Equities are expected to outperform corporate and government bonds in 2010, as governments look to consumers to replace them as a catalyst for sustained economic growth in the wake of the recession, Merrill Lynch said in its report on Wealth Management Year Ahead 2010. The global economy is forecast to grow by 4.3 percent in 2010 - after shrinking by almost one percent in 2009 - with consumer spending and borrowing expected to rise as the threat of unemployment wanes and household incomes recover, Bill O'Neill, the report author and a portfolio strategist at Merrill Lynch Wealth Management, Europe, Middle-East and Africa (EMEA). “Governments have spent trillions of dollars to revive the economy. Central banks have cut interest rates close to zero. Businesses have restructured, divested, merged and borrowed to position themselves for a recovery,” he said. “They will hand over the baton to the consumer to drive growth in 2010. By mid-year we should see first signs of whether that handover has been successful.” China and India are expected to spearhead the global economic recovery with growth of around 10 percent and 7 percent respectively, according to the Year Ahead 2010. The Chinese consumer is expected to fuel domestic growth, O'Neill said. The United States and the euro zone are forecast to record more modest growth of 3 percent and 2 percent respectively in 2010. Japan's economy is also expected to experience growth of 3 percent after suffering an estimated 6 percent decline in 2009. “We believe it will be a good year for equities,” O'Neill pointed out. “We expect growth without accompanying inflation risk. Our forecast is that equities will outperform both corporate and government bonds in 2010.” Equities are expected to benefit from accelerated growth in Asian markets in particular. Stocks with exposure to China, India, Malaysia, Indonesia and Korea are forecast to offer attractive returns in 2010, he added. As a result, emerging market equities are expected to outperform their counterparts in developed economies. Cyclical stocks, in sectors such as oil and gas, basic resources and industrials, are anticipated to outperform. Cyclical assets led the recovery in markets in 2009, with global equities generating estimated returns of more than 26 percent. In 2010, defensive stocks in the health and utilities sectors, as well as autos and chemicals, are expected to be among the laggards, O'Neill further said. Central banks are forecast to increase their focus on inflation in 2010, with the UK, India, Korea and Indonesia among countries expected to raise rates in the first half of the year. China and the euro zone are expected to follow suit by the end of the year. But the threat from underlying inflation is likely to remain muted, he added. Moreover, O'Neill said “there is a risk of a short, sharp shock in interest rates in the second half of 2010. But we don't expect inflation to be a problem over the next year. Significant government bond issuance, rising interest rates and acute sensitivity to signs of inflation are expected to weigh on government bonds.” “We believe 2010 is the year to get out of government bonds,” he said. “Yields on US and UK bonds look too low. When short-term rates start to rise, bond prices are expected to decline. We see risks particularly in the US and UK yield curves.” Valuations for corporate bonds also look stretched compared to equities although they could offer better prospects than government bonds, particularly investment-grade credit. With G10 currencies significantly overvalued relative to the currencies of emerging markets - including China, Russia and Brazil - foreign exchange volatility could rise in 2010, O'Neill noted. Nevertheless, the currencies of Brazil, Russia, India and China (BRIC) are expected to appreciate further in 2010. Foreign currency carry trades, which take advantage of differences in global interest rates, are expected to be vulnerable in 2010 to rising G10 interest rates and an appreciation in emerging market currencies if central banks relax their interventionist policies, he said. The dollar is expected to recover in 2010 on the back of stronger and sustained US economic growth and the prospect of interest rate hikes by the Federal Reserve. The dollar is expected to trade below $1.30/1 euro by the end of 2010. Commodities are expected to benefit from a 2010 return to global economic growth with crude oil expected to trade on average at around $85 a barrel. Natural gas prices should continue to recover, the report said. Total returns for investors from the energy sector, however, are forecast to be unimpressive compared to that on energy equities. Merrill Lynch Wealth Management is recommending a focus on metals, especially precious metals - gold and silver - within commodity portfolios. Among base metals, copper is expected to offer attractive returns due to emerging market demand. UK commercial real estate recovery expected Among alternative assets, UK commercial real estate - battered by the financial crisis - is expected to stage a recovery in 2010, marking the first year of gains for the sector since 2006, O'Neill said. The key challenge in 2010 will be for governments to reduce the global economy's reliance on stimulus packages, O'Neill pointed out. “We believe 2010 will be a decisive year in which the sustainability of the global recovery will be put to the test. We expect it to pass that test,” he said.
