A Confidence Vote For Equities

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OCEAN CITY – Barack Obama, who becomes our 44th President in January, ran on a platform promising change. And even as a Democratic administration portends a reshaped political agenda in this country, the conclusion of this electoral season may also bring significant change to the U.S. stock market, according to Merrill Lynch U.S. Sector Strategist Brian Belski.

“We have seen tremendous volatility the past few months, due to the number of unresolved issues weighing on the economy and markets—from the potential global recession to the future of U.S. leadership,” said Belski. “Now we have clarity on one important issue: We know Barack Obama will be our president.”

With one of the truly pivotal elections in our nation’s history now over, Belski believes U.S. markets are poised to settle into a period of outperformance. Even if there is some additional downside movement in the immediate term, he feels that this is a time to reposition portfolios for exposure to a longer-term U.S. resurgence. “The stage is now set for a run,” says Belski. “This is a significant opportunity for investors. The time horizon they should have in mind for this theme to start playing out is six to 12 months.”

According to Belski, the economic pendulum, which had heavily swung against the U.S. in recent times, is now starting to turn in its favor. “The rest of the world is beginning to feel the brunt of the economic slowdown in the U.S., raising the relative risks in non-U.S. markets,” he explains.

He notes that several years ago, many U.S. corporations made prudent business decisions such as paying down debt. Now, with strengthened balance sheets, these companies are in a better position to weather volatility than many of their global counterparts—which are, for the most part, located in countries just entering the malaise the U.S. has recently endured. As a result, many global investors who had been expressing reservations about U.S. equities are likely to re-enter the market.

One powerful economic factor driving a rejuvenated U.S. market is the recent performance of the dollar, which hit a 14-month high on Oct. 10. Merrill Lynch analysts point out that, based on the length of the two major strong-dollar cycles of the last 30 years — from October 1978 to March 1985 and from December 1987 to March 2002 — it’s reasonable to believe that the coming cycle will last for some time. Strong-dollar cycles have also historically been a bellwether for positive sector performance.

Furthermore, Merrill Lynch research shows that foreign ownership of U.S. equities increases during periods of dollar strength. For that reason, Belski expects foreign investment in the U.S. to pick up in the months ahead, further boosting domestic stock performance.

If the U.S. is ready to break out, what areas of the market are poised to provide the new leadership? Belski believes that the growth category is likely to lead investors’ move back into U.S. equities, as recessionary conditions narrow the field and highlight the true outperformers.

Belski has identified the following five cross-sector themes for the next several years. Investors can work with their financial advisors to identify potential strong performers within each of these themes.

– A growing concern for the environment. The prospects for this sector are bolstered by Obama’s climate and energy agenda. “Companies that offer products and services to reduce negative environmental impact, alleviate energy bottlenecks or help find alternative energy sources, such as wind and solar, look particularly attractive,” says Belski.

– Consumer conservatism. “Consumers are likely to look for less-costly alternatives for entertainment and leisure,” Belski says. “Look to fashions that reflect frugality and sustainability, as many individuals are faced with rising household costs and are focused on improving their financial positions.”

– Innovation will drive U.S. growth. According to the U.S. Patent and Trademark Office, for the 30th consecutive year the U.S. was awarded more than 50% of worldwide patents granted in 2007, a signal of an ongoing domestic commitment to creating breakthrough products. “The two most visible areas of innovation remain technology and health care,” Belski notes.

– A continued slowdown in commodity costs, which have cut into business margins in recent years. “As economies around the world slow, demand for commodities is likely to fall,” says Belski. “Price declines should have a positive impact on companies affected by higher input costs such as fuel.”

– Increased acquisition activity. “Market price declines have created buying opportunities for those companies with sufficient available cash or financing,” says Belski. ”Companies strong enough to grow their businesses through acquisitions are effectively identifying themselves as potential outperformers.”

To put yourself in the strongest position for a market turnaround like the one Belski anticipates in the U.S., consider focusing on these five themes — and on assets, sectors, industries and companies that deliver consistent, quantifiable earnings, cash, sales and margin growth. Change may be coming, but the time-honored practice of looking to quality will continue to serve investors well in these markets.

(A Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-8520.)

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