Merrill: Slow growth favors global fixed income, select commodities

The following is excerpted from a report by the Chief Investment Officer Team for Merrill Lynch Wealth Management. The team is headed by Lisa Shallet, CIO of Merrill Lynch Global Wealth Management and head of investment management & guidance.

We continue to believe that the dynamics of very slow global growth, debt-driven deflationary pressures and deleveraging will favor global fixed income and select commodities over stocks in the intermediate term. That said, as 2012 unwinds we believe large underweights to equities will not be warranted. For those investors who have largely been sitting on the sidelines in cash, we would source rebalancing funds from cash and U.S. Treasuries to achieve neutral equity weightings. For those already fully invested, we increasingly see the value of establishing some bar-belled exposures with increased equity risk (rotating a bit to higher volatility allocations through Emerging Markets, high-yield bonds and select cyclicals, especially those that are energy related) being balanced by solid income-generating allocations.

Active stock selection is likely to matter in 2012, with our framework favoring those who can drive earnings growth through pricing power and secular strength. With dynamic asset allocation remaining critical, we continue to see global multi-asset or flexible mandates as an effective way to navigate the crosscurrents in 2012.

With a keen eye on capital preservation, we are focused on proactive risk management. Our approach has three prongs:

-First, we encourage investors to diversify risk through a more global and multi-segmented approach to asset allocation. For equities, this means eliminating excessive home-country bias and including exposure to Emerging Markets. In fixed income, while we have continued to favor high-quality municipals, we think investors should consider exposure to a mix of corporate high-grade and high-yield bonds as well as non-U.S. sovereign and corporate debt. Broadening asset class exposure may also be appropriate for some investors who might consider including real assets, gold and low volatility/absolute return-oriented alternatives in their portfolios.

-Second, we think that overall portfolio risk can be reduced by exploiting today’s scarcity themes of Growth, Quality and Yield. Where market volatility has caused portfolios to drift from long-term asset allocations, rebalancing opportunities exist to add to these themes. Large, multinational dividend growers, many of which gain market share in the secular growth story of the Emerging Market consumer, are opportunities.

-Finally, we see opportunities to be more tactical as we actively manage risk. Higher volatility creates more risk but also more opportunities. Utilizing a flexible multi-asset manager for a portion of your equity sleeve can help raise the odds that absolute return goals are met.

What You Should Consider in Your Portfolios
-The guidance below, and how it is implemented, should be considered only in light of your individual investment plan—including your risk tolerance, horizon, objectives and liquidity needs. You should discuss these with your Financial Advisor.

For clients with cash to put to work today in risk assets:
-We would build our shopping lists to opportunistically execute during the first half of
2012. We expect continued market volatility to provide entry points. Our preferred investments include U.S. secular growth stories, including technology and energy; select Emerging Markets, specifically in the Asian Pacific and Latin American regions; global fixed income and high-yield debt.

Potential Tactical Opportunities for the Next Several Months for investors seeking to tilt their portfolios:
-Focus taxable fixed income exposure to intermediate-term high-grade corporate and global sovereign debt in countries like Canada
-For non-taxable fixed income, look to short-to-intermediate high-quality municipals, where we recommend you consider diversified actively managed investment vehicles
-Focus domestic equity exposure on dividend-growing large cap multinationals
-Utilize global flexible and unconstrained managers for a portion of core equity risk
-Increase tactical exposure to gold
-Consider using market neutral and relative value hedged strategies
-Consider principal/downside-protected market-linked investments
-Use market dislocations to rebalance toward the long-term, goal-based strategy

For clients with a longer-term investment horizon:
-Consider deep value exposure in select financials and small cap stocks