O’Neill in his forecast presentation in Bahrain on Wednesday said that investors should see the year 2012 as cautious and not as a catastrophe.
“Global economic growth, at 3.7%, will be led by emerging markets. US growth will improve slightly, rising to 1.9%, while China will benefit from a soft landing,” O’Neill, said.
The pressing need for mature economies to reduce debt, combined with weak business spending and soft asset prices, threatens to result in a global recession. However, a worldwide slump can be avoided, according to the Merrill Lynch Wealth Management Year Ahead 2012 analysis. China’s growth is expected to slow but experience a soft landing as the authorities move to reflate early in 2012.
“We see the Chinese economy expanding by 8.6% in 2012, compared to an expected 9.2% this year,” O’Neill, said. The main risks to China’s economy are higher inflation or slower investment. India and Russia should maintain their strong growth of 2011 (full year 2011 growth is expected to be 7.5% and 4%, respectively).
“The US Federal Reserve is likely to support the housing market to combat high unemployment and to keep rates flat until at least 2014,” he said. Consumers across the G5 (Canada, the Eurozone, Japan, the US and the UK) will benefit from an easing of inflation. The G5 economies should continue to grow in a meagre fashion, collectively by 1.1%, below the expected 1.4% in 2011.
A disorderly Eurozone sovereign default and/or withdrawal from the common currency head the major risks. Other potential negatives include continued policy paralysis in Europe, contagion to other regions from Eurozone deleveraging, possible currency wars, the risk of bank runs (a rapid withdrawal of deposits by investors) and over-zealous fiscal austerity. “Europe is a candidate for possible positive surprises too,” O’Neill, said.
“First, the European Central Bank (ECB) could move more quickly than expected to monetise sovereign and bank debt, however, there is a chance that such a response comes only after further damage has been done to growth prospects in the Eurozone. Second, an unexpectedly deep rate cut by the ECB to 0.5% may also improve the region’s outlook. The combination of weaker Eurozone economy and a more active central bank will likely lead to a weaker euro in 2012. A depreciated currency should provide a support for the region in the face of weak final domestic demand.”
A weak consumer and ripples from the Eurozone will likely force the Bank of England into further quantitative easing – but this might not prevent the U.K. entering recession in the first half of the year.
“While current economic challenges are very different from those experienced in previous cycles, 2011 exposed the responses of policymakers as inadequate. A lack of internal and external coordination has been one of this year’s major disappointments,” O’Neill, said. “Improving global coordinated responses to indebtedness could give a major boost to the Eurozone and world economy.”
Against the backdrop of fragile growth, investors are worried about the risks of even greater disappointment, according to Merrill Lynch Wealth Management’s Year Ahead 2012 analysis. “The task of ensuring diversification across investment portfolios is complicated by a shrinking set of ‘safe havens’,” O’Neill, said. “We are stressing yield, quality and growth in selecting equities.”
“In selecting equities in 2012, we are recommending a focus on large cap companies with strong cash flow and growing dividends,” O’Neill said. “We urge caution but do not foresee catastrophe next year and continue to stress the need for a strategic framework to deal with ‘new normal’ conditions of slow growth and higher risks. This includes anticipating periodic bouts of substantial losses, volatility bubbles and frequent switching between ‘risk on/risk off’.”
Merrill Lynch Wealth Management EMEA recommends overweighting US and UK to be most effectively positioned for this environment. US large caps are the top pick, reflecting their more reliable performance in meeting analysts’ earnings forecasts than peers elsewhere.
Consumer discretionary, consumer staples and information technology are the three preferred sectors. These areas offer the best combination of earnings quality, valuation and alignment with the macro environment. Merrill Lynch Wealth Management EMEA also favours broad growth themes, including the emerging market consumer and global infrastructure. “We await policy easing in China before increasing emerging market holdings,” O’Neill, said.