After policy, growth to take the lead in 2013 Presented by - - PowerPoint PPT Presentation

After policy, growth to take the lead in 2013

It takes two to tango

Presented by Johannes Jooste – Chief Market Strategist Merrill Lynch Wealth Management Europe, Middle East and Africa

2

Growth

• After a slump in 2012, demand and profits

growth should accelerate through 2013. The emerging economies lead a lacklustre developed bloc still dominated by public and private debt burdens.

• With fewer policy tools to accommodate

cyclical shocks, business cycles could prove shorter.

• Recovery in housing sector to prove

significant factor in stronger U.S. domestic demand.

• 2013 a better year for China’s economy

as the slow transition towards consumption continues.

• Tough first half for the eurozone as

recession persists but looking for gradual recovery through the second half of 2013. Macro call for 2013

3

Policy

• Key success of super-charged G6

monetary policy since the crisis is the avoidance of price deflation.

• Now it must deliver self-sustaining

growth in 2013 with the U.S. the crucial test case.

• Fed’s open ended quantitative easing

to persist until such time as unemployment is at least 6.5%.

• Fiscal austerity to continue across the

eurozone but the ECB is likely to undertake outright quantitative easing.

• In China, the new leadership will offer

selective stimulus balanced by deregulation and reform. Macro call for 2013

4

Politics

• Post financial crisis, an understanding
• f political trends remains crucial to

analysing economies. U.S. and China will see greater political ‘visibility’. Eurozone still overshadowed by a struggle over sovereignty.

• The U.S. ‘fiscal cliff’ remains the

biggest political story for early 2013 – base case is bipartisan agreement.

• Eurozone integration to be gradual –

after banking supervisions, budget coordination to be the focus.

• Political risk will become more

prevalent across emerging markets, focusing on legitimacy and a potential backlash against painful reform. Macro call for 2013

5

The reality of slow growth continues to disappoint hopes for sustained recovery G10* 2012 and 2013 GDP growth consensus forecasts Growth

%

Source: Bloomberg. Data as of 28 December 2012. *G10 = Group of eleven industrialised nations (Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, U.K. and U.S.)

0.0 0.3 0.5 0.8 1.0 1.3 1.5 1.8 2.0 2.3 2.5 2.8 3.0

Oct 10 Dec 10 Feb 11 Apr 11 Jun 11 Aug 11 Oct 11 Dec 11 Feb 12 Apr 12 Jun 12 Aug 12 Oct 12 Dec 12

2012 2013

6

The pre-crisis pattern of longer business cycles is unlikely to be maintained going forward Number of months from trough to peak in U.S. business cycles Growth

Sources: Bloomberg, National Bureau of Economic Research (NBER). Data as of June 2012 20 40 60 80 100 120 140

Dec 1854 Dec 1858 Jun 1861 Dec 1867 Dec 1870 Mar 1879 May 1885 Apr 1888 May 1891 Jun 1894 Jun 1897 Dec 1900 Aug 1904 Jun 1908 Jan 1912 Dec 1914 Mar 1919 Jul 1921 Jul 1924 Nov 1927 Mar 1933 Jun 1938 Oct 1945 Oct 1949 May 1954 Apr 1958 Feb 1961 Nov 1970 Mar 1975 Jul 1980 Nov 1982 Mar 1991 Nov 2001 Jun 2009

7

U.S. housing appears to have turned the corner, providing support to growth in 2013 U.S. housing activity indicators Growth

Thousands

Source: Bloomberg. Data as of December 2012

Index

10 20 30 40 50 60 70 80 300 500 700 900 1,100 1,300 1,500 1,700 1,900 2,100 2,300 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Housing Starts (Annualised, thousands, left hand side) Building Permits (Annualised, thousands, left hand side) NAHB Housing Index (Right hand side)

8

Failure to decouple as the eurozone recession

• verwhelms the core economies

Manufacturing purchasing managers’ indices (PMIs) for Italy, Germany and France Growth

Source: Bloomberg. Data as of December 2012

Index number

9

Increasing number of young Chinese to drive rebalancing from investment and exports toward consumption Little emperors; Population born pre-1980 and post-1980 (millions of people) Growth

