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

It takes two to tango After policy, growth to take the lead in 2013 Presented by Johannes Jooste – Chief Market Strategist Merrill Lynch Wealth Management Europe, Middle East and Africa

Macro call for 2013 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. 2

Macro call for 2013 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. 3

Macro call for 2013 Politics  Post financial crisis, an understanding of 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. 4

Growth The reality of slow growth continues to disappoint hopes for sustained recovery G10* 2012 and 2013 GDP growth consensus forecasts % 3.0 2.8 2.5 2.3 2.0 1.8 1.5 1.3 1.0 0.8 0.5 0.3 0.0 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 5 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.)

Growth 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 140 120 100 80 60 40 20 0 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 6 Sources: Bloomberg, National Bureau of Economic Research (NBER). Data as of June 2012

Growth U.S. housing appears to have turned the corner, providing support to growth in 2013 U.S. housing activity indicators Thousands Index 2,300 80 2,100 70 1,900 60 1,700 50 1,500 1,300 40 1,100 30 900 20 700 10 500 300 0 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) 7 Source: Bloomberg. Data as of December 2012

Growth Failure to decouple as the eurozone recession overwhelms the core economies Manufacturing purchasing managers’ indices (PMIs) for Italy, Germany and France Index number 8 Source: Bloomberg. Data as of December 2012

Growth 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) 1000 900 800 700 600 500 400 300 200 100 0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019 Post-1980 Pre-1980 9 Source: Gavekal. Data as of October 2012

Growth 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 Consumption Investment Net Exports % 7 6 5 4 3 2 1 0 -1 -2 1992-1999 2000-2008 2009-2011 2012 10 Source: BofA Merrill Lynch Global Research. Data as of October 2012

Policy 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) % 6 5 4 2000 3 2 1 0 2012 -1 1987 1992 1997 2002 2007 2012 Japan U.S. 12 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

Policy 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 % 9 8 Political events in Italy: Political events in Germany: 2013 general elections 2013 federal election 7 6 5 4 3 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Italy Germany 13 Source: BofA Merrill Lynch Global Research. Data as of October 2012

Politics U.S. ‘fiscal cliff’ – some improvement but still much to be resolved The road to resolution of the U.S. ‘fiscal cliff’  Eleventh hour bipartisan agreement to delay the “cliff” Where We  Maintain 2012 income tax levels for low and middle income Are Now earners  Increase in payroll tax but extension of unemployment benefits  Automatic spending cuts of $110 billion delayed until March What Still Needs  Debt ceiling technically breached so needs to be increased Resolution  Congress to convene in coming weeks to agree 2013 spending cuts and increase in debt ceiling Next Steps  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 Sources: BofA Merrill Lynch Global Research Economics, Merrill Lynch Wealth Management EMEA Chief Investment Office 15

Politics 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 Sources: Eurasia, BofA Merrill Lynch Global Research, Merrill Lynch Global Wealth Management EMEA Chief Investment Office. *GCC refers to the Gulf Cooperation Council 16

Growth forecasts Global growth likely to be modest in 2013, eurozone still pressured but emerging markets to rebound 2012 Forecast (%) 2013 Forecast (%) Global 3.1 3.2 G5* 1.1 0.9 United States 2.3 1.6 (consensus 2.0) -0.4 -0.4 (consensus -0.1) Eurozone 0.9 0.5 Germany 0.1 -0.2 France 1.7 1.5 Japan -2.1 -1.3 Italy -0.1 1.1 United Kingdom 1.3 1.6 Sweden -0.2 0.2 Finland 1.1 3.6 Brazil 7.7 8.1 China 3.6 3.3 Russia 5.5 6.5 (consensus 5.6) India Sources: BofA Merrill Lynch Global Research, Bloomberg. Data as of 18 January 2012. *G5 = Group of 5 industrialised nations, namely 17 France, Germany, Japan, United Kingdom and United States

Strategy 18

2013 calls 19

2013 calls Equities the most attractive against investment grade credit in over 25 years Equity risk premium relative to credit (horizontal lines indicate period averages) 6% 4% 2% 0% -2% -4% -6% 1985 1990 1995 2000 2005 2010 Earnings yield - Investment Grade Credit Yield 20 Source: Factset. Data as of end November 2012

2013 calls The case for ‘value’ investing may soon re-emerge after persistent ‘growth’ outperformance Relative price performance of MSCI All Country Growth and Value indices Relative price performance 1.05 1.00 0.95 0.90 Growth stocks outperforming value stocks 0.85 0.80 2005 2006 2007 2008 2009 2010 2011 2012 2013 21 Source: Factset. Data as of end November 2012

2013 calls 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 Investment grade High yield % 30 25 20 15 10 5 0 1999 2001 2003 2005 2007 2009 2011 2013 22 Source: Bloomberg. Data as of end November 2012