Low risk assets could offer private investors the best prospects of attractive returns in 2009 as the world’s leading industrialised nations face recession, according to Gary Dugan, the author of Merrill Lynch Global Wealth Management’s Year Ahead 2009.
With governments around the world striving to tackle the economic crisis, private investors could find value in a cautious approach towards asset allocation. Options include high-grade corporate bonds and high-quality, high-yielding equities in defensive industries, in the view of Mr. Dugan, chief investment officer of Merrill Lynch Global Wealth Management in Europe, Middle-East and Africa (EMEA).
Governments are expected to play a pivotal role in tackling the economic crisis, using tax cuts and public spending to spur growth. Governments will have to strike a delicate balance between promoting growth through public spending and resorting to excessive borrowing.
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“It’s going to be a decisive year for the world economy,” says Mr. Dugan. “Government intervention will play a critical role in determining whether we experience a relatively short and sharp downturn -- which could draw to a close within the next 12 months -- or a long and lingering recession such as that experienced in Japan in the 1990s.”
Government intervention could prove decisive
Governments may have to consider significant fiscal packages worth between 2%-5% of gross domestic product (GDP) to help kick-start their economies and boost flagging consumer and business confidence, according to Mr. Dugan.
“Investors will look to long-term U.S. government bonds as an important barometer of the progress of global recovery,” says Mr. Dugan. “Sharply rising bond yields will show that the governments have overspent.”
The policy response of governments globally to the crisis, however, could prove decisive in determining the length and severity of the downturn.
“Policy makers will have to offer effective fiscal packages to stimulate their economies,” he says. “The seeds of recovery could be sown in 2009 but if they fail to germinate we could face a multi-year recession.”
The risk of global deflation
In addition to a continued unwinding of high levels of borrowing and further profit warnings, deflation could emerge as a major theme in 2009.
“The risk of deflation is greater than many people expected,” says Mr. Dugan. “We think there is a low probability of persistent deflation but it would have a major detrimental impact. Monetary policy will need to remain aggressive and innovative to counter the threat.”3-
Global equity rally possible but likely to be short-lived
While earnings downgrades are likely to dominate the first quarter of 2009, a rally in global equity markets could be on the cards for the first half of the year with consumer and cyclical stocks among the potential beneficiaries.
Broad equities indices could also offer trading opportunities to private investors in 2009.
“Equities could outperform as an asset class in 2009 unless there is a serious deflation risk,” says Mr. Dugan. “Our view is that deflation will be avoided.”
“Government action to stimulate economic growth and central bank interest rate cuts could fuel a rally on global equity markets in the first half of 2009,” he adds. “Investors should remain cautious. They need to be prepared to take profits. We think any such rally would run out of steam by the second half of the year.”
While commodity markets could also bounce back in the first half of the year, a rebound is likely to be short-lived in the absence of strong U.S. consumer demand. Precious metals, led by gold, could enjoy a more sustained rally with gold benefiting from a weakening of the dollar in the second half of the year.
Selective investment in high-grade corporate bonds could also provide attractive returns. High-yield and emerging markets debt is likely to remain unattractive with risks of emerging markets undergoing a strong reassessment as developing economies – including the United States, United Kingdom and Canada – face recession in 2009.
Investors could also look to private equity, which produced strong returns in the downturns in 1991 and 2001, on an opportunistic basis. Some hedge fund strategies may be worth following but hedge funds should be treated with caution as an asset class in its own right in Mr. Dugan’s view.
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Sterling faces dollar pressure
While the dollar has returned to fair value, sterling is expected to remain under pressure against the dollar in the first half of 2009 amid fears of a protracted recession in the U.K., Mr. Dugan believes. But sterling could stage a recovery by the second half of the year.
Currencies of emerging markets like Russia, Brazil and South Africa could face added pressure because of their sensitivity to commodity prices.
“A potential run on emerging market currencies remains a concern,” says Mr. Dugan. “Emerging markets are expected to under perform even in a rally due to concerns about the long-term prospects for sustained growth, such as inflation and tightness of credit.”
With interest rates in some economies heading towards zero, a return of consumer confidence will be vital to reignite economic growth.
“In addition to interest rate cuts and government spending, consumers will need to feel their jobs are safe in order to feel confident about spending money,” says Mr. Dugan.
NOTES TO EDITORS
Merrill Lynch is one of the world's leading wealth management, capital markets and advisory companies, with offices in 40 countries and territories and total client assets of approximately $1.5 trillion at September 26, 2008. As an investment bank, it is a leading global trader and underwriter of securities and derivatives across a broad range of asset classes and serves as a strategic advisor to corporations, governments, institutions and individuals worldwide. Merrill Lynch has approximately 50 percent ownership in BlackRock Inc., one of the world's largest publicly traded investment management companies, with approximately $1.3 trillion in assets under management at September 30, 2008. For more information on Merrill Lynch, please visit ml.com. Merrill Lynch was acquired by Bank of America on January 1, 2009.
