2016 Market Outlook: BofA Merrill Lynch Global Research Forecasts the Return of Value Investing on Rising Rates, Risks and Earnings
Glass Half-Full: Bullish on Stocks, Not Sectors;
Modest Global Growth: U.S. Grows, China Slows and Brazil Contracts;
Volatility as Monetary Policies Diverge, Rates and Regulations Collide
BofA Merrill Lynch Global Research today released its outlook for the
markets in 2016, forecasting a year of modest global and U.S. economic
growth, the start of a slow, emerging markets recovery and single-digit
stock returns led by high-quality cyclicals. However, with the world’s
two largest economies – U.S. and China – set to diverge on monetary
policy and a contrarian expectation of further weakness in China, next
year’s market outlook is fraught with credit, rates and currency risks.
BofA Merrill Lynch presented their 2016
Year Ahead Outlook today at events held in New York and London, with
similar events this week in Tokyo, Hong Kong, Sydney, Singapore, Sao
Paulo, and Mexico City. Analysts from the top-ranked global research
firm summarized their views on the U.S. and global economies with
tempered optimism. When the Federal Reserve begins raising the Federal
funds rate, monetary policy is expected to take center stage as the key
theme for 2016. However, low inflation, improving fundamentals and
supportive policy should bode well for global economic expansion,
consumers and opportunistic investors.
Cautiously bullish, the firm’s house view is for stronger growth and
higher rates; however, virtually every sector is facing macro risks and
innovation disruptors. Value investing is expected to outperform growth
beginning in 2016, and Main Street is expected to outperform Wall Street
as the tailwind of low rates, oil prices and rising employment continues
to benefit consumers.
“We’re seeing an aging bull market with a lot of upside potential in it,
but also the beginning of slow, steady growth in the capital markets and
innovation-led shifts in business cycle,” said Candace Browning, head of
BofA Merrill Lynch Global Research. “The greatest opportunities for
investors may be found among carefully selected, healthy dividend-paying
stocks and thematic investments in innovators reshaping market dynamics
over the next decade.”
Against this backdrop, the BofA Merrill Lynch Global Research team made
the following 10 macro calls for the year ahead.
1. S&P 500: The ultimate “anti-credit play.” The
Standard and Poor’s 500 Index is expected to reach 2,200 by the end of
next year, beginning a slow trajectory toward 3,500 in 10 years. Gains
in the year ahead imply a 5 percent return for the S&P, roughly
equivalent to earnings growth or a 2016 EPS forecast of $125. With
credit-sensitive investments the biggest risk in 2016, the S&P 500 could
be viewed as the ultimate anti-credit play: large, liquid stocks with
healthy balance sheets and above average cash balances.
2. Modest U.S. and global economic growth. Global GDP is
forecast to grow by 3.4 percent, up from 3.1 percent in 2015, which is
slightly below trend. Growth of about 0.5 percent faster than trend is
forecast for Europe, the U.S. and Japan. In the U.S., GDP growth is
expected to remain steady at 2.5 percent next year as a solid labor
market offsets weak productivity growth.
3. Gentle rise in inflation. Globally, headline inflation
is expected to inch up to 2.8 percent as the effects of commodities
price drops begin to fade. Underlying inflation should remain stable,
with key differences between developed and emerging markets. By
year-end, U.S. unemployment should reach 4.5 percent, causing a gentle
rise in inflation next year, including wage and price inflation at 0.5
percent and 0.2 percent respectively. Emerging market inflation could
decelerate to 3.8 percent, down from 4.3 percent in 2015. The strongest
El Niño weather pattern in 18 years represents a potential upside risk
to inflation, particularly in Asia and Latin America.
4. Start of emerging markets recovery. For the first time
since 2010, average annual growth in emerging markets should begin
rising to 4.3 percent in 2016 from 4.0 percent in 2015. Excluding China,
growth should pick up to 3.1 percent in 2016 from 2.6 percent in 2015.
About three-quarters of emerging market economies could show signs of
recovery by the middle of 2016, whereas Brazil could contract further to
-3.5 percent as it struggles to climb out of recession. Investment
likely will become the key driver of the emerging market recovery. Asset
price returns of roughly 2.7 percent for external sovereign debt, 2.5 to
3.5 percent for emerging market corporate debt, and 1.0 percent for
local currency debt are expected in 2016.
