Mar 8, 2016 - Furthermore, February's strong jobs report ... global growth to recover modestly in 2016, to 3.2%, from 3.1% in. 2015 .... Information Technology.
CIO REPORTS
The Weekly Letter
Chief Investment Office • MARCH 8, 2016
Sunshine Through the Clouds: Challenges to the global economy have led to lower 2016 economic growth and financial forecasts. We acknowledge those challenges, but we believe they may present an opportune environment for investors, as attractive bargains tend to materialize in times of much pessimism. We are bullish on U.S. Investment Grade corporate bonds and constructive on U.S. stocks, Japanese stocks, and currency-hedged European stocks. Markets in Review: Last week equities rose, with the S&P 500 Index up 2.7%, while international equities, as represented by the MSCI EAFE Index, rallied 4.6%. Bonds fell on the week, with the 10-year Treasury yield at 1.87%, versus 1.76% in the prior week. Commodities overall, as measured by the Bloomberg Commodity Index, rose 3.9% last week, as WTI crude increased 9.6%, to $35.9 per barrel, while gold rose 3.0%, to $1,259.3 per ounce. Looking Ahead: In the U.S., initial jobless claims likely inched lower and import prices also likely fell. In the eurozone, fourth-quarter gross domestic product growth is expected to be unrevised at 0.3% quarter-over-quarter and 1.5% yearover-year.
Global growth estimates lower … The International Monetary Fund (IMF)1 is projecting global gross domestic product (GDP) growth of 3.4% (revised down from 3.6%) in 2016 and 3.6% in 2017, representing a more gradual pickup in global activity than estimated in its October report on a less rosy outlook for both Emerging Market (EM) and Developed Market (DM) economies. The IMF expects a modest and uneven recovery to continue in DM economies, with a gradual narrowing of the gap in growth rates between DM and EM economies (see Exhibit 1). BofA Merrill Lynch (BofAML) Global Research expects global growth to recover modestly in 2016, to 3.2%, from 3.1% in 2015, chiefly driven by EM economies. 1
Growth Gap (percentage points)
Developed Markets
8%
BofAML Global Research Forecast
6.5 4.5
4.6 3.7
4%
3.4
2.8
2%
2.2
2.5
2016E
5.8
Emerging Markets
2015E
6%
3.0
0%
2017E
2014
2013
2012
2010
2009
-4%
2011
-2%
2008
The global economy is facing a myriad of challenges that have contributed to reduced economic growth and financial forecasts for 2016. While we acknowledge those challenges, we believe they may present an opportune environment for investors, as attractive bargains tend to materialize in times of much pessimism. Furthermore, February’s strong jobs report supports our base case that the U.S. economy is unlikely to be heading into a recession any time soon.
Exhibit 1: The Gap in Growth Rates Has Been Narrowing
GDP Growth
Sunshine Through the Clouds
Source: IMF, BofAML Global Research and Chief Investment Office. Data as of March 8.
… along with U.S. growth, Fed hike expectations Investors have been dealing with meaningful market weakness since the start of the year and, therefore, might conclude the economy is equally weak. Furthermore, U.S. economic data broadly have come in weaker than expected, which has reinforced the notion of a weaker economy. This has led to lower revised economic forecasts among economists, including those of BofAML Global Research, who lowered their 2016 GDP forecast to 2.0%, from 2.3% at the beginning of the year.
World Economic Outlook Update, January 19. Merrill Lynch Wealth Management makes available products and services offered by Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S), a registered broker-dealer and member SIPC, and other subsidiaries of Bank of America Corporation (BofA Corp.). Investment products: Are Not FDIC Insured
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May Lose Value
potential bottoming of the BofAML Global Research proprietary GLOBALcycle3, which picked up in February as business conditions improved in both DM and EM economies (see Exhibit 2). This may spell investment opportunities for investors because, in the absence of a recession, we see a meaningful dislocation between market beliefs and the fundamental state of the economy from which asset mispricing could arise. Exhibit 2: GLOBALcycle Rises in February
A lower 10-year rate target
Corporate credit woes Both the Investment Grade (IG) and High Yield (HY) markets are pricing in an imminent recession. With IG spreads at approximately 200 basis points (bps) and HY spreads at approximately 750 bps, U.S. corporate credit spreads have been wider only about onequarter of the time in the last 20 years2. Credit mutual funds and Exchange Traded Funds have experienced some of the largest outflows in more than two decades. What is more, concerns around bond market liquidity brought about by regulation are keeping investors cautious. Risk of defaults in the Energy, Metals and Mining sectors, which account for a large proportion of HY credit, is elevated, and there is fear of contagion to other sectors.
