2005 marked a year of 'muddling through' for the US financial markets, according to Bob Doll, President and CIO of Merrill Lynch Investment Managers.
'Stocks were up around 5 per cent (as measured by the S&P 500® Index), cash returned around 3 per cent and bonds (represented by the 10-year Treasury) returned close to 2 per cent. These returns represent the closest finish for these three asset classes in well over a century.
This was reasonably impressive performance given the number of times the Federal Reserve raised interest rates, the more than 50 per cent increase in the price of oil and the rise of the US dollar. We believe this resilience reflects strong earnings growth, low core inflation and extremely healthy corporate balance sheets. Strength in the global economy and non-US equity markets helped as well, as did dividend increases, share buybacks and strong merger and acquisition activity.
While US economic growth slowed from around 4.5 per cent in 2004 to close to 3.5 per cent in 2005, earnings growth remained strong with low double-digit percentage gains. The US economy is beginning its fifth year of expansion (the average length of an economic expansion is 5.75 years), but real economic growth has been only about half of what it would be in a normal economic cycle, while corporate profit growth has been much stronger than normal.
The length of the equity bull market has now matched the average of post-WWII bull markets (38 months), but is some distance short of the typical bull market gain. 2005 ends with a US consumer who is challenged, a Fed that is hopefully almost finished raising rates, profit margins at record levels and continued concerns about the structural problems of debt and deficits in the U.S. It is with this backdrop that we venture forward with our ten predictions for 2006:
1. The overall U.S. economy slows to 3% growth as the front end (the consumer)
weakens while the back end (capital spending) is relatively strong.
2. Earnings fail to meet the consensus expectation of double-digit percentage gains.
3. The U.S. yield curve inverts for the first time since 2000, while the US 10-year
Treasury trades with a four-handle yield all year.
4. The U.S. equity market experiences its first 10% correction since 2002, preparing the way for the second half of the bull market.
5. Growth outperforms value and large cap outperforms small cap for the first time since 1999.
6. The U.S. dollar resumes its downtrend.
7. Lead by Asia, non-U.S. equity markets outperform the U.S. for the fifth year in a row.
8. Strong cash flow leads to another year of high dividend increases, share buybacks and M&A activity.
9. Commodity prices are higher in 2006 than they were in 2005.
10. Republicans retain control of Congress, but relinquish some of their advantage in the 2006 election.'
Background notes: Bob Doll is President and Chief Investment Officer of Merrill Lynch Investment Managers (MLIM) and its investment advisory affiliates, including Mercury Advisors. He joined MLIM in 1999 and has held a variety of senior management positions. Merrill Lynch Investment Managers has more than USD 518 billion in assets under management.
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