The long bull market cycle of excess stock and bond returns is expected to finally wind down next year, according to Bank of America Merrill Lynch Global Research, but not before “one last hurrah”. 
In its outlook for the global markets and economy in 2019, the bank said “the bear market vibe” that struck investors at the end of 2018 will likely continue into the new year. Asset prices are expected to hit lows during the first half of the 2019 once rate expectations peak and global earnings expectations trough.
That said, BofA Merrill Lynch also forecasts a ‘record high’ peak in earnings for the S&P 500 next year and “plenty of upside potential” for investors who are willing to embrace the renewed volatility that the market throws out.
Candace Browning, head of BofA Merrill Lynch Global Research, said: “In our view, the current weakness in the markets is not a reflection of poor fundamentals.
“Rather, it’s caused by a confluence of idiosyncratic shocks that create very real risks for investors to be concerned about but also opportunities for vigilant, well-positioned investors to pursue.”
Against this backdrop, FE Trustnet reviews 10 macro calls that BofA Merrill Lynch Global Research is making for the coming 12 months.
1. Global profit growth declines
The BofA Merrill Lynch research team expects earnings growth to decline “sharply” in 2019 on a global basis, moving from a 15 per cent increase on 2017 this year to a 5 per cent year-on-year decrease next year.
This leads its analysts to be bearish on stocks, bonds and the US dollar, while bullish towards cash and commodities, and long on volatility.
“We expect to turn tactically risk-on in late spring, but to start 2019 with a bearish asset allocation of 50 per cent stocks, 25 per cent bonds and 25 per cent cash,” the team added.
2. S&P 500 peaks
BofA Merrill Lynch’s analysts also see US earnings growth slowing in the US, although they added that the near-term outlook remains “somewhat positive”.
The group has forecasted earnings per share (EPS) growth for the index of 5 per cent next year, which would put the S&P 500 EPS at a record high of $170.
That said, the S&P 500 index is expected to peak at or slightly above 3,000 before easing off to end 2019 at around 2,900.
When it comes to positioning, the bank’s US equity strategists are overweight healthcare, technology, utilities, financials and industrials, while underweight consumer discretionary, communication services and real estate.
3. Cash gets competitive
“For most of this long cycle, cash yields couldn’t hold a candle to more compelling asset class alternatives like stocks and bonds; with cash yields higher than dividend yields for 60 per cent of the S&P 500 already, cash becomes even more competitive in 2019,” BofA Merrill Lynch analysts said.
The bank’s outlook for the Federal Reserve puts short rates at close to 3.5 per cent by the end of 2019, which is well above the S&P 500’s 1.9 per cent dividend yield.
“Moreover, in a rising-rate environment, cash-generative investments have outperformed credit-sensitive assets,” the outlook continued. “Given cash’s re-rating, 2019 boils down to a strategy of buying sources of cash and selling users of cash.”
4. US economy slows as fiscal stimulus fades
The US economy is the largest in the world by some margin but the BofA Merrill Lynch research team sees real US GDP growth of 2.7 per cent in 2019, slowing down in the second half as the effects of fiscal stimulus start to fade.
Analysts added that the housing market is no longer a tailwind for the US economy; they consider housing sales to have peaked and noted that home price appreciation is forecast to slow.
However, the US unemployment rate is also tipped to fall to 3.2 per cent, which would be a 65-year low. This could lead to wage growth of 3.5 per cent in aggregate, which would gradually push core price inflation to 2.2 per cent through 2019 – where it would remain as rates rise.
5. Global economic growth decelerates
Forecasts have the global economy as growing by 3.6 per cent in 2019, which is slightly down from the 3.8 per cent anticipated this year. Inflation will hover around the 3 per cent mark.
Most major economies are likely to see decelerating activity, with real GDP growth for both Europe and Japan expected to be 1.4 per cent in both Europe and Japan. Emerging markets are tipped for 4.6 per cent growth, in aggregate.
China, which is the world’s second biggest economy, is expected to see its growth weaken in 2019 on the back of the US-China trade spat and still-tight financial conditions. But a steady stream of monetary and fiscal stimulus from Chinese authorities would help turn the economy around.
6. Global monetary policy divergence
“Global monetary policy is expected to become less friendly in 2019,” BofA Merrill Lynch’s analysts said.
“A divided government means that additional fiscal stimulus in the US seems unlikely. Europe is largely frozen in place by its budget rules, and Japan appears ready to implement yet another ill-timed consumption tax hike, in our view.
“Further divergence in monetary policy between the Fed and other major central banks is expected to continue. We forecast the Fed will hike rates four times in 2019, reaching a terminal funds rate of 3.25-3.50 per cent by year-end.
“Meanwhile, the European Central Bank and Bank of Japan are unlikely to raise policy rates meaningfully above zero for at least another two years.”
7. Credit cycle continues despite widening spreads and flattening curves
Global credit markets will be struck by high levels of episodic volatility in 2019 as shrinking supply and quantitative tightening from central banks put an additional 25-to-50 basis points of upward pressure on investment grade and high yield bond spreads.
BofA Merrill Lynch forecasts total returns of 1.42 per cent for investment grade corporate bonds and 2.4 per cent for high yield. The US leveraged loan market is expected to achieve returns of between 4 and 5 per cent, making it “a bright spot in the credit spectrum”.
In Europe, investment grade and high yield are seen as making total returns of 1 per cent; in Asia, expected returns stand at 3 per cent and 4.9 per cent, respectively.
8. Emerging markets
Emerging market assets have sold off heavily across 2018, leading BofA Merrill Lynch’s analysts to describe them as “cheap and under-owned”.
They added that emerging markets could be “a big winner in 2019” as the US dollar weakens but pointed out that the asset class remains highly vulnerable to spillover effects from the US-China trade dispute.
“We are bullish Brazil and expect its post-election rally to continue and Russia is expected to improve as we believe sanction risk is priced in,” the research team said.
“Meanwhile, the outlook is bearish for Mexico, where credit rating downgrades are a concern and volatility surrounds policy changes under its new president.”
9. Foreign exchange volatility on a weaker dollar
The US dollar was the best performing asset class in 2018 but BofA Merrill Lynch’s research argued that most of the greenback’s gains appear to be in the past.
It predicted that the dollar will be weaker in 2019, against a stronger euro and Japanese yen. EUR/USD is expected to reach 1.25 by the end of next year; USD/JPY is tipped for 125.
“The strength of the dollar will depend heavily on evolution of the trade relationship between China and the US, which in the short term may mean selling the dollar against a currency insulated from trade war rhetoric, such as the British pound and Swiss franc,” the analysts said.
10. Commodities modestly positive
BofA Merrill Lynch’s outlook for commodities is modestly positive, even though it sits against a challenging global macro environment.
“We forecast Brent and WTI [west Texas intermediate] crude oil prices to average $70 and $59 per barrel, respectively in 2019; weather-induced volatility is expected in the near term for US natural gas, as cold weather could propel winter natural gas over $5/MMbtu [million British thermal units], yet we remain bearish longer term on strong supply growth,” the bank’s analysts said.
“In metals, we remain cautious about copper because of Chinese downside risk. We forecast gold prices will rise to an average of $1,296 per ounce, but could rally to as high as $1,400, driven by US twin deficits and Chinese stimulus.”