Investors Should See Sunshine Through The Clouds

Investors Should See Sunshine Through The Clouds
new sense photo brian selzer

OCEAN CITY — The global economy is facing a myriad of challenges that have contributed to reduced economic growth and financial forecasts for 2016. While we acknowledge those challenges, we believe they may present an opportune environment for investors, as attractive bargains tend to materialize in times of much pessimism.

Furthermore, February’s strong jobs report supports our base case that the U.S. economy is unlikely to be heading into a recession any time soon. Global growth estimates lower. The International Monetary Fund (IMF) is projecting global gross domestic product (GDP) growth of 3.4% (revised down from 3.6%) in 2016 and 3.6% in 2017, representing a more gradual pickup in global activity than estimated in its October report on a less rosy outlook for both Emerging Market (EM) and Developed Market (DM) economies. The IMF expects a modest and uneven recovery to continue in DM economies, with a gradual narrowing of the gap in growth rates between DM and EM economies. BofA Merrill Lynch (BofAML) Global Research expects global growth to recover modestly in 2016, to 3.2%, from 3.1% in 2015, chiefly driven by EM economies.

Investors have been dealing with meaningful market weakness since the start of the year and, therefore, might conclude the economy is equally weak. Furthermore, U.S. economic data broadly have come in weaker than expected, which has reinforced the notion of a weaker economy. This has led to lower revised economic forecasts among economists, including those of BofAML Global Research, who lowered their 2016 GDP forecast to 2.0%, from 2.3% at the beginning of the year.

Our base case does include further decline in the unemployment rate, which currently stands at 5%, and a modest increase in wage and core inflation. However, given recent market volatility, which translates into tighter financial conditions, BofAML Global Research is now calling for only two Federal Reserve (Fed) interest rate hikes, rather than three, as predicted earlier this year. Hence, our house view is for the Fed to hike in June and December, but not in September.

On Dec. 16 last year, the Fed hiked interest rates for the first time since 2006. At the time, the 10-year U.S. Treasury yield was 2.30%. Since then, it has declined to 1.87% as of last Friday. In anticipation of fewer Fed hikes this year, the BofAML Global Research Rates Strategy team has lowered its 2016 forecast for the 10-year Treasury yield to 2.00%, from 2.65%.

Acknowledging recent market gyrations and near-term downside risks to current levels, the BofAML Global Research Equity Strategy team recently lowered its S&P 500 Index forecast to 2000, from 2200, for 2016. By the same token, the year-end S&P 500 earnings per share forecast has been lowered to $120, from $125, on lower commodity prices and slower global growth. Wrapping up the earnings season, results have been better for larger companies, with the S&P 500 seeing a higher proportion of top- and bottom-line beats, as well as better earnings and sales growth, than small-cap stocks, as measured by the S&P 600 Index, according to BofAML Global Research.

Both the Investment Grade (IG) and High Yield (HY) markets are pricing in an imminent recession. With IG spreads at approximately 200 basis points (bps) and HY spreads at approximately 750 bps, U.S. corporate credit spreads have been wider only about onequarter of the time in the last 20 years2 . Credit mutual funds and Exchange Traded Funds have experienced some of the largest outflows in more than two decades. What is more, concerns around bond market liquidity brought about by regulation are keeping investors cautious. Risk of defaults in the Energy, Metals and Mining sectors, which account for a large proportion of HY credit, is elevated, and there is fear of contagion to other sectors.

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