth Management's CIO Bill O'Neill on the economic outlook for next year, the US fiscal cliff and why he predicts an end to the bull market in bonds
AT MERRILL'S YEAR Ahead conference, one can usually judge the state of the economy from the state of the CIO, Bill O’Neill.
He’s had a few sleepless nights since 2008, but this year the Irishman was looking sprightly. ‘Investors should position themselves for the great rotation out of fixed income and into equities,’ he began.
‘The economic and market outlook for the coming year is brighter than in 2012, as proven by the Fed’s progress in rekindling the U.S. economy, a gradual Eurozone recovery in prospect during the second half, and China’s GDP growth forecast to improve slightly from 7.7 percent to 8.1 percent.
‘This leads us to favour equities over bonds in 2013, and the notable valuation gap between the two asset classes, now at its most favourable level for stocks in over 25 years, adds to our conviction.’
Such optimism relies largely on the fiscal cliff turning into more of a hill. Here, O’Neill reasons the recent elections have brought fresh clarity.
Merrill Lynch Wealth Management's CIO Bill O'Neill
‘We view bipartisan agreement as a likely consequence of a second-term president and a weakened opposition. Both sides are now incentivised to compromise and an 11th hour compromise will likely be followed by cuts of $250bn to $320bn.
‘The U.S. offers the potential for a positive macroeconomic surprise, but fiscal retrenchment is likely to weigh on GDP growth during the first half of 2013. BofA Merrill Lynch Global Research expects a modest 1.4 percent increase in GDP, but growth is likely to pick up later in the year.’
If so, the view is liable to lead to an asset class evolution. Bonds will burn and equities will rise from their ashes.
‘The combination of over-investment, excessive optimism and low levels of income generation all point to the end of the bull market in bonds,’ the University College Dublin graduate said.
‘Meanwhile, the structural case for higher returns in equities is strong: healthier and more robust companies are emerging from this drawn-out crisis who have leaner balance sheets and a growing global demand base.
‘Merrill will focus on four main ideas driving portfolio performance over the next three years. First, new sources of income form a pressing need with money market interest rates so low.
‘Second, consumer power is blossoming in emerging economies. Third, some unloved assets, such as European equities, have been oversold during the financial crisis and could return to favour as solutions to the European crisis emerge.
‘Finally, improvements in technology, energy and labour costs will support multi-year growth themes. For example, a more competitive labour force is ready to drive a U.S. manufacturing revival much further.’
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