Turning Analysis into Action
Portfolio Strategies Desk
Market Outlook
February 2013
Mark Hebeka, CFA
Head of Portfolio Strategies Desk
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2
Markets Review
STOCKS
WORLD BY REGION
S&P 500
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
25%
20%
15%
10%
5%
0%
-5%
Cons
Financials Industrials Materials Cons Disc Healthcare Staples
MSCI WORLD
MSCI EAFE
MSCI EUROPE
MSCI EMERGING
Energy
Utilities
MARKETS
Info Tech Telecom
MSCI PACIFIC
Q4 2012
2012
S&P 500 SECTOR RETURNS
Cons
Industrials
Disc Cons
Healthcare
Cons Staples
EnergyEnergyUtilities
Tech
FinancialsMaterials
Industrials Cons
Materials
Disc Healthcare
UtilitiesInfoInfo
Tech Telecom
Telecom
Staples
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
Q4 2012
2012
IG
IG
US Broad
High
Non-US Cons
Emerging
Asset- Preferred Preferred
Financials
Materials
Tech Telecom
Market Treasury
Yield Healthcare
IG Staples
Markets Energy
Backed Info–Fixed
TIPSIndustrials
Municipal
Corp. Cons Disc
MortgageUtilities
–Floating
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
Q4 2012
2012
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
HFRX
Russell
Russell
Russell
Global
1000
1000
2000
Global
Cons
NAREIT
Gold
HF
Growth
Value
Growth
Financials Industrials Materials Cons Disc Healthcare Staples
YTD % Chg
-1.7%
-2.7%
-0.4%
3.6%
1.9%
2.6%
6.6%
5.6%
10.2%
17.5%
16.0%
17.9%
16.3%
16.5%
17.9%
18.6%
ML US Broad Market Master
ML US Treasury Master
ML Agency Master
ML Muni Master
ML US Corp Master
ML High Yield
As of 12.31.12
Quarterly % Chg
YTD % Chg
261.9
1490.8
179.4
475.1
2449.6
952.0
0.3%
-0.1%
0.2%
0.5%
1.2%
3.2%
4.5%
2.2%
2.5%
7.3%
10.4%
15.6%
DJ-UBS Total Return
Gold Spot*
Silver Spot*
Copper Spot*
WTI Crude $/Barrel*
As of 12.31.12
Quarterly % Chg
YTD % Chg
279.8
1675.4
30.2
365.3
91.8
-6.3%
-5.5%
-12.7%
-2.8%
-0.4%
-1.1%
7.1%
8.2%
6.3%
-7.1%
As of 12.31.12
Quarterly % Chg
YTD % Chg
1.3193
86.75
1.6255
0.9154
2.6%
11.3%
0.5%
-2.6%
1.8%
12.8%
4.6%
-2.4%
As of 12.31.12
Quarterly % Chg
YTD % Chg
2007.6
2,379.9
385.1
1,148.3
5.8%
2.4%
-3.4%
0.8%
28.7%
18.2%
4.8%
3.5%
CURRENCIES*
EUR/USD
USD/JPY
GBP/USD
USD/CHF
CROSS ASSET RETURNS
DJ-UBS
TR
Quarterly % Chg
13,104.1
3,019.5
1,426.2
1020.4
849.4
1,338.5
1,604.0
1,055.2
COMMODITIES
BOND MARKET RETURNS
25%
20%
15%
10%
5%
0%
-5%
As of 12.31.12
BONDS
Financials
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
DJIA
NASDAQ
S&P 500
S&P 400 Mid Cap
Russell 2000
MSCI World
MSCI EAFE
MSCI Emerging Mkts
Russell
Russell
Russell
2000
Midcap
Midcap
S&P
500
Value
Growth
Value
Energy
Utilities Info Tech Telecom
ALTERNATIVES
Q4 2012
2012
Global NAREIT
US NAREIT
Alerian MLP
HFRX Global Hedge Fund
Returns calculated are total returns unless otherwise stated (*indicates spot returns). All bond indexes represented by BofA Merrill Lynch Global Bond Indexes.
3
US Economy Continues to Heal
The US economy continues to show signs of improvement with the FED committing to low interest rates and asset purchases (QE3) on the order of $40 billion
per month in an effort to reduce unemployment rate, currently at 7.9%. Inflation concerns remain muted as consumer confidence and various retail metrics
showing signs of stabilization. On the investment front, capex spending is set to rise after years of underinvestment. In addition, housing recovery shows
continued momentum.