100 200 300 400 500 600 700 800 900 1000 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019

Post-1980 Pre-1980

Source: Gavekal. Data as of October 2012

10

Increasing number of young Chinese to drive rebalancing from investment and exports toward consumption Annual growth in China’s fixed asset investment (cumulative) and net exports, three-month moving average Growth

• 2
• 1

1 2 3 4 5 6 7 1992-1999 2000-2008 2009-2011 2012

%

Source: BofA Merrill Lynch Global Research. Data as of October 2012

Consumption Investment Net Exports

• 1

1 2 3 4 5 6 1987 1992 1997 2002 2007 2012

Japan U.S. 12

The U.S. Fed delivers super low interest rates helping to avoid Japan-like deflation Japan and U.S. real interest rates (10-year government bond yield minus inflation/breakeven inflation) Policy

%

Source: Bloomberg. Data as of December 2012. Japan data from January 1987 to December 2012. U.S. data superimposed from November 2000 to November 2012, for illustrative purposes

2000 2012

13

Still huge difference in cost of borrowing facing business, north vs. south eurozone Offered bank lending rates on new business loans for selected eurozone nations Policy

%

Source: BofA Merrill Lynch Global Research. Data as of October 2012 3 4 5 6 7 8 9 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Italy Germany

Political events in Italy: 2013 general elections Political events in Germany: 2013 federal election

15

U.S. ‘fiscal cliff’ – some improvement but still much to be resolved The road to resolution of the U.S. ‘fiscal cliff’ Politics

• Eleventh hour bipartisan agreement to delay the “cliff”
• Maintain 2012 income tax levels for low and middle income

earners

• Increase in payroll tax but extension of unemployment benefits

Where We Are Now

• Automatic spending cuts of $110 billion delayed until March
• Debt ceiling technically breached so needs to be increased

What Still Needs Resolution

Sources: BofA Merrill Lynch Global Research Economics, Merrill Lynch Wealth Management EMEA Chief Investment Office

• Congress to convene in coming weeks to agree 2013 spending

cuts and increase in debt ceiling

• Likely to result in more negotiations, leading to another eleventh

hour deal

• Expect a deal to be agreed before March, leading to U.S. fiscal

drag of around 1.5% of GDP in 2013 – in line with our expectations Next Steps

16

Political risk growing in importance for emerging economies

• Political risk will become more prevalent and varied across emerging markets
• Political systems that attract legitimacy with leaders that are credible will

be favoured – Brazil, Mexico, Colombia and India

• Governments with weak leadership and stressed political structures will

struggle to reform; relying on stimulus measures – South Africa, Indonesia, Peru, GCC* and possibly Russia

• China falls somewhere in between; facing huge social/governance challenges to be

managed in a gradual fashion with stimulus used to address shocks and downturns

• Increasingly wide acceptance of private sector involvement in strategic sectors

such as transport, infrastructure and energy Politics

Sources: Eurasia, BofA Merrill Lynch Global Research, Merrill Lynch Global Wealth Management EMEA Chief Investment Office. *GCC refers to the Gulf Cooperation Council

2012 Forecast (%) 2013 Forecast (%) Global 3.1 3.2 G5* 1.1 0.9 United States 2.3 1.6 (consensus 2.0) Eurozone

• 0.4
• 0.4 (consensus -0.1)

Germany 0.9 0.5 France 0.1

• 0.2

Japan 1.7 1.5 Italy

• 2.1
• 1.3

United Kingdom

• 0.1

1.1 Sweden 1.3 1.6 Finland

• 0.2

0.2 Brazil 1.1 3.6 China 7.7 8.1 Russia 3.6 3.3 India 5.5 6.5 (consensus 5.6)

17

Global growth likely to be modest in 2013, eurozone still pressured but emerging markets to rebound Growth forecasts

Sources: BofA Merrill Lynch Global Research, Bloomberg. Data as of 18 January 2012. *G5 = Group of 5 industrialised nations, namely France, Germany, Japan, United Kingdom and United States

