OCEAN CITY – 2008 turned out to be a year investors would like to forget, but instead will vividly remember, according to Bob Doll, a former president and chief investment officer of Merrill Lynch investment managers and current vice chairman and director BlackRock, a premier provider of global investment management, risk management and advisory services.
The following is a look at what Doll wrote in his look ahead to 2009.
For much of the first half of the year, equity markets held together as the hope of global decoupling kept investors from panicking despite substantial deterioration in credit markets. The seminal event appears to have been Lehman Brothers’ bankruptcy declaration in September, which drove fear higher and confidence lower while causing a massive decline in economic activity in the United States and globally. Although at times somewhat erratic, monetary and fiscal policy efforts became aggressive, attempting to fight off systemic collapse and growing deflationary forces. As a result, risk premia of all types rose substantially and geographic and other correlations increased. The price of riskier assets, including equities, lower quality bonds and commodities, collapsed in record time
as volatility levels soared. By contrast, higher quality assets, especially Treasury instruments, advanced as returns on cash fell to near zero.
The new year begins with uncertainty high, expectations low and problems significant. The investment debate is likely to center around the issue of debt-induced deflation versus policy-induced reflation. Our guess is the latter will win out, but the timing, path to get there and ancillary consequences are highly uncertain.
While we are likely in the longest and deepest recession of the post-World War II period, record massive fiscal and monetary stimuli are likely to eventually turn the US and global economies around before the deleveraging forces promoting deflation overwhelm us. Policy needs to be consistently aggressive and there is not much room for error.
Therefore, 2009 is likely to be marked by negative real growth, weak nominal growth and significant earnings declines. When recovery finally comes, it is likely to be muted as deleveraging on the part of the consumer and the financial sector will take many years. If our assessments are correct, however, 2009 will see a slow, but noticeable, return to “risky” assets over “safe” assets. We believe an equity market bottoming process began in October.
Bottoming processes typically take months to complete with re-tests of lows possible. However, increasingly attractive valuations, coupled with high degrees of skepticism supported by massive sideline cash, lead us to believe that equities will have a positive, albeit volatile, year.
We expect the United States to outperform Europe, and emerging markets to outperform developed ones. In our scenario, interest rates rise gradually and spreads narrow. Commodity prices should bottom and start moving higher. As we had hoped for 2008, perhaps 2009 will be the year when reflation and liquidity begin to beat credit woes and fear.
(A Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-8520.)