US REAL GDP GROWTH IN 2013
UNEMPLOYMENT RATE ABOVE HISTORICAL AVERAGE
8.0%
18%
6.0%
16%
14%
4.0%
2.0%
10%
8%
0.0%
BofA ML Forecasts:
1Q 2013: 1.0%
2Q 2013: 1.5%
3Q 2013: 2.2%
4Q 2013: 2.5%
-4.0%
-6.0%
-10.0%
2002
6.5%
7.7%
6%
-2.0%
-8.0%
14.4%
10.4%
12%
2%
0%
1970
Historical Average
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
INFLATION RATE REMAINS MUTED DESPITE QE
5.8%
4%
1976
1982
1988
1994
2000
2006
2012
Recession
Unemployment Rate
Historical Average
Broader Unemployment Rate (U-6)
Historical U-6 Average
FED Target Unemployment
RETAIL SALES CONTINUE TO STABILIZE (YoY %)
$3,500
7%
6%
$3,000
5%
$2,500
4%
3%
$2,000
20%
15%
10%
5%
2%
$1,500
$1,000
0%
0%
-5%
-1%
$500
$0
1990
1%
-2%
-3%
1992
1995
1997
Fed Assets
2000
2002
Headline CPI
2005
2007
Core CPI
2010
2012
-10%
-15%
1968
1972
1976
1980
Recession
1984
1988
1992
1996
Retail Sales, YoY %
2000
2004
2008
2012
Average
Source: BofA-ML Global Research, Investment Management & Guidance (IMG)
4
US Economy Continues to Heal
US REAL GDP GROWTH IN 2013
8.0%
6.0%
4.0%
2.0%
0.0%
BofA ML Forecasts:
1Q 2013: 1.0%
2Q 2013: 1.5%
3Q 2013: 2.2%
4Q 2013: 2.5%
-2.0%
-4.0%
-6.0%
-8.0%
Historical Average
-10.0%
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Source: BofA-ML Global Research, Investment Management & Guidance (IMG)
5
US Economy Continues to Heal
UNEMPLOYMENT RATE ABOVE HISTORICAL AVERAGE
18%
16%
14%
14.4%
12%
10.4%
10%
8%
6.5%
7.9%
6%
5.8%
4%
2%
0%
1970
1976
1982
1988
1994
2000
2006
Recession
Unemployment Rate
Historical Average
Broader Unemployment Rate (U-6)
Historical U-6 Average
FED Target Unemployment
2012
Source: BofA-ML Global Research, Investment Management & Guidance (IMG)
6
US Economy Continues to Heal
RETAIL SALES CONTINUE TO STABILIZE (YoY %)
20%
15%
10%
5%
0%
-5%
-10%
-15%
1968
1972
1976
1980
1984
Recession
1988
1992
1996
Retail Sales, YoY %
2000
2004
2008
2012
Average
Source: BofA-ML Global Research, Investment Management & Guidance (IMG)
7
Housing Recovery
Various housing fundamentals such as household formation, home prices, housing starts, housing inventory, etc. point to an improvement in the sector. Existing
home sales increased 5.9% in November from the previous month, representing an annual rate of 5 million units. Home prices are projected to increase 5% year
over year in 2012 compared to 3.7% decline in 2011. Residential homebuilding is expected to contribute 0.3 percentage point to US GDP growth in 2012 and 0.4
percentage points in 2013.
HOME PRICES TRENDING UPWARD
180
EXISTING HOME SALES AND INVENTORY
8,000K
Case-Shiller National, Up 5% in 2012
Indexed to 2002=100
170
Case-Shiller 20 City, +5% in
2012
160
14
Months of supply of
existing homes
Existing Homes Sales
Existing Home Inventory
7,000K
12
6,000K
10
Market Peak: 3.6
months of supply
150
5,000K
140
4,000K
6
3,000K
4
2,000K
2
1,000K
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
0
130
FHFA House Price Index,
+4% in 2012
120
110
100
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Supply in Months
HOUSING STARTS FORECASTED TO AVERAGE 975k in 2013
According to BofA
Research, housing starts
are forecasted to add 0.4
(pp) to GDP in 2013.
