The Economy

2015 Outlook: Equities “Slow to a Jog”

BofA Merrill Lynch's research team says the bull market will continue, but higher volatility, wider credit spreads and lower liquidity are on the h...
Vincent RyanDecember 11, 2014
2015 Outlook: Equities “Slow to a Jog”

Your company’s shares might not do as well next year, at least according to BofA Merrill Lynch, nor its traded bonds.

The global bank’s research outlook for 2015 predicts the bull market in global equities will continue next year but returns will slow to the single digits. What’s more, the bank foresees higher volatility, wider credit spreads and lower liquidity, especially after the Federal Reserve hikes interest rates, however slowly.

“While our key measures suggest that the bull market in equities can continue, the sentiment is far from euphoric,” according to Candace Browning, head of BofA Merrill Lynch global research. “As stocks near fair value, sentiment among the research team shifts from extremely bullish to slightly bullish,” said the research report.

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Although BofA Merrill Lynch says “robust U.S. economic growth continues to outpace the rest of the world, boding well for U.S. employment, wages and housing in 2015,” it has some reservations about the the direction of the global macroeconomy:

Inflation and Disinflation. “Core inflation in the U.S. is expected to remain steady at about 1.5%, well below the Federal Reserve’s 2% target. Meanwhile, the global backdrop is disinflationary. In 2015, we expect Japan to focus on ending deflation, while Europe faces a major threat of outright deflation, which if it occurs, could trigger another debt crisis.”

Headwinds for Commodities. “We see downside risks to energy prices on the back of OPEC’s decision to allow the market to ‘stabilize itself.’ This could result in lower oil prices but also higher price volatility. Our Brent crude oil forecast is reduced for an average of $77 per barrel, and our WTI forecast is reduced to $72 per barrel in 2015. The combination of a strong U.S. dollar, higher interest rates and relatively subdued growth should keep other commodity prices in check in 2015.”

Related, the bank expects the U.S. energy boom to moderate. “Total U.S. energy production continues to be driven by substantial shale production; however, most shale oil projects generate very little free cash flow, which means that output is highly price-sensitive. The steep price drop will impact operations of small, levered shale producers. Thus we see U.S. shale oil output growth dropping down to half of this year’s levels.”

Credit Market Pressures. “We expect next year to bring an end to an unprecedented five-year reach for yield trade as investment-grade credit spreads widen to 140 basis points with total returns close to zero. A paradigm shift in U.S. high-yield outlook should occur in 2015 with returns in the low single-digit range, as investors demand a higher premium for liquidity. Defaults should rise moderately to about 2.0-2.5%. Investment-grade and high-yield issuance is expected to decline by 10-15% next year on less refinancing activity.”

Despite all of the above factors, BofA Merrill Lynch still predicts that the Standard and Poor’s 500 (currently at 2053) will rise to 2200. “While we believe the era of excess returns and excessively low volatility is in the past, the secular bull market in stocks should continue. Expected gains in the year ahead imply a price return of approximately 6%, in line with an anticipated modest deceleration in earnings growth,” the bank’s research team said.

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