5. Interest rates: up from zero. The Federal Reserve is expected
to carefully calibrate a rate hike over the next two years, with a 0.25
percent hike this month and three or four 0.25 percent increases in each
of the next two years. Meanwhile, further quantitative easing is
expected in Europe and Japan and a mixed bag of policies in the rest of
the world. U.S. 10-year Treasuries could reach 2.65 percent, and the
dollar should remain strong, rising by 4 percent to 6 percent. The
confluence of modestly higher rates, a Fed liftoff, and more regulatory
pressures will likely keep liquidity risks in bond markets at the
6. Divergent monetary policies: U.S. and China go separate
ways. With the Federal Reserve set to raise rates and the People’s Bank
of China likely cutting rates, divergent monetary policies will shape
the rates and currency markets in 2016. More weakness in the renminbi
(RMB) is expected, with the currency depreciating over 7 percent against
the U.S. dollar in 2016. This could have negative effect spillovers on
emerging Asian currencies and commodity markets.
7. Commodities under pressure. A strong U.S. dollar and
restrained global growth could create downward near-term pressures on
commodity prices – not just in metals, but also in energy and grains.
Overall, commodity returns could be flat to down by as much as 3.7
percent next year. Oil balances are set to improve in the second half of
the year, with the combination of global demand and lower non-OPEC
output potentially pushing crude oil back up to $55 a barrel. Meanwhile,
natural gas demand should remain robust, with the spread between gas and
crude oil widening. Base metals will likely stay soft, with gold
continuing to struggle as the dollar strengthens and rates rise.
8. Credit is complicated. Fundamental trends in the global
credit markets are divergent, and there appears to be no single global
credit cycle. Optimism is highest for U.S. high grade, with 3 to 4
percent of excess returns expected next year. The bear market for U.S.
high yield continues, with expected total return losses of 2 to 3
percent. Persistent yield differentials between U.S. and global
corporate bonds are expected to force global investors into the U.S.
market, and with potential returns as high as 6 to 7 percent, 30-year
corporate bonds could deliver equity-like returns in 2016. It could be a
tough year for credit in emerging markets, with stark divergence in
returns from nation to nation. Still, the overall forecast for emerging
market credit is positive, with a 4.0 percent total return for high
yield and 2.5 percent for investment grade.
9. Global investment strategy. Global stocks are expected
to rise by 4 percent to 7 percent in the next year, with equity markets
in Japan (strength across the board), Europe (banks) and the United
States (high-quality cyclicals) among the standouts. BofAML’s asset
allocation calls are long U.S. dollar, volatility and real estate; short
commodities and other credit sensitivities; stocks over bonds; developed
markets over emerging markets; and investment-grade over high-yield
bonds. And with Main Street bulls and Wall Street risks, the best ways
to invest could be to buy what the middle class buys: mass retailers,
regional banks and investment grade bonds.
10. U.S. housing recovery continues. Further expansion of
the U.S. housing market is forecast for 2016, with housing starts of
1.275 million, reflecting a recovery in household formation. Existing
home sales could increase by 5 percent in 2016, while new home sales see
a more robust 10 percent growth rate. Home price appreciation could slow
in 2016, with prices up by only 1 percent, a reflection of home price
overvaluation relative to income. Though the rise in interest rates
poses some risk to the U.S. housing recovery, the Fed’s go-slow approach
should prevent a painful rise in mortgage rates. Long term, there are
signs of a structural shift in the housing market toward renting over
home ownership, and, in turn, an increase in multi-family housing
Detailed highlights of the BofA Merrill Lynch Global Research 2016
outlook can be found here.
Follow us on Twitter at @BofAML
and join the conversation at #BofAMLYearAhead.
BofA Merrill Lynch Global Research
The BofA Merrill Lynch Global
Research franchise covers over 3,350 stocks and 1,250 credits globally
and ranks in the top tier in many external surveys. Most recently, the
group was named Top Global Research Firm of 2015 by Institutional
Investor magazine; No. 1 in the 2015 Institutional Investor All-America
survey; No. 1 in the 2015 Institutional Investor Latin America survey;
No. 1 in the Institutional Investor 2015 Emerging EMEA Survey; No. 1 in
the 2015 All-Europe Fixed Income survey; No. 2 in the 2015 Institutional
Investor All-Asia survey; and No. 2 in the 2015 All-America Fixed Income
survey for the fourth consecutive year.
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