Ten Investment Themes For 2010 ~ market folly

Tuesday, December 8, 2009

Ten Investment Themes For 2010

From Bank of America Merrill Lynch comes investment strategy in the form of '10 themes for 2010.' Keep in mind that these represent their opinion so take everything with a grain of salt. They feel that next year will be "a genuine watershed" in that it will reveal whether or not this 'recovery' is real or whether the fundamentally drawn out weakness typically associated with bear markets will rear its ugly head. Their Research Investment Committee thinks that the printing of money through quantitative easing and record budget deficits will help the country on the road to recovery but think inflation will remain low throughout 2010, thus providing a bullish environment for stocks and commodities. As with many other market pundits, they feel emerging market demand will fuel commodities (especially gold). On the contrary, they dislike government bonds. The 'top 10' theme seems to be prevalent out of Bank of America Merrill Lynch lately as we also recently covered the top ten stocks owned by hedge funds.

Here is Bank of America Merrill Lynch's Ten Themes For 2010:

  1. Government balance sheet risk
  2. Rising taxation
  3. Alternative yield strategies
  4. Financial sector rehabilitation
  5. Corporate cash flow beneficiaries
  6. Rising global growth
  7. The emerging market consumer
  8. Commodity price inflation
  9. The return of active management
  10. Alternative energy

So, an interesting set of themes with some arguably already taking place as we head into the end of this year. Let's now take a closer look at each individual theme to examine their rationale, possible investment ideas, and assets to avoid. Here we go:

Theme #1) Government balance sheet risk: For this theme, they cite IMF data that "total public debt as a % of GDP will exceed 100% in advanced economies in 2010." They think that 10 year Treasury yields will be above 4% by the end of 2010.

Investment ideas for this theme: Materials equities and emerging market stocks. Also, intermediate term investment grade corporate bonds.

They think you should avoid long duration US Treasuries. Many prominent investors and market gurus have advocated avoiding treasuries in one form or another, including hedge fund legend Julian Robertson whose inflationary wager we've covered before.

#2) Rising taxation: They again cite the US budget deficit here as well as health care reform and a second stimulus package as the rationale for higher income taxes on both the state and local level in 2010.

Investment ideas: They like general obligation municipal bonds and muni bond ETFs as well as closed end funds. (Specifically: NUV, MYD, NPI, and NPM).

Avoid: Private purpose muni bond issues.

#3) Alternative yield strategies: Next, Bank of America Merrill Lynch's focus turns to the possibility of higher taxes chasing people out of typical dividend plays and they see tax deferred strategies benefiting here.

Investment ideas: Tax advantaged strategies and also large cap plays such as KMP, EPD, PAA, and ETP.

Avoid: Stocks with rising yields due to their decreasing stock price. Be wary of high yield 'traps.'

#4) Financial sector rehabilitation: Fourthly, we see that they think financials will benefit from low rates here in the US with steep yield curves elsewhere in the world. They also believe that the normalized earnings power of many financials has been underestimated.

Investment ideas: Mega cap financials in global markets (particularly in Brazil, China, and Europe).

Avoid: Regional financials and small cap plays. We've seen this trade many times before as many hedge funds have been long money center banks and short regional banks. Whitney Tilson's T2 Partners has been short Regions Financial (RF) as a perfect example. Not to mention, Bank of America (BAC) was one of the most widely owned stocks amongst hedge funds we track in our portfolio tracking series.

#5) Corporate cash flow beneficiaries: BofA Merrill thinks that large cash piles will be deployed in the form of M&A, dividends, and capital spending.

Ideas: Companies that will benefit from capital spending, including temporary staffing companies and the industrial sector. They also like small caps in the sectors of health care and technology.

Avoid: Auto and airline industry equities. Also be wary of corporate bonds of lower-rated issuers.

#6) Rising global growth: For this theme they cite global policy stimulus as well as higher capex obviously and feel the growth will be led by emerging markets.

Investment ideas: Exchange traded funds (ETFs) with exposure to both US and European cyclical plays (large cap industrials and materials). They also suggest mega cap multinational companies.

Avoid: They say to avoid domestic industries/sectors such as telecom, healthcare, as well as consumer discretionary.

#7) The emerging market consumer: This potential theme can be attributed to higher savings rates in other countries as well as the revaluation of the RMB in China which they claim will make the Chinese "5% richer."

Ideas: Asian banks, mega-cap multinational plays as well as emerging market forex versus the US dollar.

Avoid: Discretionary stocks in developed markets.

#8) Commodity price inflation: While we have already seen strong signs of this occurring, they feel the theme plays into 2010 due to emerging market demand strength as well as supply constraints. As far as gold is concerned, they argue that diversification in reserve currency by other central banks (particularly in emerging markets) should yield higher gold prices. Gold has been a hot topic as of late with its notable price ascension. Famous hedge fund manager John Paulson is now banking on inflation and betting against the US dollar via his new gold fund which we examined in-depth.

Investment ideas: Exchange traded funds (ETFs) with exposure to gold or global energy stocks; High quality diversified miners, commodity exporters.

Avoid: Automakers, airlines, and consumer durables.

#9) The return of active management: They feel a decrease in market volatility will see "greater differentiation in asset price performance."

Ideas: Actively managed funds and high quality stocks.

Avoid: Benchmark weightings.

#10) Alternative energy: Apparently this theme will be back with a vengeance after falling out of the spotlight when oil prices crashed down from record highs. Bank of America Merrill Lynch believes that this is a long-term secular theme and that emerging market trends will help fuel this growth. Obviously, higher oil prices will drive further investment into alternatives as well.

Investment ideas: Exchange traded funds (ETFs) that give you exposure to the vast spectrum of alternatives (wind, solar, nuclear, etc).

Avoid: Utilities and 'old energy' equities.

So there you have it, quite an interesting list of potential themes. We'll have to see if the vast majority of them play out, because we've already seen signs of a few of them. For more 'top 10' lists worth checking out, head over to our post on the top ten stocks owned by hedge funds.

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