End of the Great Bull Market in Bonds, and Other Key Predictions
From rising inflation and a pick-up in global growth to the end of historically low interest rates, Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research, gives his take on the most significant events and trends shaping the global investment landscape.
What we saw in 2016:
- Global interest rates fell to 5,000-year lows; central bank purchases of financial assets topped $25 trillion (and the stock of negatively-yielding global bonds surged to $13.3 trillion).
- Surprise outcomes of the Brexit vote in Great Britain and elections in the U.S. are causing policy leadership to shift from monetary to fiscal stimulus.
- A corporate earnings recession in the first half was followed by acceleration in wage inflation in the second half (to 7-year highs in the U.S.).
- The greatest bull market in bonds ever likely ended on July 11, 2016 with a 30-year Treasury bond yield reaching intra-day lows of 2.088%.
What we’re watching for in 2017:
- We believe that for the first time since 2006, there will be no big easing of monetary policy in the G7 group of developed countries, and that interest rates and inflation will surprise to the upside.
- We forecast an acceleration in growth. In the U.S., nominal growth could rise to 3 to 4%, with a real GDP gain of 2 percent. In the rest of the world, nominal growth could be near 7%, with a real economic gain of 3.8% and inflation of 3.0%.
- We believe fiscal stimulus accelerates, trade and immigration policies tighten, and wage growth picks up, boosting domestic demand across the G7, and strengthening our “buy Main Street, sell Wall Street” theme.
- Finally, disruptive technology and aging demographics remain powerful secular forces. They won’t likely prevent a cyclical pick-up in inflation, but they are likely to constrain the magnitude of the rise in both inflation and interest rates.
Note: This article is adapted from the Bank of America Merrill Lynch research paper: The Year Ahead: Peak Returns, Big Rotations (Nov. 20, 2016).
3 Key Themes for the U.S. Economy
Much of the outlook for growth and inflation hinges on the policies of the new leadership in Washington, according to Michelle Meyer, head of U.S. Economics at BofA Merrill Lynch Global Research. Here are the major economic themes and risks she’s watching for.
The story of 2017 will be the change in leadership in Washington, DC. We expect a slow start to the year for the economy, but acceleration in the second half as tax cuts kick in. The long awaited uptrend in inflation has already arrived, and core inflation will likely come just shy of the 2.0% target by year-end. Heightened uncertainty at the beginning of the year combined with tighter financial conditions should result in only one rate hike by the Federal Reserve (Fed) in the second half of 2017.
With this backdrop, we see three key economic themes emerging in the coming year:
1. Transition from monetary easing to fiscal stimulus
The Fed is likely to remain cautious at the start of the year. However, if and when fiscal stimulus is passed and it starts to filter into the real economy, the Fed's rhetoric will become more hawkish, setting up for a faster hiking cycle in 2018.
2. A move from disinflation to inflation
We expect core inflation to continue to creep higher, nearly touching the 2% target. The potential policy changes are generally inflationary, including fiscal stimulus, restricted immigration (lower labor force participation rates), and restricted trade (higher import prices). The offset is a stronger dollar.
3. A shift from uncertainty to… uncertainty
We continue to believe that the only certainty is uncertainty. The big risk factors include significant shifts in government policy both here and globally, as well as potential market volatility.
Looking farther out, the main source of risk for the next few years comes from policy changes in Washington. Despite the move to single-party government, there is a great deal of uncertainty about the actual policies to be implemented. The campaign included a wide range of proposals, including tax reform, increased infrastructure and defense spending, anti-free trade policies, a promise to repeal and replace the Affordable Care Act, restrictions to immigration and changes to the Federal Reserve. We’ll be watching developments closely in the months—and years—to come.
Note: This article is adapted from the Bank of America Merrill Lynch research paper: Global Economic 2017 Year Ahead: Regime Shift (Nov. 20, 2016).
A Shift in Sector Preferences for 2017
The policy priorities of the Trump administration could have important implications for U.S. equities—creating new sector opportunities, in particular. Here, Savita Subramanian, head of U.S. Equity Strategy at BofA Merrill Lynch Global Research, outlines the changes in her outlook.