2,000K
1,500K
Average 1,352K
1,000K
500K
1992
1994
1996
1998
2000
2002
2004
Housing Inventory
CONSTRUCTION JOBS LAG HOUSING STARTS
2,500K
0K
1990
Total Existing Home Sales
8
2006
2008
2010
2012
2,400K
5.2%
2,200K
5.0%
2,000K
4.8%
1,800K
4.6%
1,600K
4.4%
1,400K
4.2%
1,200K
4.0%
1,000K
3.8%
800K
3.6%
600K
3.4%
400K
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
3.2%
Housing Starts Lagged 5 Qs (LHS)
Construction jobs as % of Labor Force (RHS)
Source: Federal Housing Finance Agency, S&P, Haver Analytics, National Association of Realtors, Census Bureau, BofA Global Research, IMG
8
Housing Recovery
HOME PRICES TRENDING UPWARD
180
Case-Shiller National, Up 5% in 2012
170
Case-Shiller 20 City, +5% in 2012
Indexed to 2002=100
160
150
140
130
FHFA House Price Index,
+4% in 2012
120
110
100
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Source: Federal Housing Finance Agency, S&P, Haver Analytics, National Association of Realtors, Census Bureau, BofA Global Research, IMG
9
Housing Recovery
EXISTING HOME SALES AND INVENTORY
8,000K
14
Existing Homes Sales
Existing Home Inventory
Months of supply of existing homes
7,000K
12
6,000K
10
Market Peak: 3.6
months of supply
5,000K
8
4,000K
6
3,000K
4
2,000K
2
1,000K
1999
0
2000
2001
2002
2003
Supply in Months
2004
2005
2006
2007
Total Existing Home Sales
2008
2009
2010
2011
2012
Housing Inventory
Source: Federal Housing Finance Agency, S&P, Haver Analytics, National Association of Realtors, Census Bureau, BofA Global Research, IMG
10
Housing Recovery
HOUSING STARTS FORECASTED TO AVERAGE 975k in 2013
2,500K
According to BofA Research,
housing starts are forecasted to
add 0.4 (pp) to GDP in 2013.
2,000K
1,500K
Average 1,352K
1,000K
500K
0K
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
Source: Federal Housing Finance Agency, S&P, Haver Analytics, National Association of Realtors, Census Bureau, BofA Global Research, IMG
11
Housing Recovery
CONSTRUCTION JOBS LAG HOUSING STARTS
2,400K
5.2%
2,200K
5.0%
2,000K
4.8%
1,800K
4.6%
1,600K
4.4%
1,400K
4.2%
1,200K
4.0%
1,000K
3.8%
800K
3.6%
600K
3.4%
400K
1991
3.2%
1993
1995
1997
1999
Housing Starts Lagged 5 Qs (LHS)
2001
2003
2005
2007
2009
2011
2013
Construction jobs as % of Labor Force (RHS)
Source: Federal Housing Finance Agency, S&P, Haver Analytics, National Association of Realtors, Census Bureau, BofA Global Research, IMG
12
US Energy Independence
Advancement in technology has boosted US energy production over the past 5 years. US is on track to supply a large portion of Non-OPEC supply growth in the near
future. Harnessing these reserves gives the US a significant competitive advantage that will grow in years to come, with Commodity Strategist Francisco Blanch
estimating that the US enjoys a $700mn per day “energy carry” relative advantage.
