Asset Allocation and Portfolio Perspectives

Q and A with Paul McCauley, Private Wealth Advisor for Merrill Lynch Private Banking, Boston, MA

Should investors approach their financial allocation with the mindset that the worst is behind them?

For the time being, the peak in investor fear has passed. Earlier in the year investors were fearful of systemic bank failures, bank nationalizations, a deep global recession, if not depression, and the view that policymakers were far behind the curve in understanding the problems the world faced.

Since then, signs of improving fundamental support have begun to surface. According to the Banc of America Securities-Merrill Lynch Research Investment Committee, many indicators such as earnings revisions, industrial production, and producer prices appear to be near bottoms. This fundamental data is coming off very low levels and the recent upturn needs to be maintained to further restore confidence and sustain any rally from this point forward.

If the market appears to be stabilizing, where do you see the market moving in the next few months?
Both bulls and bears make valid and compelling arguments about the future direction of markets. Policymakers have done a good job of reducing the risk of a deflationary depression and monetary, fiscal and financial policies have likely created a floor for credit and equity markets. But, there are a few macro convictions that are likely to change portfolio behavior in the coming quarters.

According to Banc of America Securities-Merrill Lynch analysts, a return to the high growth/low inflation combo of recent years is unlikely and this recovery will be uneven. Because of this effect, we are likely to see a wide trading range in many credit and equity markets. A more balanced, flexible and tactical approach is required of investors rather than a dogmatic bull-bear dichotomy.

Inflation is currently a low risk scenario, but pockets of inflation around the globe are very likely and investors need to hedge against this risk.

If there is opportunity in the market now, how should investors manage their assets in today’s market?
Investors should stress the importance of income in their portfolios and focus on higher quality assets. Quality will prevail over time even if markets are vulnerable to large trading swings in lower quality assets. Investors should be prepared to put cash to work on pullbacks.

Investment Grade Bonds offer more attractive yields than Treasuries for moderate and aggressive portfolios, according to the Banc of America Securities-Merrill Lynch Research Investment Committee. There are some people who believe the risk of a severe global recession has been reduced, and for those believers, these bonds are a relatively attractive alternative to Government bonds.

Should long term investors adjust their portfolios to address the changes in today’s economy?
Many long term investors are turning to the global infrastructure theme as a way to further diversify portfolios and capture the growth that is taking place globally. According to Banc of America Securities-Merrill Lynch analysts, construction, engineering, utilities and certain commodities benefit from infrastructure spending.

Another major long-term investment opportunity can be found in emerging markets with the rise of the emerging market consumer. The size of the emerging market population coupled with rising incomes and rising credit growth create compelling long term investment opportunities.

This is an extremely critical time for investors to evaluate current portfolios to reflect risk tolerance, income requirements, and time horizon.

Paul McCauley; Merrill Lynch Private Banking and Investment Group; Paul_mccauley@ml.com