Our S&P 500 2017 year-end target of 2300 assumes a year of decent returns against a backdrop of improving growth. But 2017 could be anything but normal. And with the recent break in the market — roughly marked by the U.S. election — our sector preferences have shifted. We’ve moved from a “lower for longer” view on growth and inflation to one of rising rates and a pickup in growth and inflation. The Trump presidency and Republican sweep of the House and Senate are expected to usher in fiscal stimulus and tax reform, as well as a roll-back of regulation, all of which would be positive drivers of near-term economic and profits growth.
But that positive outlook on growth requires that policy-makers deliver the growth without the negatives resulting from protectionist policies. In keeping with our bifurcated view on the market, and given that sentiment and valuations have so firmly swung to the reflation/growth camp, we believe that a more prudent approach to sector investing is a barbell approach, where we hedge out some of the tail risks.
- Within defensives, we remain overweight Health Care (which is still cheap), but lower Consumer Staples to underweight (from market weight), given risks from rising interest rates and a stronger dollar.
- Within bond proxy sectors, we remain overweight Telecom (which remains cheap, and a good hedge against consensus on rising rates being wrong) but we lower our view on Utilities—which has a lower dividend yield but higher valuations and payout ratios—to underweight (from market weight). We move Real Estate to market weight (from overweight).
- Within cyclicals, we move Financials and Consumer Discretionary to overweight (from underweight) as beneficiaries of fiscal stimulus. Financials additionally benefits from potential for higher rates and less regulatory overhang. We lower Energy to market weight (from overweight) given risks around supply and a stronger US Dollar, and keep Industrials at market weight. We also lower Tech to market weight (from overweight) given risks around trade and tax policy. Materials remains underweight given poor fundamentals and lofty valuations.
In sum, our outlook for all 11 sectors is as follows:
- Overweight: Health Care, Telecom, Financials, Consumer Discretionary
- Market weight: Real Estate, Tech, Industrials, Energy
- Underweight: Consumer Staples, Utilities, Materials
Note: This article is adapted from the Bank of America Merrill Lynch research paper: 2017 – The Year Ahead: Euphoria or Fiscal Fizzle? (Nov. 22, 2016).
Investment Insights: Where Italy Goes from Here
The “No” vote in Italy’s recent referendum to reform the country’s constitution appears to have had limited impact on the markets. But, as our CIO team explains in this special report, the next real test of Europe’s populist movement will come in a series of elections in 2017.
Investment Insights: What Are Investors Watching for Next?
With the 2016 U.S. elections now over, could the administration of Donald J. Trump lead to some potentially major market shifts? In this special report, "The Hills Have Eyes," our CIO team outlines what they see as key shapers of the economic and investment landscape in the coming months—and point to steps investors can consider now to capture emerging opportunities.
Post Election - We Maintain our Balanced View
The global capital markets are repositioning themselves in the immediate aftermath of the election. In our Investment Insights piece, the CIO team shares its market expectations over the short and medium terms. The report also looks back at the performance of the U.S. equity markets following recent U.S. presidential elections and highlights the implications of the Republican policy agenda on several sectors.
Don't Let Taxes Be Such a drag
Are you looking for some year-round tax tips? In this "Weekly Letter," our CIO team explores four strategies that could help make investment portfolios more tax-efficient—something they believe will be even more important in an environment of lower investment returns and higher tax rates.
Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
A Bridge to the Other Side
In its October "Monthly Letter," our CIO team reviews 2016's market performance so far and looks ahead to what investors might expect through year end. You'll also find answers to 12 frequently asked questions on topics keeping investors up at night—from election uncertainty to a possible rate hike—plus a chart on key sector implications of the election.
Storm After the Calm? Why Volatility Has Returned to Equity Markets
A combination of factors—including rising political uncertainty in the U.S. and Europe—are interrupting the recent advance in equity prices. Our CIO team takes a close look at what's driving this latest bout of market volatility
Oil—The Swing Factor
After a rocky start to the year for oil, prices have been rallying. In this Weekly Letter, our CIO team reviews the supply and demand dynamics of the oil market and explains why now could be a good time for investors to consider their exposure to the energy sector.
The U.S. election: Can two negatives make a positive?