TECHNOLOGY ADVANCEMENT BOOSTS US PROVED RESERVES
Oil (billion barrels)
US TO SUPPLY A LARGE PORTION OF NON-OPEC SUPPLY GROWTH BETWEEN 2011-2016
Natural gas (trillion cubic feet)
33
350
31
300
29
27
25
Brazil
Canada
Biofuels
250
Columbia
200
Russia
India
23
21
19
150
17
15
100
1980
1986
1992
1998
2004
2010
Mexico
-500
0
500
1,000
1,500
ENERGY COSTS AS % OF TOTAL OPERATING COSTS (2010)
24.0
…While U.S. demand is expected
to decline by 3%
23.0
8.0
22.0
7.0
21.0
6.0
20.0
5.0
19.0
4.0
Demand (billions of barrels)
10.0
9.0
UK
Norway
-1,000
US OIL SUPPLIES FORECASTED TO RISE ~15% BY 2016…
Supply (billions of Barrels)
United States
18.0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Total US Oil Supplies
Total US Oil Demand
Source: BofA-ML Global Research, IMG
13
US Energy Independence
TECHNOLOGY ADVANCEMENT BOOSTS US PROVED RESERVES
Oil (billion barrels)
Natural gas (trillion cubic feet)
33
350
31
300
29
27
250
25
23
200
21
19
150
17
15
100
1980
1986
1992
1998
2004
2010
Source: BofA-ML Global Research, IMG
14
US Energy Independence
US OIL SUPPLIES FORECASTED TO RISE ~15% BY 2016…
10.0
…While U.S. demand is expected to
decline by 3%
23.0
8.0
22.0
7.0
21.0
6.0
20.0
5.0
19.0
4.0
18.0
2005
2006
2007
2008
2009
2010
Total US Oil Supplies
2011
2012
2013
2014
2015
Demand (billions of barrels)
Supply (billions of Barrels)
9.0
24.0
2016
Total US Oil Demand
Source: BofA-ML Global Research, IMG
15
US Energy Independence
ENERGY COSTS AS % OF TOTAL OPERATING COSTS (2010)
Source: BofA-ML Global Research, IMG
16
Pent Up Demand
While US GDP growth remains tepid, US corporate profits have soared allowing companies to build cash on their balance sheets. However, capex has not kept
pace after years of underinvestment. Mergers and acquisitions activity can also rise given strong balance sheets, low interest rates, and attractive equity
valuations. In lieu of M&A, idle cash has resulted in increased dividend payouts and share buybacks.
CORPORATE PROFITS SOAR
CAPEX SPENDING HAS NOT KEPT PACE
30%
11%
20%
10%
9%
10%
8%
0%
7%
-10%
6%
-20%
5%
-30%
4%
3%
1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012
Recession
Corporate Profits*
-40%
Dec-93
Dec-95
Dec-97
Dec-99
Dec-01
Dec-03
Dec-05
Dec-07
New Orders: Non-defense capital goods ex. Aircraft, YoY%
Average
Dec-09
Dec-11
Average
USE OF CASH: SHARE BUYBACKS AND DIVIDENDS AMONG S&P 500 COMPANIES
M&A ACTIVITY LOWEST SINCE 2002
$900
$180
$31
$800
$160
$29
$700
$140
$27
$600
$120
$500
$100
$400
$80
$300
$60
$200
$40
$19
$100
$20
$17
$0
1997
1999
2001
2003
2005
2007
M&A Transactions (in $bilions)
2009
2011
$25
$23
$21
$0
$15
1998 1999 2000 2001 2002 2004 2005 2006 2007 2008 2009 2011 2012
Share Buybacks (in $billions, LHS)
Dividends per Share (12 Months, RHS)
Source: BofA-ML Global Research, IMG
17
Pent Up Demand
CORPORATE PROFITS SOAR
11%
10%
9%
8%
7%
6%
5%
4%
3%
1947
1952
1957
1962
1967
Recession
1972
1977
1982
1987
Corporate Profits*
1992
1997
2002
2007
2012
Average
Source: BofA-ML Global Research, IMG
18
Pent Up Demand
CAPEX SPENDING HAS NOT KEPT PACE
30%
20%
10%
0%
-10%
-20%
-30%
-40%
Dec-93
Dec-95
Dec-97
Dec-99
Dec-01
Dec-03
Dec-05
New Orders: Non-defense capital goods ex. Aircraft, YoY%
Dec-07
Dec-09
Dec-11
Average
Source: BofA-ML Global Research, IMG
19
Pent Up Demand
M&A ACTIVITY LOWEST SINCE 2002
$900
$800
$700
$600
$500
$400
$300
$200
$100
$0
1997
1999
2001
2003
2005
2007
2009
2011
M&A Transactions (in $bilions)
Source: BofA-ML Global Research, IMG
20
Pent Up Demand
USE OF CASH: SHARE BUYBACKS AND DIVIDENDS AMONG S&P 500 COMPANIES
$180
$31
$160
$29
$140
$27
$120
$25
$100
$23
$80
$21
$60
$19
$40
$17
$20
$0
$15
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Share Buybacks (in $billions, LHS)
Dividends per Share (12 Months, RHS)
Source: BofA-ML Global Research, IMG
21
International Markets Also Improving
Economic conditions around the world are also improving. BofA-ML’s Economic Conditions Index (ECI), a broad measure of business conditions around the
world, has been trending up steadily and uniformly across regions. The world economy, outside of the U.S., is expected to grow around 4% annually between
now and 2014. Stress in financial markets is now at the lowest levels since 2007.