18

Strategy

19

2013 calls

20

Equities the most attractive against investment grade credit in over 25 years Equity risk premium relative to credit (horizontal lines indicate period averages) 2013 calls

• 6%
• 4%
• 2%

0% 2% 4% 6% 1985 1990 1995 2000 2005 2010

Earnings yield - Investment Grade Credit Yield

Source: Factset. Data as of end November 2012

21

0.80 0.85 0.90 0.95 1.00 1.05 2005 2006 2007 2008 2009 2010 2011 2012 2013

The case for ‘value’ investing may soon re-emerge after persistent ‘growth’ outperformance Relative price performance of MSCI All Country Growth and Value indices 2013 calls

Relative price performance

Source: Factset. Data as of end November 2012

Growth stocks

• utperforming

value stocks

22

In the U.S., investment grade no longer looking attractive but high yield still offers value Real yields (nominal yields adjusted for 10-year inflation expectations) for selected fixed income classes 2013 calls

5 10 15 20 25 30 1999 2001 2003 2005 2007 2009 2011 2013

%

Source: Bloomberg. Data as of end November 2012

Investment grade High yield

23

Emerging market sovereign debt to be rewarded for better fundamentals Economic data for selected nations 2013 calls

Country 2012 growth (%) 2012 inflation (%) Gross government debt/GDP (%) General government balance/GDP (%) Current 10-year local currency bond yield

Italy

• 2.0

3.3 126.3

• 0.6

4.15 U.K.

• 0.1

2.8 71.4

• 7.0

2.03 U.S. 2.3 2.1 107.2

• 6.1

1.87 Brazil 1.7 5.5 62.5

• 1.7

9.34 Turkey 3.2 9.1 36.7

• 2.3

6.55 Indonesia 6.1 4.4 23.2

• 2.4

5.17 Russia 3.6 5.2 11.8

• 0.4

6.72 Mexico 3.7 4.1 32.3

• 2.4

5.28

Sources: Bloomberg, Bank of America Merrill Lynch Economic Research teams, International Monetary Fund. Data as of 18 January 2013

24

U.S. dollar to be supported by stronger domestic U.S. economy relative to eurozone The U.S. dollar index against the spread of U.S. bonds

• ver Germany (two-year maturity)

2013 calls

72 73 74 75 76 77 78 79 80 81 82 83 84 85

• 1.5
• 1.3
• 1.0
• 0.8
• 0.5
• 0.3

0.0 0.3 0.5 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Apr 12 Jul 12 Oct 12 Jan 13

Yield Spread (2-year U.S. Treasuries minus 2-year German Bunds) U.S. dollar Index (right hand scale)

Source: Bloomberg. Data as of December 2012

% Index number

25

2013 calls

Strategy calls for the year ahead – 2013 Equities to outperform fixed income, including credit, on favourable policy and improving economic momentum – Europe and emerging market equities to lead a higher beta, value-driven regional performance – Value will likely start outperforming growth, small cap relative performance potentially to improve – The bull market in investment grade debt is maturing, potentially approaching an end in 2013 – U.S. dollar to move higher as selected ‘risk-on/risk-off’ correlations begin to break down

26

Portfolio 2015

Strategy calls for the year ahead – 2013

27

Diversifying income: Focus on dividend ‘growers’ rather than high dividend ‘yielders’ Portfolio 2015

Yet dividend ‘growers’ trade at a valuation discount to ‘yielders’ for the first time in 20 years S&P 500 Index dividend payout ratio

20% 40% 60% 80% 100% 120% 140% 1900 1920 1940 1960 1980 2000 Dividend Payout Ratio Average

• 40%
• 20%

0% 20% 40% 60% 80% 100% 120% 1990 1995 2000 2005 2010 Premium (Discount) of Dividend Growth to Dividend Yield Source: BofA Merrill Lynch Global Research U.S. Equity Strategy. Data as of December 2012 Dividend growth more expensive Dividend yield more expensive

28

New growth driver: Growing emerging middle class to drive the next consumer cycle Portfolio 2015