This year's race for the White House is notable both for the unpopularity of the candidates and the divisiveness of the campaign—and greater unity following the elections is far from certain. In this Weekly Letter, our CIO team explores four critical policy issues the next administration and Congress will need to confront, and offers specific steps investors can take now to prepare for what will likely be a volatile few months ahead for financial markets.
Mid Year Review
In this Weekly Letter, our CIO team explores the major events that moved the markets in the first half of 2016—culminating in U.K's surprise Brexit vote on June 23. They also explain why today's market can be thought of as neither a bear nor a typical bull, but rather a buffalo, and how its movements are shaping the outlook for investment opportunities. They then close with guidance on interest rates, equities versus bonds and the importance of rebalancing portfolios in today's uncertain market.
For What It's Worth: Something's Happening Here…
In this midyear 2016 edition of The Monthly Letter, our CIO team explores the risks and opportunities investors need to consider in the second half of the year, and shares their outlook for equities, fixed income and other asset classes. They also survey the broader macroeconomic landscape and explain why the U.S. will be the engine that keeps the global economy growing.
Investment Insights: The Brexit Vote and Its Implications
In this special Q&A, our CIO team answers the most important questions on investors' minds and explores the implications of the UK's exit from the European Union for the markets, economic growth and the future of European unity.
CIO Weekly Letter: Infrastructure Impulse
After years of underinvestment, spending on America's aging infrastructure is getting a major boost, thanks to Congress' passage of a fiscal stimulus bill back in December. And while a lot more funds will be needed over the coming years, private industry and investors could play a significant role in making up the shortfall, as our CIO team explains in this weekly letter.
CIO Monthly Letter: Investing in a Range-Bound Market
With U.S. equities facing a number of headwinds from now through the end of the year, a natural question many are asking is, where to invest from here? Our CIO team believes there are opportunities in today's market, especially for investors who are selective and explore industries and sectors that offer the best potential for growth. They also explain why the three key criteria of value, yield and growth can provide a solid framework for investors in today's range-bound market.
CIO Monthly Letter: Where's the Beef? Finding Value in Fixed Income
Changing market conditions make this an opportune time for investors to review their bond holdings, particularly in the area of high yield. In this monthly letter, our CIO team discusses where they see the best value in fixed income today. There's also an interview with Dennis Stattman, head of the Global Allocation team within BlackRock's Multi-Asset Strategies Group, on his outlook for the markets, interest rates and the challenges of planning for retirement.
Investment Insights: Monetary Policy Is Not Enough
Our CIO team explains how a renewed focus on fiscal policy—at the Federal, state and local levels—could be the key to stimulating U.S. economic growth going forward.
Forget Jack, Focus on Charlie-in-the-Box
Shifts in the global economy are often discounted if they don't fit with the prevailing idea of "normal." Our CIO team looks at several of the unexpected—and underestimated—ways that markets are changing, and the investment opportunities this creates.
CIO Monthly Letter: Asset Allocation in a Flatter World
There's no doubt the recent market volatility has been unsettling for investors. In this monthly letter, our CIO team offers specific steps investors can take in an environment of higher volatility and lower returns, and lists strategies that may help investors stay on track toward their long-term goals. There's also an interview with Howard Marks, Co-chairman and Founder of Oaktree Capital Management, on his outlook for equities, fixed income and the U.S. economy.
Investment Insights: A Market Under Stress — We Believe This, Too, Shall Pass
What's behind the correction in the markets? Our CIO team looks at the current investing environment, explains why a U.S. recession is unlikely and offers some portfolio strategies to consider.
CIO Weekly Letter: Watching the Four C's
Our CIO team takes a close look at what they call the "Four Cs": China, commodities, credit and consumers. These are the key risks which have been continuing to pressure stocks since the beginning of the year. But positive surprises in one or more of them could also set the stage for the return of market stability and investor confidence.
Dealing With the Market's Latest Roller Coaster Ride
It's hard not to ask: "Should I sell or stay put?" every time the Dow takes a nosedive. According to Michael Liersch, Merrill Lynch's head of behavioral finance, your decisions should always be made in a thoughtful way, with your long-term goals in mind. In this interview, he offers some advice to help you deal with the ups and downs as the markets continue to respond to global change through year-end.
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