BUSINESS CONDITIONS GLOBALLY TICKING UP
7%
BofA-ML Economic Conditions Index (ECI)
5%
z-scores
0
4%
-1
3%
-2
2%
-3
1%
-4
0%
-5
Dec-07
-1%
Dec-08
Dec-09
GLOBALcycle
Dec-10
DMcycle
Dec-11
2011
Dec-12
2012
Global xU.S.
GEMcycle
2013
Euro Area
Japan
2014
Emerging Markets
GLOBAL FINANCIAL STRESS INDEX AT LOWEST SINCE 2007
GLOBALLY INFLATION IS UNDER CONTROL
3.5
450
8%
3.0
400
7%
2.5
350
6%
2.0
300
1.5
250
1.0
200
0.5
150
0.0
100
-0.5
50
9%
Forecasts
GFS Index
Inflation Rate (YoY%)
Forecasts
6%
1
5%
4%
3%
2%
1%
0%
2002
World
2004
2006
2008
Advanced economies
2010
2012
2014
-1.0
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
MSCI AC World Index
2
GROWTH OUTSIDE U.S. TO RISE IN 2013 AND 2014
0
Dec-12
EM and Developing economies
Source: BofA-ML Global Research, International Monetary Fund, Bloomberg, IMG
22
International Markets Also Improving
BUSINESS CONDITIONS GLOBALLY TICKING UP
2
BofA-ML Economic Conditions Index (ECI)
1
z-scores
0
-1
-2
-3
-4
-5
Dec-07
Dec-08
GLOBALcycle
Dec-09
Dec-10
DMcycle
Dec-11
Dec-12
GEMcycle
Source: BofA-ML Global Research, International Monetary Fund, Bloomberg, IMG
23
International Markets Also Improving
GROWTH OUTSIDE U.S. TO RISE IN 2013 AND 2014
7%
Forecasts
6%
5%
4%
3%
2%
1%
0%
-1%
2011
2012
Global xU.S.
Euro Area
2013
Japan
2014
Emerging Markets
Source: BofA-ML Global Research, International Monetary Fund, Bloomberg, IMG
24
International Markets Also Improving
MSCI AC World Index
Dec-12
Sep-12
Jun-12
Mar-12
Dec-11
0
Sep-11
-1.0
Jun-11
50
Mar-11
-0.5
Dec-10
100
Sep-10
0.0
Jun-10
150
Mar-10
0.5
Dec-09
200
Sep-09
1.0
Jun-09
250
Mar-09
1.5
Dec-08
300
Sep-08
2.0
Jun-08
350
Mar-08
2.5
Dec-07
400
Sep-07
3.0
Jun-07
450
Mar-07
3.5
Dec-06
GFS Index
GLOBAL FINANCIAL STRESS INDEX AT LOWEST SINCE 2007
Source: BofA-ML Global Research, International Monetary Fund, Bloomberg, IMG
25
Equity Fundamentals & the Great Rotation
One of the major themes of Research is the coming “Great Rotation” from bonds to stocks. Play this theme by emphasizing bonds that act like stocks and favor
intermediate maturities over longer-term maturities
STOCKS ATTRACTIVELY PRICED RELATIVE TO BONDS
RECORD INVESTOR FLOWS INTO BONDS FUND SINCE 2007
6% Equity risk premium
5%
4%
3%
2%
+1 std deviation
1%
0%
-1%
-2%
-3%
-4%
-5%
1976
1981
1986
1991
1996
Net Flows (billions, $)
500
400
300
200
100
0
-100
-200
-300
2007
2008
2009
Equities
2010
2011
2012
Bonds
Tech bubble peak
2001
2006
2011
S&P 500 FORWARD PRICE-EARNING (PE) RATIO BELOW HISTORICAL AVERAGE
S&P 500 EARNINGS PER SHARE FORECASTED TO GROW
30.0x
$120
$100
25.0x
$80
20.0x
$60
$40
15.0x
Average= 15.1x
$20
10.0x
$0
2005
2006
2007
2008
2009
2010
2011
2012E
BofA-ML Strategy EPS estimates vs Consensus
2012: $102.75 vs $102.74 | 2013: $110.0 vs $106.59
2013E
5.0x
1986
1990
1994
1998
Forward P/E
2002
2006
2010
Average
Source: BofA-ML Global Research, ICI, http://www.econ.yale.edu/~shiller/data.htm, IMG
26
Equity Fundamentals & the Great Rotation
RECORD INVESTOR FLOWS INTO BONDS FUND SINCE 2007
500
Net Flows (billions, $)
400
300
200
100
0
-100
-200
-300
2007
2008
2009
Equities
2010
2011
2012
Bonds
Source: BofA-ML Global Research, ICI, http://www.econ.yale.edu/~shiller/data.htm, IMG
27
Equity Fundamentals & the Great Rotation
STOCKS ATTRACTIVELY PRICED RELATIVE TO BONDS
