Outlook 2011: Sluggish Growth, Potentially Stronger Markets

OCEAN CITY — The top analysts at BofA Merrill Lynch Global Research, who gather in December each year to share their thoughts on key trends and opportunities in the year to come, are delivering mixed opinions for 2011. On the downside, a combination of stubbornly high unemployment, cautious spending by consumers and lagging home prices in the U.S. seems likely to keep the domestic economy from gaining much momentum. Yet they are more optimistic about the prospects for financial markets, highlighting some potential bright spots both at home and abroad.

In past years, slow growth and a battered consumer might have heralded a tough year ahead for U.S. stocks. But equity markets may well avoid that pattern in 2011, suggests David Bianco, head of U.S. Equity Strategy for BofA Merrill Lynch Global Research. Bianco looks for a particularly strong performance in 2011 from the Standard & Poor’s 500, an index dominated by large, well-capitalized companies with international reach that now earn nearly 40% of their profits abroad.

U.S. companies are increasingly looking beyond the borders for growth, a sign of the growing disparity between developed and emerging markets. As the U.S. economy struggles to expand, China’s gross domestic product will likely rise by 9% and the economy of emerging Asia by 8% overall, according to T. J. Bond, Emerging Asia Economist for BofA Merrill Lynch Global Research. "Asia really is leading the global economy," Bond says.

As China and other emerging economic powers race to develop their infrastructures and meet the needs of their rapidly developing consumer classes, a number of U.S. industries are well positioned to tap into that growth. Bianco’s favored sectors now are technology, energy, industrials and materials. "Emerging countries remain very welcoming to leading global brands and leading technology," he says. "That puts the S&P companies in a great position to take advantage of cheap capital from the U.S. and good business expansion opportunities abroad."

Like the U.S., Europe remains mired in a long, slow recovery process. If anything, Europe’s challenges are even greater, considering the sovereign debt crises that have led to bailouts for both Greece and Ireland.

"Portugal and Spain may also wind up seeking help from the European Union," says Ethan Harris, head of Developed Markets Economics for Bank of America Merrill Lynch. "I believe it’s going to be a rocky year for Europe, at least in the first half."

Still, investors may not want to let a cloudy picture obscure their view of one part of Europe that is doing well.

"Germany has been an export machine, and it is currently having a very solid recovery," says Kate Moore, Global Equity Strategist for BofA Merrill Lynch Global Research. "It has great, well-capitalized exporting companies, access to emerging markets and excellent growth prospects." In particular, Moore sees promise in large companies that do much of their business internationally.

Some economists have suggested that collateral damage from Europe’s debt crisis could send the U.S. back into recession. However, the BofA Merrill Lynch Global Research team believes that the concerted policy moves the Federal Reserve has undertaken should keep the economy growing, albeit slowly. Although the Fed has been criticized for some decisions — including its resolve to buy at least $600 billion in U.S. Treasury bonds to keep interest rates low — Harris anticipates that the government efforts will pay off.

"It’s hard for people to understand the importance of what the Fed has achieved and is continuing to achieve," he says. "The outcome could have been a lot worse if the Fed hadn’t acted. Its moves restarted the markets."

Even with the central bank’s support, the U.S. economy is unlikely to surge this year, and a robust recovery in the job market won’t come quickly.

"There are still a lot of headwinds," Harris adds. "The U.S. economy grew by about 3% in 2010, and we are looking for similar growth in the year ahead," helped along in part by the recent tax law signed in December.

Still, Harris doubts that the unemployment rate will drop below 9% by the end of 2011. And home prices, which plummeted during the mortgage crisis and have remained depressed, are also unlikely to rebound. On the positive side, although consumers today are spending less and saving more — adding another short-term drag on the economy — getting household balance sheets in order after years of heavy borrowing should eventually help fuel sustainable long-term growth.

Investors, meanwhile, should proceed with caution, weighing how much investment risk they can handle, how much equity exposure fits their needs and where to look for opportunities during the year ahead. The search may not always be easy, nor the recovery as robust as most investors would hope for. But a clearly visible light at the end of the tunnel is cause for cautious optimism. Says Harris: "This may be a below-normal recovery, but it is a recovery nevertheless, and there is the potential for opportunities."

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