Improving business conditions present opportunities
0 -1 -2 -3
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2003
2002
2001
-4 2000
Acknowledging recent market gyrations and near-term downside risks to current levels, the BofAML Global Research Equity Strategy team recently lowered its S&P 500 Index forecast to 2000, from 2200, for 2016. By the same token, the year-end S&P 500 earnings per share forecast has been lowered to $120, from $125, on lower commodity prices and slower global growth. Wrapping up the earnings season, results have been better for larger companies, with the S&P 500 seeing a higher proportion of top- and bottom-line beats, as well as better earnings and sales growth, than small-cap stocks, as measured by the S&P 600 Index, according to BofAML Global Research.
GEMcycle
1
1999
A lower S&P 500 outlook
GLOBALcycle 2
Z-scores
On December 16 last year, the Fed hiked interest rates for the first time since 2006. At the time, the 10-year U.S. Treasury yield was 2.30%. Since then, it has declined to 1.87% as of last Friday. In anticipation of fewer Fed hikes this year, the BofAML Global Research Rates Strategy team has lowered its 2016 forecast for the 10-year Treasury yield to 2.00%, from 2.65%.
2004
Our base case does include further decline in the unemployment rate, which currently stands at 5%, and a modest increase in wage and core inflation. However, given recent market volatility, which translates into tighter financial conditions, BofAML Global Research is now calling for only two Federal Reserve (Fed) interest rate hikes, rather than three, as predicted earlier this year. Hence, our house view is for the Fed to hike in June and December, but not in September.
Source: Organisation for Economic Co-operation and Development, BofA Merrill Lynch Global Research and Chief Investment Office. Data as of March 2.
Portfolio Strategy: We believe that 2016 will be characterized not by wildly veering highs and lows, but by episodic market volatility, an environment that could create opportunities for astute investors. We currently see attractive value in U.S. IG corporate bonds, where our strategists believe spreads could tighten about 60 bps, to 150bps, between now and year-end. We are bullish on IG chiefly for three reasons: big foreign inflows, attractive valuations, and an expectation of improving fundamentals. Within equities, we remain constructive on U.S. stocks, Japanese stocks, and currency-hedged European stocks, given our expectation of further central bank easing. Broadly, we continue to favor high-quality companies with stable earnings, cash flows and the potential for dividend growth. Our view that market volatility will increase across many asset classes from the lows we have experienced over the past few years, detailed in the February Monthly Letter, Asset Allocation in a Flatter World, calls for a broader approach to diversification. Where suitable, select hedge fund strategies can help mitigate traditional equity and fixed income risk found in balanced portfolios.
BofAML Global Research is seeing only a 25% probability of a recession. Supporting the view of no recession might be the 2 3
As measured by the option-adjusted spreads of the BofA Merrill Lynch U.S. Corporate Index and BofA Merrill Lynch U.S. High Yield Index. The GLOBALcycle is a real-time indicator of economic activity covering 80% of the world economy. It extracts a common factor from weekly, monthly and quarterly data. It is a GDPweighted average of Economic Conditions Indices for (i) the U.S., eurozone, Japan, the U.K., Canada and Australia, in DMs, and (ii) Brazil, Russia, India, China, Indonesia, Korea, Poland, Turkey, Mexico and South Africa, in EMs. It is based on the Aruoba-Diebold-Scotti Business Conditions Index, developed by the Federal Reserve Bank of Philadelphia.
CIO REPORTS • The Weekly Letter
2
Markets in Review Trailing Economic Releases
Equities
The
February ISM non-manufacturing index came in roughly in line with consensus expectations, inching down to 53.4, from 53.5 in January. The index continues to point to moderate expansion in the services sector.
February
non-farm payrolls rose 242,000, much more than expected, net of positive revisions of 30,000, setting the three-month moving average at 228,000. Household jobs also were exceptionally strong, increasing 530,000.
