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Don't waste your time on the Fed, Merrill tells investors

Ethan Harris has some advice for investors who are fixating on the U.S. Federal Reserve Board for clues to the direction of financial markets: You're hitching yourself to the wrong horse.

"My advice to investors is, don't read anything about the Fed these days. It's a non-story," Mr. Harris, head of developed-markets economics research at Bank of America Merrill Lynch, told investors and media at the big U.S. investment bank's mid-year economic and markets outlook event in New York on Monday. "The Fed is many, many months from tightening."

In a wide-ranging presentation from Merrill's top strategists, the investment bank offered a cautiously upbeat outlook for the rest of 2010 and into 2011 - something of an evolution away from the bank's more bearish tone of previous years, perhaps reflecting a changing of the guard at Merrill's research department since Bank of America acquired the prominent Wall Street investment house early last year.

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Merrill's current group of strategists is telling investors that despite cheap liquidity and high government deficits, inflation is not a threat in the United States; that the European sovereign-debt problems look likely to be well-contained; and that government deficit reductions won't be as difficult or painful as many people fear.

The odds right now greatly favour the bull. David Bianco, head of U.S. equity strategy, Bank of America Merrill Lynch

As a result, Merrill's experts predict a slow-but-gradual "healing" of the U.S. economy, solid growth in emerging economies, relatively stable financial markets - and opportunities for equity investors to cash in.

"The odds right now greatly favour the bull," said David Bianco, head of U.S. equity strategy.

Mr. Bianco argued that the markets are pricing in another recession - which has left U.S. stocks undervalued relative to their earnings-growth outlook. He said that even pricing the S&P 500 based on a modest valuation of 15 times forward earnings estimates, it looks poised for something like 1,300 by the end of 2010 - more than 20-per-cent higher than current levels.

And this could happen even in an environment of fairly modest U.S. economic growth, he said, because the stocks in the S&P 500 have much more exposure to foreign markets than the broader U.S. economy does - meaning more exposure to parts of the world likely to outpace the U.S. economy.

"Too often we look at the S&P 500 through a U.S. prism," he said. In reality, 40 per cent of the U.S. stock benchmark's earnings are derived from foreign markets. It also has a greater exposure to commodities relative to the U.S. economy, which adds to the influence of economic growth in developing markets such as China.

G20 countries should be able to naturally grow their way out of the deficits to meet the deficit-reduction targets by 2013, without any stifling spending cuts or tax increases.

Mr. Bianco noted that the S&P 500 does derive 18 per cent of its profits from troubled Europe, but said most of that is outside the financial sector, and thus less at risk to the sovereign debt threat.

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"As long as Europe doesn't go into full-blown recession, S&P European profits should be fine."

Mr. Harris played down concerns that government austerity commitments, the centrepiece achievement of the G20 summit, threaten the economic recovery. He said they should be able to naturally grow their way out of the deficits to meet the deficit-reduction targets by 2013, without any stifling spending cuts or tax increases.

"What does that require? They don't have to do anything," he argued.

The one big concern for the U.S. economy, though, remains the still-weak jobs market.

"Job growth is essential to the healing process," Mr. Harris said. "It's the key to sustainable growth."

But even there, he sees steady improvement as the year progresses, the U.S. economy shows traction and companies finally get back to hiring.

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"We think that people overfired" during the recession, he said.

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About the Author
Economics Reporter

David Parkinson has been covering business and financial markets since 1990, and has been with The Globe and Mail since 2000. A Calgary native, he received a Southam Fellowship from the University of Toronto in 1999-2000, studying international political economics. More

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