merrill lynch research expects global economy to rebalance in 2008
Global economy to remain resilient to a slowdown in U.S. growth
NEW YORK and LONDON, December 4, 2007 — A new report by Merrill Lynch (MER) Global Research expects the global economy to remain resistant to a slowdown in U.S. growth. However, Merrill Lynch economists and strategists believe that whereas 2007 was a year of continuing trends, 2008 will likely be a year of economic inflection points with the rate of GDP growth rapidly changing in many countries. In the report “2008: The Global Macro Year Ahead,” Merrill Lynch has identified the following three significant cross-regional themes for 2008:
1. Global imbalances are unwinding; therefore, export-oriented companies are likely to outperform in the U.S., and domestically-oriented companies elsewhere.
2. There are risks and limits arising from decoupling that need to be monitored.
3. Investment in Sovereign Wealth Funds continues to grow.
“All three calls underscore our optimism that the global economy remains resilient to U.S. economic slowdown,” said Alex Patelis, head of international economics at Merrill Lynch. The report forecasts global growth ex-U.S. moderating to 5.6% next year from 6.0%, even as the U.S. slows from 2.2% to 1.4%.
Global economy to rebalance in 2008
The rebalancing of the global economy is one of three main calls for 2008 from Merrill Lynch. Imbalances in the global economy, stemming from historic dependence on the U.S. consumer, have peaked and will unwind throughout the coming year, conclude Merrill Lynch’s economists and strategists. This ‘rebalances’ the growth within countries. At the heart of this rebalancing, which could last several years, is the growing power of consumers outside the U.S. and the prospect of a consumer recession within the U.S. High levels of personal debt are curtailing spending habits of U.S. consumers, while prospects for domestic demand are strong outside the U.S. Merrill Lynch believes that rebalancing will be the dominant economic theme for the next three to five years. Rebalancing implies that investors should take overweight positions on export-oriented companies in the U.S. and domestically-oriented companies elsewhere. Also contributing to the rebalancing is the continued weakness of the dollar. Merrill Lynch’s trading conditions will favor two groups - U.S. corporations focusing on exports, and non-U.S. companies focusing on their domestic markets.
Risks and limits arising from decoupling need to be monitored.
In the second call, Merrill Lynch argues that investors should monitor risks and limits rising from the continued trend of the U.S. and world economies decoupling. While many investors are asking whether a severe U.S. downturn could prompt a world slowdown, Merrill Lynch focuses on the exact opposite: which risks might arise from the continued boom in the rest of the world relative to the U.S.? The report notes that these risks include the possibility of a U.S. dollar crisis, inflation, tightening (via higher rates, stronger currencies, capital controls or quantitative measures) or the negative side-effects of inflation. Although these issues could emerge in specific countries in 2008, Merrill Lynch does not think they will be binding for the global economy as a whole.
Investment in Sovereign Wealth Funds continues to grow
Finally, in the third call, Merrill Lynch believes that Sovereign Wealth Funds, boosted by rapidly growing central bank reserves, will play an important role in boosting global liquidity. Merrill Lynch expects Sovereign Wealth Funds to double or triple their share of riskier global assets by 2010, and grow to a potential US$8 trillion by 2011.
Recession ahead for US consumer
According to the Merrill Lynch report, export-led companies are the silver lining for the U.S. economy.
“The U.S. is on the precipice of its first consumer recession since 1991, which was the last time the market suffered from a confluence of high energy prices, weakening employment conditions, real estate deflation and tightening credit,” said David Rosenberg, Merrill Lynch chief North American economist.
Merrill Lynch expects modest growth to take hold late in 2008, though the U.S. Federal Reserve will need to cut interest rates to 2% by mid-2009 to sustain the recovery. Latin America faces another year of solid and less volatile growth. However, the region faces challenges from less favorable U.S. market conditions and from high inflation that will limit scope to stimulate growth through rate cuts.
Japan’s economic cycle could bottom in late 2008; liquidity abundant in Asia
Merrill Lynch expects that the Japanese economic cycle could reach a bottom in the second half of 2008, as wages begin to climb again and the Bank of Japan cuts interest rates to stimulate growth. Job losses have already resulted from lower profits at smaller companies.
Liquidity is abundant in the rest of Asia, but constraints on economic resources are drawing near, with upside risks to inflation, domestic asset prices, or both.
“Looking into 2008, we think the macro backdrop remains positive for Asian stocks and especially currencies—for us, a multi-year standing call,” said TJ Bond, Merrill Lynch chief Asia Pacific economist.
Fundamentals to underpin Eurozone growth
"Growth in the Eurozone will slow but remain solid in 2008." said Klaus Bader, Merrill Lynch Chief Europe economist. Merrill Lynch believes that the strong currency, high oil prices and credit turmoil will impede faster growth. However, according to the report, strong fundamentals, including an absence of imbalances, and supportive monetary and fiscal policies underpin the region’s strength. U.K. growth is expected to slow significantly, while Switzerland’s dependence on the financial sector counts against it.
Growth in emerging EMEA will be strong in 2008, but with large variations from country to country. Uniting the entire region is the risk of higher inflation which could prompt revaluations of certain currencies. In the Gulf, fiscal spending should surge as the region starts spending windfall proceeds from the high oil price.
Oil price to spike before falling; dollar to recover against G10 currencies
Merrill Lynch believes that oil prices could spike further before Emerging Market governments move to reduce demand or OPEC moves to increase supply. Francisco Blanch, Merrill Lynch head of Commodities Research, points out that increased production and potentially slower growth should push prices below US$70/bbl by the final quarter of the year. Prices of precious metals should continue to rise, but the outlook for industrial metals, except nickel, is negative.
Merrill Lynch expects the dollar to fall further against the euro and yen before starting to recover against G10 currencies. More heavily-managed currencies, such as those in Asia, Middle East and Russia, will continue to appreciate.
Investment implications
Under these scenarios, Merrill Lynch believes that the macro backdrop remains positive for equities versus bonds. Merrill Lynch recommends that rising economic volatility, declining correlations and higher short rates require shifting some money from stocks to cash, purchasing protection, carefully managing risk, and ensuring a diversified portfolio.
Merrill Lynch Global Research has consistently achieved high rankings for its equity and fixed income research in numerous regional and global investor surveys, such as Institutional Investor, The Wall Street Journal, LatinFinance, Asiamoney, Euromoney, Extel and Reuters.
Merrill Lynch is one of the world's leading wealth management, capital markets and advisory companies, with offices in 38 countries and territories and total client assets of approximately US$1.8 trillion. 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 owns approximately half of BlackRock, one of the world's largest publicly traded investment management companies, with more than US$1 trillion in assets under management. For more information on Merrill Lynch, please visit www.ml.com.