The
eurozone Services PMI came in at 53.3 for February, slightly higher than consensus expectations of 53.0.
DJIA NASDAQ S&P 500 S&P 400 Mid Cap Russell 2000 MSCI World MSCI EAFE MSCI Emerging Mkts
Level 17,006.8 4,717.0 2,000.0 1,399.2 1,081.9 1,608.0 1,628.8 791.0
Fixed Income Yield (%)
S&P 500 Sector Returns (as of last Friday’s market close) S&P 500 Sector Total Returns (week-to-date) Energy Financials Materials Information Technology Consumer Discretionary Industrials Telecom Utilities Consumer Staples Health Care -1%
4.5%
0.2% 0%
1%
5.8%
3.3% 2.9% 2.5% 2.5% 2.1% 2.0% 1.9% 2%
3%
4%
Total Return in USD (%) WTD MTD YTD 2.2 3.0 -1.8 2.8 3.5 -5.6 2.7 3.5 -1.7 4.4 4.9 0.3 4.3 4.7 -4.5 3.5 4.0 -3.0 4.6 4.6 -4.7 6.9 6.9 -0.2
ML US Broad Market ML 10-Year US Treasury ML US Muni Master ML US IG Corp Master ML US HY Corp Master
2.27 1.87 2.12 3.58 8.56
Total Return in USD (%) WTD MTD YTD -0.2 -0.4 1.8 -1.0 -1.2 3.4 -0.4 -0.4 0.8 0.2 -0.1 1.1 3.1 2.5 1.3
Commodities & Currencies
5%
6%
Bloomberg Commodity WTI Crude $/Barrel1 Gold Spot $/Ounce1
Level 158.0 35.9 1,259.3
Level EUR/USD USD/JPY
Current 1.1 113.7
Total Return in USD (%) WTD MTD YTD 3.9 3.2 -0.2 9.6 6.4 -3.0 3.0 1.7 18.6 Prior Prior 2015 Week End Month End Year End 0.6 1.2 1.3 -0.2 0.9 -5.4
Source: Bloomberg.1 Spot price returns. All data as of last Friday’s close. Past performance is no guarantee of future results.
Looking Ahead In the U.S., initial jobless claims likely inched lower and import prices also likely fell. In the eurozone, fourth-quarter gross domestic product (GDP) growth is expected to be unrevised at 0.3% quarter-over-quarter (QoQ) and 1.5% year-over-year (YoY). Upcoming Economic Releases On
Thursday, initial jobless claims likely inched lower, to 275,000, for the week ended March 5, from 278,000 in the prior week. This could result in the four-week moving average rising slightly, to 271,750, from 270,250, remaining consistent with a strong labor market.
On
Friday, import prices likely fell 0.5% month-over-month in February. Although petroleum product prices likely rose slightly, prices for non-petroleum goods likely tapered 0.7%, due to a stronger U.S. dollar.
On
Tuesday, eurozone fourth-quarter GDP growth is expected to be unrevised at 0.3% QoQ and 1.5% YoY.
BofA Merrill Lynch Global Research Key Year-End Forecasts S&P 500 Outlook Target
2016 E 2,000
EPS
$120.00
Real Gross Domestic Product
2016 E
Global
3.2%
U.S.
2.0%
Euro Area
1.5%
Emerging Markets
4.2%
U.S. Interest Rates
2016 E
Fed Funds
0.88%
10-Year T-Note
2.00%
Commodities
2016 E
WTI Crude Oil $/Barrel
$45.00
Gold $/Ounce
$1,250
All data as of last Friday’s close. CIO REPORTS • The Weekly Letter
3
CHIEF INVESTMENT OFFICE Christopher Hyzy
Chief Investment Officer Bank of America Global Wealth and Investment Management
Christopher J. Wolfe
Mary Ann Bartels
Karin Kimbrough
Niladri Mukherjee
Head of the Merrill Lynch Chief Investment Office
Head of Merrill Lynch Wealth Management Portfolio Strategy
Head of Macro and Economic Policy Merrill Lynch Wealth Management
Managing Director Chief Investment Office
Maxwell Gold
Emmanuel D. “Manos” Hatzakis
Jon Lieberkind
John Veit
Vice President
Director
Vice President
Vice President
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