Investing In The Recovery

OCEAN CITY - One of the biggest concerns among investors today: Does this recovery have legs?

"I'm in the 'yes' camp," says David Bianco, head of U.S. Equity Strategy at BofA Merrill Lynch Global Research.

Bianco predicts that Standard & Poor's 500-stock index is likely to reach 1,200 by Memorial Day and should hit 1,275 by year-end. He bases this optimism on a number of key indicators, including his earnings outlook for the S&P 500. "Annualized earnings per share were about $70 in the first quarter of 2009, and $75 is well within reach for 2010," he says. "That's healthy earnings growth and should be easily achieved if U.S. GDP growth is 3.2% this year, which BofA Merrill Lynch Global Research economists expect."

Another sign of economic recovery is the fact that many S&P 500 companies and households were able to refinance their debt at low rates locked in for long durations. "Low interest rates are an important part of the recovery story," says Bianco.

Finally, Bianco thinks that the U.S. recovery will be boosted by its connections to growth overseas, particularly in exports and business-related spending. Globalization and the fast growth of many emerging economies have created significant growth opportunities for American corporations.

With these trends as backdrop, Bianco encourages equity investors to own the S&P 500 broadly, with moderate overweights on three sectors.

Energy. One byproduct of recovery will be an increase in oil prices, as the slowly healing U.S. economy and growing markets in Asia and elsewhere fuel demand for energy. Bianco and other members of the Merrill Lynch research team now project worldwide oil demand in 2010 to move above 2008 levels, pushing prices to an average of $84 a barrel for the year. They predict that prices could reach $92 per barrel by the second half of 2010, and $100 isn't out of the question by the start of 2011.

Industrials. The same sort of demand pressures should buoy the manufacturing and equipment sector. Ongoing urbanization in Asia will help boost manufacturers of trucks and electrical equipment, industrial suppliers, and multinational construction and engineering firms. Another potential impetus, says Bianco, is China's air travel market, which will soon be the world's second largest.

Financials (yes, financials). Hit hardest by the downturn, the stock prices of U.S. financial firms came under more pressure in late January when President Obama announced proposals for sweeping regulatory reform within the industry. Bianco believes the resulting pullback in valuations is temporary. "The market tends to overreact to signs of new government intervention," he says, "but over time the shock fades and the stocks tend to recover the initial sell-off."

Although Bianco is encouraged by what he sees, he cautions investors that the markets aren't entirely in the clear. Persistently high unemployment, a sudden spike in interest rates and the potential for sovereign debt default in Europe are among the wild cards that could still send stocks tumbling.

Investors considering reweighting their portfolios should work with their financial advisors to adopt a strategy that allows them to take advantage of these inevitable dips and adjust to changing market conditions.

(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)