After hearing Wednesday’s news that the U.S. economy contracted 2.9% in the first quarter, Bank of America-Merrill Lynch experts shared their thoughts on what’s holding growth back and what’s driving equities forward.
“There’s nothing great happening in the economy,” said Bank of America-Merrill Lynch global economist Ethan Harris on a call with the press, “though we are getting rid of the fiscal headwind.”
Harris says the -2.9% growth in Q1’14 is the “ugly elephant in the room. We can’t figure it out. It’s like watching [Uruguayan striker Luis] Suarez bite someone on the soccer field!”
Analysts with BofA-Merrill “put low weight on the message being sent by the latest GDP report,” he adds. “In many ways, it’s a healthy U.S. economy, but the global backdrop is not supporting it.”
What Your Peers Are Reading
Earlier this week, BofA-Merrill issued a three year outlook for productivity and other measures. The group forecasts U.S. GDP growth of 2.0% in 2014, 3.2% in 2015 and 3.4% in 2016.
The group is more upbeat about the stock market and sees the S&P 500 hitting 2,000 this year. The index traded at 1,957 on Wednesday.
“The second half of the year could be interesting in terms of volatility related to a change in interest rates and the lead-up to such a shift,” said Savita Subramanian, head of U.S. equity strategy for the BofA-Merrill research team.
In terms of concerns that the market is complacent due to low volatility, Subramanian points to sell-side indicators — Wall Street’s recommendations – that she and other analysts follow. As of May 31, it was at a 51%-equity portfolio allocation.
“This is a very reliable contrarian indicator,” she explained, noting that the 15-year average is 60%. “In other words, there is more upside than downside risk.”
Far from being overly euphoric, “We’re still climbing a wall of worry. The [51% figure] is surprisingly low, given the fact that other assets – like bonds and cash – are not attractive,” Subramanian said.
As for sector weights, BofA-Merrill is overweight the energy, technology and industrial groups with an emphasis on large-cap holdings. “These are globally exposed, GDP-sensitive sectors,” she explained.
The research group is underweight on consumer discretionary, utilities and telecommunications.
“There’s a real opportunity to play the increasing-interest-rate trade,” the analyst added. She pointed to sectors that are relatively cheap at the moment: technology, autos, consumer finance and electrical equipment, as well as communications equipment.
“If interest rates don’t rise, then these aren’t the plays,” Subramanian said, “and it’s better to look at utilities and tobacco, for instance.”