2009 2020 2030

North America & Europe 1002 54% 1036 32% 1002 21% Central & South America 181 10% 251 8% 313 6% Asia Pacific 525 28% 1740 54% 3228 66% Middle East and Africa 137 8% 222 7% 341 7% World 1845 100% 3249 100% 4884 100%

Numbers (millions) and Share (percent)

• f the Global Middle Class

Exposure to the emerging world has been a beneficial strategy*

50 100 150 200 250 2005 2007 2009 2011 Exposure Index Developed Market Equity Index Sources: OECD, Factset, HSBC, Merrill Lynch Wealth Management EMEA Chief Investment Office. Data as of December 2012. *Exposure Index is created by using each of the 10 high level sectors within developed country indices which have the highest sales generation from the emerging economies. For example. U.S. technology or U.K. materials

29

Unloved assets: The Great Reconvergence – The end of the euro project or the start of a new era? Selected eurozone members’ 10-year sovereign bond yield (%) Portfolio 2015

1 2 3 4 5 6 7 8

2006 2007 2008 2009 2010 2011 2012 2013

Germany Italy Spain %

Source: Bloomberg. Data as of January 2013

30

Secular Growth: A competitive U.S. labour force to drive a manufacturing renaissance Unit labour costs in manufacturing, local currency basis, between 2002 and 2010 Portfolio 2015

• 40%
• 30%
• 20%
• 10%

0% 10% 20% 30% 40% Source: U.S. Bureau of Labor Statistics (BLS). Data as of October 2011 Taiwan Japan Singapore USA Germany France

• S. Korea

UK Spain Australia Italy USA

31

Portfolio 2015

Strategy calls for the year ahead – 2013 Capturing strategic opportunities

• ver the next few years

– Diversifying income e.g. dividend growing equities – New drivers of global growth e.g. emerging middle class consumers – Unloved assets e.g. European investments with attractive risk premium – Secular growth e.g. U.S. manufacturing renaissance

32

Longer term themes

33

Compared to history, fixed income returns in this decade have been exceptionally strong Annualised returns of selected asset classes on a decade basis (2010 to 2012 year to date)

1980-1989 1990-1999 2000-2009 2010-2012 Equities: Equities: Gold: Gold: 11.8% 14.8% 11.5% 11.8% BBB bonds: High yield bonds: Oil: BBB bonds: 8.9% 7.4% 9.1% 11.0% U.S. 10 year Treasuries: BBB bonds: BBB bonds: U.S. 10 year Treasuries: 7.3% 6.9% 6.0% 7.6% Gold: U.S. 10 year Treasuries: U.S. 10 year Treasuries: Equities:

• 7.6%

4.9% 4.0% 7.4% Oil: Oil: High yield bonds: High yield bonds:

• 10.0%
• 1.2%

3.9% 7.4% Gold: Equities: Oil:

• 6.8%
• 3.4%

1.8%

Source: Deutsche Bank. Data as of September 2012

Longer term themes

34

The last time U.S. Treasury yields were this low, subsequent inflation adjusted returns were negative 10-year U.S. Treasury yields (nominal) and the subsequent 10-year real (inflation adjusted) total returns Longer term themes

• 10%
• 5%

0% 5% 10% 15% 20% 1900 1908 1916 1924 1932 1940 1948 1956 1964 1972 1980 1988 1996 2004 2012

10-year U.S. Treasury yields Subsequent 10-year realized 10-year returns (real)

Sources: Robert Shiller. Merrill Lynch Wealth Management EMEA Chief Investment Office. Data as of October 2012

35

Starting valuation is an important driver

• f long-term returns

S&P 500 Index normalised price/earnings ratio compared to 10-year forward price returns Longer term themes

• 10%
• 5%

0% 5% 10% 15% 20% 12 16 20 24 28 32 36

Forward 10 year annualised price return Normalised PE

Source: BofA Merrill Lynch U.S. Equity and U.S. Quant Strategy Research. Data as of 11 December 2012 S&P 500 P/E as of December 2012: 15.0

36

Inflation has been the reality over the last century – need to be alert to its potential return Selected occasions when global inflation has doubled and length of time taken Longer term themes

Sources: Deutsche Bank, GFD. Data as of September 2012

1981-1988 7 years 1976-1981 5 years 1811-1918 107 years 1587-1811 224 years 1248-1482 234 years

37

Longer term themes

Strategy calls for the year ahead – 2013 Positioning portfolios for the ‘great rotation’ during the next economic cycle – The end of the multi-decade bond bull market – The structural case for equities – The threat of inflation

38

Thank you

Any questions?