6%
Equity risk premium
5%
4%
3%
2%
+1 std deviation
1%
0%
-1%
-2%
-3%
-4%
-5%
1976
Tech bubble peak
1981
1986
1991
1996
2001
2006
2011
Source: BofA-ML Global Research, ICI, http://www.econ.yale.edu/~shiller/data.htm, IMG
28
Equity Fundamentals & the Great Rotation
S&P 500 EARNINGS PER SHARE FORECASTED TO GROW
$120
$100
$80
$60
$40
$20
$0
2005
2006
2007
2008
2009
2010
2011
2012E
2013E
BofA-ML Strategy EPS estimates vs Consensus
2012: $102.75 vs $102.74 | 2013: $110.0 vs $106.59
Source: BofA-ML Global Research, ICI, http://www.econ.yale.edu/~shiller/data.htm, IMG
29
Equity Fundamentals & the Great Rotation
S&P 500 FORWARD PRICE-EARNING (PE) RATIO BELOW HISTORICAL AVERAGE
30.0x
25.0x
20.0x
Average= 15.1x
15.0x
10.0x
5.0x
1986
1990
1994
1998
2002
Forward P/E
2006
2010
Average
Source: BofA-ML Global Research, ICI, http://www.econ.yale.edu/~shiller/data.htm, IMG
30
Key Implementation Themes
• Globalize Equity Portfolios: Move beyond the U.S.
• Housing: Banks key beneficiaries
• Dividend Growth Over Dividend Yield
• Fixed Income Positioning:
•Credit risk over duration risk
31
International Developed Markets: Receding Risks
& Attractive Valuations
Receding tail risks associated with the European Central Bank ‘s (ECB) actions has led to lower volatility, declining bond yields and rising equity markets in the
Euro area. BofA Research’s base case calls for Europe to further stabilize in 2013 with most growth coming in 2H13. Risks to continued European recovery
include: contagion effects associated with Spain seeking entry into OMT program amid intense market pressure, potential Greek exit, inability to resolve the
US fiscal cliff, and escalation of Mid-East tensions leading to a spike in oil prices. The pro-stimulus policies of Japan’s new government is supportive of equities.
EUROPEAN VOLATILTY AT MULTI-YEAR LOWS
EUROPEAN EQUITY MARKETS: ATTRACTIVE VALUATIONS
40%
35%
50
30%
40
25%
30
20%
15%
20
10%
10
0.9
10 Yr Bond Yields
Euro Stoxx 50 Volatility Index
60
+1 Standard
Deviation
0.8
Average=0.74
5%
0
2009
-1 Standard Deviation
0%
2010
2011
Euro Stoxx 50 Volatility Index
0.70
0.7
0.6
1996
2012
Greek 10 Yr Bond Spreads
1998
2000
2002
2004
2006
2008
MSCI Europe relative to MSCI US - Price to Book
YEN’S WEAKESS INCREASES JAPANESE COMPETITIVENESS
2010
2012
Average
JAPANESE EQUITIES: ALSO ATTRACTIVE VALUATIONS
130
0.8
120
0.7
110
0.6
100
0.5
90
0.46
0.4
80
70
2002
Average=0.54
2003
2004
2005
2006
JPYUSD
2007
2008
2009
200-day MA
2010
2011
2012
0.3
1996
1998
2000
2002
2004
2006
2008
MSCI Japan relative to MSCI US - Price to Book
2010
2012
Average
Source: BofA-ML Research, Bloomberg, IMG
32
China Rebounding with Emerging Markets
Leading Global Growth
EM economies are expected to lead global growth. In particular, the risk of a Chinese hard landing have eased with 4Q GDP growth forecasted at 7.8% vs 7.4% in
3Q (lowest since 1Q 2009). Exports are expected to remain flat in 2013 (forecasted to grow at 7.5%) on weakness of EU, US, and Japan. With inflation subdued,
accommodate pro-growth policy remains in effect. Other metrics such as industrial production (+10%, YoY), fixed asset investment (+21%, YoY), credit growth
(+16%), Purchase Mangers Index (50.6), retail sales (+15%, YoY) remain healthy.
