Investors can look for the bull market in global equities to continue in 2015, though returns will slow to single-digit rates.
BofA Merrill Lynch Global Research based this forecast in its annual year-ahead outlook, released Tuesday, on strong fundamentals and robust growth in the U.S. economy.
It cautioned, however, that in the lower-return, higher-volatility environment ahead, selective allocation and defensive portfolio moves would be crucial for performance.
“While our key measures suggest that the bull market in equities can continue, the sentiment is far from euphoric,” Candace Browning, head of BofA Merrill Lynch Global Research, said in a statement.
“The world appears to be under-allocated to stocks, and we believe we are still only a third of the way into the Great Rotation from bonds.”
Browning said BofA Merrill Lynch was maintaining its long-term sector weightings in the U.S., with no changes from 2014, as many of last year macroeconomic expectations had been delayed.
“In the current environment, now is the time for investors to be highly selective and make tactical moves to position portfolios for more thematic investing in a transforming world,” she said.
BofA Merrill Lynch said healthy U.S. economic growth boded well for U.S. employment, wages and housing in 2015.
It expected core inflation to remain steady, and noted that with the new year about to begin, confidence was high, oil prices low, the dollar strong and Washington relatively calm.
BofA Merrill Lynch said its research team’s sentiment had shifted from extremely bullish to slightly so as stocks approached fair value.
It expected the U.S. Federal Reserve to begin hiking interest rates, probably starting in September, and said investors could anticipate three key changes: lower liquidity, wider credit spreads and higher volatility.
Following are 10 macro calls the BofA Merrill Lynch Global Research team made in its outlook for the year ahead.
1. S&P 500 Index at 2200
Although BofA Merrill Lynch believes that the era of excess returns and excessively low volatility is in the past, it expects the secular bull market in stocks to continue. It says expected gains in the year ahead imply a price return of approximately 6%, in line with an anticipated modest deceleration in earnings growth.
2. U.S. and Global Economic Growth
BofA Merrill Lynch expects the U.S. economy to continue to grow next year on the strength of nearly recovered household and corporate balance sheets and more stable federal, state and local fiscal policy. In 2015, it projects U.S. GDP growth of 3.3%, global real GDP growth of 3.7% (up from 3.2% in 2014) and Euro area GDP growth of 1.2%.
3. Emerging Markets
According to the outlook, stronger U.S. growth, lower energy prices and cyclical rebounds in several big economies such as India and Brazil should push economic growth in emerging markets to 4.5% next year, up from 4.2% in 2014 but below the consensus call of 4.8%.
4. Inflation, Disinflation and Deflation
Low inflation is driving policies in every country. The outlook expects U.S. core inflation to remain well below the Fed’s 2% target at about 1.5%.
The global backdrop, meanwhile, is disinflationary. In 2015, BofA Merrill Lynch expects Japan to focus on ending deflation, while Europe must deal with a major threat of outright deflation, “which if it occurs, could trigger another debt crisis.”
The outlook foresees downside risks to energy prices on the back of OPEC’s decision to allow the market to “stabilize itself.” This could result not only in lower oil prices, but also in higher price volatility. BofA Merrill Lynch’s forecast for Brent crude oil and West Texas Intermediate is $77/bbl and $72/bbl, respectively.
The combination of a strong U.S. dollar, higher interest rates and relatively subdued growth should keep other commodity prices in check in 2015, according to the outlook. Still, base metals, particularly aluminum and zinc, should perform relatively well on falling inventories, though copper is less certain. Gold prices could fall to $1,100 per ounce.
6. Global Rates and Currencies
The greenback should remain strong in 2015 as the U.S. economy outperforms and the Fed moves to the exit, BofA Merrill Lynch said. The outlook expects rates outside the U.S. to remain low, or even decline, with the five-year German government bond yield potentially falling to zero and the euro/U.S. dollar and U.S. dollar/yen trades reaching 1.20 and 1.23, respectively, by the end of 2015.
7. Credit Markets
BofA Merrill Lynch expects the five-year reach for yield trade to end next year as investment grade credit spreads widen to 140 basis points, with total returns close to zero. It says a “paradigm shift in U.S. high-yield outlook” should occur in 2015, with returns in the low single-digit range, as investors demand a higher premium for liquidity.
It expects defaults to rise moderately to about 2–2.5%. And investment grade and high-yield issuance should decline by 10–15% next year on less refinancing activity.
8. Global Fixed Income
Outflows for both retail and institutional investors in the U.S. and wider investment-grade spreads may be the story of 2015, according to the outlook. U.S. investment-grade bonds could see a total return of zero, it says.
At the same time, investment grade in emerging markets should return 2.4%; in Europe, 1.5–2%; and in Asia, 1.4%. Total returns for high yield could finish around 6% in Asia and the emerging markets, around 5% in Europe and 2–3% in the U.S.
9. U.S. Housing Market
BofA Merrill Lynch says new home sales are returning to more normal levels, and projects rises of 18% in 2015 and 13% in 2016 from extreme lows. It says existing home sales should increase by a more moderate 5% in 2015 and 3.2% in 2016, while home price appreciation continues to slow.
10. Slowing U.S. Energy Boom
Substantial shale production continues to drive total U.S. energy production, but most shale oil projects generate little free cash flow, making output highly price sensitive, according to the outlook. The steep price drop will affect operations of small, levered shale producers, cutting U.S. shale oil output growth down to half of this year’s levels.
In 2015, BofA Merrill Lynch expects natural gas prices to average $3.90 per million British thermal units, driven by continued strong domestic production growth of 3.1 billion cubic feet per day and a drop in weather-sensitive demand. It further expects both the U.S. natural gas and thermal coal markets to remain weak throughout next year, with liquid natural gas possibly entering a bear market.
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