39

Important information

• Issued in the UK by Merrill Lynch International Bank Limited (“MLIB”) and Merrill Lynch Portfolio Managers Ltd ("MLPM").

− Merrill Lynch International Bank Limited (“MLIB”) is authorised by the Central Bank of Ireland and subject to limited regulation by the Financial Services Authority. Details on the extent of MLIB's regulation by the Financial Services Authority are available from us on request. MLIB is a member of the London Stock Exchange. Registered Office: Central Park, Leopardstown, Dublin 18,

• Ireland. Branch Office: Bank of America Merrill Lynch Financial Centre, 2 King Edward Street, London EC1A 1HQ.

− MLPM is authorised and regulated by the Financial Services Authority. Registered Office: Bank of America Merrill Lynch Financial Centre, 2 King Edward Street, London EC1A 1HQ.

• Investment services and products mentioned in this document may be provided by either MLIB or MLPM. Services described as advisory are provided by MLIB and those described as discretionary or

which are of an investment management nature are provided by MLPM.

• This document is provided for information only and is not intended as a solicitation for any particular investment. It does not have regard to the specific investment objectives, financial situation or

particular needs of any client and does not represent investment advice or a personal recommendation to any person. Exchange rate fluctuations may adversely affect the value of and income from

• investments. The value of investments and their income can go down as well as up and could rise or fall dramatically. Investors may not get back the full amount invested. If you have any doubt about

the suitability of investments, you should consult your Financial Advisor.

• Past performance should not be seen as an indication of future performance and no projection, representation or warranty is made regarding future performance.
• Information relating to taxation is based on information currently available. The levels and bases of, and relief from taxation can change and depend on your individual circumstances. The benefits of

structures discussed may cease to exist.

• This document is not intended to provide and should not be relied on for, accounting, legal or tax advice or investment recommendations. Merrill Lynch does not provide tax advice. We recommend you

consult your tax or legal advisor about your personal tax position.

• Opinions expressed are held by MLIB and MLPM at the date of this document and are subject to change and do not necessarily represent the views of other parts of the Merrill Lynch Group.
• Statements regarding MLPM investment policy refer to the official strategy of its investment committee. They are subject to change and do not necessarily reflect the strategy employed for all

accounts managed by MLPM, which is influenced by specific client guidelines and suitability requirements.

• Information included herein was obtained from sources we believe are reliable, but we have not verified and cannot ensure its accuracy.
• Merrill Lynch has or may have a position or a material interest in any investment referred to in this document, or related investments, and an associate is or may be the only market maker in certain
• investments. Merrill Lynch may have, or may have had within the previous 12 months, business relationships, including investment banking relationships, with, or provided significant advice to,

companies referred to in this document or related investments. Any research in this document has been procured and may have been acted on by MLPM or MLIB and/or any of our associates for its

• wn purpose. The results are being made available only incidentally.
• This document is only for your use and must not be given or shown to anyone else without our consent.
• Some products and services may not be available in all jurisdictions or to all clients.
• Certain Merrill Lynch entities, including Merrill Lynch, Pierce, Fenner & Smith, Inc. (“MLPF&S”), have no place of business in the UK and are not authorised or regulated by the UK Financial Services

Authority ("FSA"). UK rules for the protection of retail customers and the UK Financial Services Compensation Scheme do not apply to such business. As against such entities the regulatory regime governing an investor’s rights will be different to that of the UK. Investors may, however, be entitled to similar protection in the jurisdiction in which the relevant entity is organised or resident.