ESTIMATED CONTRIBUTION TO GLOBAL GROWTH BY REGION*
CHINA REAL GDP FORECASTS (%, YoY)
14%
BofA ML Forecasts:
4Q 2012: 7.8%
1Q 2012: 8.3%
2Q 2013: 8.3%
3Q 2013: 8.0%
4Q 2013: 8.0%
12%
DM Others, 9%
10%
China, 40%
8%
Japan, 4%
EM, 76%
UK, 0%
India, 12%
EU, -1%
U.S., 12%
6%
Brazil, 3%
Russia, 3%
4%
EM Other, 18%
2%
0%
2007
CHINA EXPORTS TO REMAIN FLAT IN 2013(%, YoY)
$50
50%
$40
40%
$30
30%
20%
$20
10%
$10
0%
$0
-10%
-$10
-20%
2013
10%
8%
2012
Export Growth (%, YoY), LHS
Consumption
5.4%
2%
-2%
2011
Net Exports
Investments
4%
0%
2010
4.8%
6%
-$30
Trade Surplus in $ billions, RHS
2012
Consumption as component
of GDP growth exceeded
investments in 2011
12%
-$20
2009
2011
14%
-40%
2005
2008
2010
16%
-30%
2007
2009
CONSUMPTION EXPECTED TO LEAD CHINESE GROWTH
60%
2006
2008
-0.4%
-4%
2006
2007
2008
2009
2010
2011
Source: BofA-ML Research, Bloomberg, Haver Analytics, National Bureau of Statistics of China, IMG. *For 2012
33
Housing and the Banks
Housing starts were up 25% and home prices increased 5% in 2012. BofA-ML Research forecasts the recovery will continue in 2013, with another 25% rise in
housing starts and 3% increase in home prices in 2013.Homebuilders and other direct sectors have already rallied substantially. Financials is our preferred way to
play the continued rebound in housing is through the Financials, particularly the large banks.
BANKS HAVE LAGGED OTHER HOUSING SENSITIVE SECTORS (3Q2011 -2012)
RALLY IN HOUSING STOCKS SINCE 3Q 2011
400
160
200%
350
150
175%
300
140
250
130
200
120
150
110
100
100
75%
50
90
50%
80
2012
25%
0
2002
2003
2004
2005
2006
2007
2008
2009
S&P Homebuilders Idx
BKX Index
2010
2011
S&P Home Improv Idx
S&P/Case-Shiller C20
150%
125%
100%
0%
S&P Homebuilders
Idx
REGIONALS OUTPERFORMED MONEY CENTERS IN 2012
S&P Home Improv
Idx
KBW Bank Idx
S&P 500
THE MONEY CENTERS-REGIONALS VALUATION GAP
180
160
140
120
100
80
Dec-11
Feb-12
Apr-12
JPM
Jun-12
C
Aug-12
RF
Oct-12
Dec-12
STI
Source: BofA-ML Research, Bloomberg, IMG
34
Dividend Growth Investing
Stocks with the highest dividend growth have been one of the most consistent strategies. In fact, over the long-run dividend growth accounts for a majority of the
total return on stocks. The low interest rate environment and high demand for income from retiring baby boomers supports the secular case for dividends.
