Merrill Lynch Wealth Shuns Treasuries, Bunds on Recession Doubts
Merrill Lynch Global Wealth Management is shunning “expensive” debt from the U.S., U.K. or euro-region core in favor of local-currency denominated Asian bonds as a global double-dip recession is unlikely.
The company, which oversees more than $1.2 trillion, sees more value in developing nations’ securities, betting their currencies are more likely to appreciate, said Bill O’Neill, chief investment officer for Europe, Middle East and Africa. Merrill Lynch views Irish bonds as having the best potential among euro-area securities in the next three to six months. The company is underweight sovereign bonds, meaning it keeps its holdings of such debt below levels recommended by benchmark indexes used to gauge performance.
“Short of a rerun of a Japan experience in these countries, I don’t see significant value in these bonds relative to other asset classes,” said London-based O’Neill in an interview. Japan has struggled with deflation since a recession two decades ago.
Bond yields of top-rated nations such as the U.S., Germany and the U.K. fell to records this month as investors sought havens amid signs that the global economic recovery is sputtering two years after the deepest recession since the 1930s. Rates have also been driven down as a debt crisis in the euro region deepened.
German 10-year yields will need to rise to about 2.5 percent to 3 percent from less than 2 percent today before Merrill Lynch Global Wealth considers investing in the securities.
“We need to see safe-haven premiums washed out before we buy them,” said O’Neill. “These excessive premiums were driven by the need to preserve capital. They are too expensive in our view. I don’t see yields at these levels as having a basis for a healthy return.”
An auction of five-year German notes yesterday only drew bids from banks that are obliged to participate in debt sales, according to six people with knowledge of the offer.
Central banks in the U.S., the euro-area and the U.K. have implemented programs of asset purchases to inject stimulus into their slowing economies. The European Central Bank began buying bonds in May 2010 to stabilize markets rocked by the region’s sovereign-debt crisis.
O’Neill said it was unlikely the world will sink back into recession, even as developed economies reduce investment to pay down their national debts.
“I have no doubt central bankers still have adequate tools in the box to support growth,” said O’Neill. “They can do further quantitative measures that are more focused than in previous rounds.”
The International Monetary Fund cut its forecast for global growth on Sept. 20 and predicted “severe” repercussions if Europe fails to contain its debt crisis or if U.S. policy makers fail to resolve a deadlock over the nation’s fiscal plan.
The world economy will expand 4 percent this year and next, the IMF said on Sept. 20, compared with its June forecasts of 4.3 percent in 2011 and 4.5 percent in 2012. Its U.S. growth projection for 2011 was lowered to 1.5 percent from 2.5 percent in June. In the euro area, the IMF cut its prediction to 1.6 percent from 2 percent for this year and to 1.1 percent from 1.7 percent for next year.
The ECB’s bond-purchase program differs from the policies pursued by the Federal Reserve and the Bank of England because it mops up, or sterilizes, the liquidity created by its asset purchases, meaning the net effect on the money supply is neutral.
O’Neill predicts the ECB may stop sterilizing its bond purchases or cut interest rates later this year.
“The process of debt deleveraging still has a long way to run and that will leave the economy susceptible to shocks,” he said. “There are countries that still enjoy growth, such as Germany and the emerging-market block. They should be prepared to stimulate the economy to offset the impact from austerity measures elsewhere.”
Merrill Lynch Global Wealth is also avoiding bonds from the euro region’s most indebted countries, O’Neill said. Ireland and Portugal followed Greece this year in requesting financial aid from the European Union and the International Monetary Fund. Greece has since sought a second bailout.
The company may consider buying Ireland’s debt in the near future as the nation has made the most progress in stabilizing its debt and economy, he said.
Irish bonds handed investors a 7 percent return this year, beating all peers in the so-called euro-area periphery, including Greece, whose bonds lost 41 percent, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies.
“It’s too early to move into the periphery market, but we may be reaching that point within the next three-to-six months,” O’Neill said. “We want to see the economy moving from a primary deficit into a balance or a surplus. Ireland is in a better position to achieve this before Greece or Portugal -- it would be the one we are most likely to buy in that market.”
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