NEW YORK - Although he stopped short of declaring himself bearish, Merrill Lynch Investment Managers President and CEO Robert Doll expects a decline in the capital markets in 2006, and said that the $500 billion asset manager's plan to re-brand its retail mutual funds is moving forward.
Doll, who delivered his annual 10 predictions for the coming year here last week, said Merrill Lynch would formally announce the new name for its funds this quarter with an eye on implementing it in the second quarter. Merrill first announced in November its decision to begin using outside brokers and insurers to sell its retail funds in the U.S. under a non-Merrill name. Since then, its cross-town rival, Morgan Stanley, has hinted that it intends to do the same.
"It's such a strong brand, it's difficult for advisers at other firms to recommend Merrill Lynch products," Doll explained. "The client sitting across from them typically asks, Why did I come here then, I should have just gone to Merrill Lynch.'"
Doll did not offer any indication of what that name might be, saying only that it would accelerate the firm's greatest potential growth area and that the name change would be restricted to its third-party retail funds.
Looking ahead in 2006, Doll said he would be overweight in technology and energy, underweight in financials and consumer staples, and middle-of-the-road on healthcare, ex-pharmaceuticals. And like 2005, asset allocation will be just as important to investors as diversification.
"It will probably be an up year, but we'll have to work a little bit harder, with our seat belts on a little bit tighter," said Doll, who said he scored on "7.5 out of 10" of his predictions for 2005. Doll said he was too pessimistic about corporate earnings growth, too optimistic about the shrinking deficit, and narrowly missed on his predictions for short-term interest rates and bond yields.
Speaking more broadly, the 25-year investment management veteran said he expects that the U.S. equity market will experience its first 10% decline in four years, although a strong start to the year and an impressive finish should provide balance.
"We are not bearish," Doll warned. "We simply think that volatility is going to pick up. A 10% correction is normal. On average, they happen every 18 months, and the notion is that we haven't had one for almost fours years, so to think a 10% correction might happen is very normal."
But it's more than just timing, added Doll, whose unit boasts 42 products with four- to five-star Morningstar ratings. The bull market that began in October 2002 is in the process of maturing and is closely tracking its predecessors, he said, so to think it might experience a pullback is normal.
Also, every bull market with the exception of 1986 has experienced a lull in its fourth year before proceeding forward again. Furthermore, when the bond yield curve flirts with inversion, as it did last month when short-term Treasury returns threatened to overtake 12-year notes, the stock markets tend to flatten.
"So perhaps a correction is on the way, consistent with the 1980s and the 1990s, preparing the way for the second half of a bull market," Doll remarked.
Doll additionally predicts that, led by a slowdown in consumer spending, U.S. real GDP growth will slow to around 3%. Higher interest rates and energy prices are the culprits behind consumer reluctance, he said.
"Rate hikes and oil prices are not yesterday's stories," Doll observed, adding that weakness in what to date has been a resilient housing market will further tighten consumers' wallets in 2006.
Doll doesn't expect earnings to record an unprecedented fourth consecutive year of double-digit growth in 2006 but instead to slow to a more normalized rate of 5% to 7%. The U.S. yield curve should invert this year for the first time since 2000 on further rate tightening by the Fed, and 10-year Treasuries will trade with a yield range between 4% and 4.99% all year long.
The U.S. dollar will resume its downward trend, Doll added, while non-U.S. equity markets will outperform those here at home for a fifth consecutive year and fund flows will therefore continue into international products. In addition, Republicans will likely retain a majority of seats in Congress, a development Doll hopes will ensure preservation of important tax cuts on dividends and capital gains.
Returning to equity selection, Doll reiterated the importance of asset allocation and said he expects that for the first time since 1999, growth will outperform value and large-cap will outperform small. Between 2003 and 2005, value beat growth by an average of more than 7% and small outpaced large by 10%.
"It's time for a reversal for a host of reasons," he declared.
For starters, there's the notion of mean reversion, he said, but further under the surface are factors like earnings growth, a pre-cash flow yield advantage, non-U.S. exposure and a valuation advantage that point to "large over small and big over little."
Companies with pricing power will likely perform best, he added, while capital-related companies will perform ahead of consumer-related companies.
More specifically, Doll said he likes technology because its executives are no longer talking about market share and new gizmos; rather, they're now discussing topics like cash flow, share buybacks and margin improvement that point to a more shareholder-friendly management style. Energy is a popular choice for many of the same reasons that made it a hit in 2005, namely that oil and gas prices will remain stubbornly high. On the healthcare front, Doll is more cautious, but he underscores the services side.
Concerns over the flattening yield curve, additional Fed hikes and the overcapacity in banks makes it difficult to determine where the growth lies, so Doll is underweight in financials. The same goes for consumer staples, where anticipated cost increases in raw materials would adversely impact corporate profits.
In term of bets on merger and acquisition activity, Doll predicts a repeat of the environment of 2005, where it was very broad-based from an industry and sector standpoint. That being said, he continued, companies with excess cash flow generation, and therefore consolidation potential, lie in sectors like energy, technology, healthcare and some financials.
"That's well over half of the U.S. stock market capitalization, so we would argue that M&A activity is likely a feature we'll live through in this environment," Doll said.
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