DIVIDEND GROWTH AT MOST DISCOUNT TO YIELD SINCE 1990
DIVIDEND GROWERS HAVE OUTPERFORMED OVER TIME…
100%
80%
Dividend Growth More Expensive
60%
40%
20%
0%
-20%
Dividend Yield More Expensive
-40%
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
HIGHEST YIELDING STOCKS NOT THE OPTIMAL SOLUTION
10%
Non-Dividend Payers
(25.7%, 1.35%)
2%
14%
Dividend Cutters
(25.7%, -0.89%)
15%
20%
25%
30%
Risk (Annualized Standard Deviation)
26%
24%
22%
Highest
Returns
12%
10%
20%
18%
8%
16%
Lowest
Volatility
6%
0%
-2%
10%
Annual Returns
Dividend Payers w/ No Change (18.5%, 7.0%)
6%
4%
Lower returns,
higher volatility
16%
All Dividend Payers (17.2%, 8.6%)
8%
Annualized Returns
18%
Dividend Growers (16.4%, 9.4%)
14%
4%
Risk (Standard Deviation)
…AND WITH LESS RISK
12%
1
2
3
4
5
6
7
8
Decile (1=lowest D/Y, 10=highest D/Y)
Annualized Return
9
10
Risk
Source: BofA-ML Research, Oppenheimer, http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html, IMG
35
Fixed Income Solutions
The yield on the 10-year Treasury is currently lower than the dividend yield on the S&P 500. That has not happened on a sustained basis since the 1950s. Low yields
present a problem for bond holders (duration risk). While our base case calls for still positive credit returns in 2013 , the era of equity like returns in fixed income has
likely come to an end. The key will be higher-yield, lower quality credit markets.
S&P DIVIDEND YIELD VS 10-YEAR TREASURIES
YIELDS ACROSS THE FIXED INCOME MARKET (Dec 2012)
16%
7.0%
14%
Higher yielders have lower
duration risk
6.0%
12%
5.0%
10%
4.0%
8%
6%
3.0%
4%
2.0%
2%
1.0%
0%
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
0.0%
S&P Dividend Yield
U.S.
DM
Mortgages
Treasuries Sovereigns
(xU.S.)
10-Yr Tsy Yield
IG
EM
IG
EM LCL
HY
Corporates Sovereigns Preferreds Currency Corporates
EM DEBT ONE OF THE BEST PERFORMING BOND SECTORS (2007 -2012)
HY SPREADS HAVE ROOM TO NARROW FURTHER
170
160
150
140
130
120
110
100
90
80
70
2500
2000
1500
1000
500
2007
0
1996
Munis
1998
2000
2002
2004
2006
2008
2010
2012
2008
EM Sovereigns
2009
EM Local Debt
2010
DM Sovereigns
2011
2012
U.S. Treasuries
Source: BofA-ML Global Research, http://www.econ.yale.edu/~shiller/data.htm, Bloomberg, IMG
36
Appendix
37
APPENDIX 1: Rotation Scenarios
BofA ML Forecast
•
•
•
•
•
•
•
Federal funds rate increase mid-2015 (same timeframe outlined by Federal Reserve)
10-year U.S. Treasury target for year-end 2013
2.0%
30-year U.S. Treasury target for year-end 2013
3.25%
GDP forecast 2013
1.4%
CPI ex Food & Energy 2013
1.8%
Private Payrolls (Avg MoM change) 2013
94,000
Housing Starts (Thous. SAAR) 2013
897
Orderly Rotation
• Attractive equity returns over a longer period
combined with less attractive bond returns
• 2.5% tailwind becomes 2.5% headwind
• Slowly rising interest rates – 10-year Treasury
yields can move above 3% without causing alarm
• Employment and GDP data continue to improve
but at a sluggish pace
Disorderly Rotation
• Employment, GDP and housing data continue to
improve at an accelerating pace
• 10-year Treasury moves a second leg higher
toward 4% in a matter of months
• Flows abruptly change
Source: BofAML Research, ML GWM Investment Management & Guidance
38
APPENDIX 2: Checklist / Worry List
Metric
Current Level
Trending
Goal
Unemployment Rate
7.7
6.9
GDP (Annual Growth Rate)
2.0
< 3.0
Retail Sales
3.8
4.7
Consumer Confidence
73.7
85.0
CPI
1.9
< 2.5
S&P/Case-Shiller Home Price Index
146.2
160.0
ISM Manufacturing
49.5
55.0
What concerns us (scored 1-10 with 10 being the most worrisome) and how is it trending
>
>
>
>
Weight of Fiscal cliff – Higher taxes and austerity measures (6) - flat
European debt crisis – Spain asking for debt relief and Elections in Italy (7) - improving
China - Economic outlook and new leadership (4) - flat
Mid-East unrest – Syria, Egypt, Palestine and Israel (5) – flat
Source: Bloomberg, BofAML Global Research, Portfolio Strategies Desk Research
39
