Speaking at a press event today in New York City, analysts at Bank of America (BofA) Merrill Lynch said they predict a 3.2% GDP growth for the U.S. economy and a 4.4% growth on a global scale, led by China at 10.1%.

Similar to other industry outlooks for 2010, BofA Merrill’s is modestly optimistic (see “Equities Look Good for 2010” and “ING: Expect ‘Lackluster’ Recovery for 2010”). “We aren’t forecasting a swift return to robust growth. In fact, the recovery will likely lag behind those of previous recessions—but we believe that the world economy will perform better than the economic consensus would indicate,” said Ethan Harris, head of North America economics and coordinator of global economics, in a statement.

David Bianco, head of U.S. equity strategy, expects the S&P 500 to be 1275 by year-end 2010 (about a 15% increase). Bianco said sales growth will be driven by four sectors: Technology, Energy, Industrials, and Materials—all of which have high direct foreign sales and benefit from high commodity prices. Bianco also expects Financials to “climb high” as a result of steepening yield curves and underestimated normalized earnings power.

Michael Hartnett, chief global equity strategist and chairman of the BofA Merrill Lynch Research Investment Committee, is bullish on European equities, Asia, and emerging markets.

In contrast to equities and commodities, rising long-term rates make government and corporate bonds look less attractive, according to BofA Merrill Lynch. The analysts expect modestly negative returns on long-term Treasuries, forecasting the 10-year Treasury yield to be 4.25%.

Harris said he doesn’t expect the Federal Reserve to hike interest rates again until the economy has returned to normalcy, or in about March 2011. “The Fed doesn’t want to see a weak recovery; they want to see a real recovery,” he said.

For investors who remain risk-averse but aren’t getting good returns in fixed-income, Bianco suggested “bond substitutes” in the sectors Consumer Staples and Utilities.

While there has been a lot of hype around inflation, BofA Merrill’s forecast projects low inflation. Harris said it will likely continue to ease back and that central banks will be able to take in liquidity before inflation becomes a real issue.

10 Investment Themes for ‘10

The RIC Report, recently published by the BofA Merrill Lynch Research Investment Committee, identified 10 key themes that the bank’s clients should be positioned for in 2010:

• Government balance sheet risk: The soaring U.S. budget deficit and a Chinese currency revaluation will drive 10-year U.S. Treasury yields above 4% by year-end 2010. Shorter-duration Treasuries and U.S. investment-grade corporate credit are less susceptible to such risks, according to the firm.
• Rising taxation: In addition to the budget deficit, looming health care reform and a “likely second stimulus package” will need to be funded through higher tax rates, the firm said. Investment opportunities include municipal bonds and municipal bond exchange-traded funds (ETFs).
• Alternative dividend yield strategies: The firm said dividend taxes are likely to rise in 2011 and, as the prospect of higher taxes erodes the popularity of traditional dividend yield-oriented strategies, tax-advantaged or tax-deferred strategies will benefit.
• Financial sector rehabilitation: The financial sector will see better returns because of steepening yield curves, increased M&A activity, and still-underestimated normalized earnings power. The firm said opportunities can be found in best-of-breed mega-cap global financials.
• Corporate cash flow beneficiaries: High cash balances will translate into strategic M&A and companies will increase capital spending and possibly dividends, BofA Merrill Lynch predicted. Increased capital spending will likely benefit the industrial sector and temporary staffing companies as production expands.
• Rising global growth: The stimulus in 2009 will continue to support global growth, led by emerging markets. BofA Merrill Lynch sees opportunities in multinationals based in developed markets with a large presence in emerging markets.
• The emerging market consumer: As the emerging market consumer is at the beginning of the credit cycle, there are opportunities in emerging market currencies versus the U.S. dollar, and in equities such as U.S. energy stocks, global energy majors and mega-cap multinationals.
• Commodity price inflation: As commodity demand outpaces supply, investment opportunities include gold and global energy stocks, the firm said. At today’s investment outlook, Francisco Blanch, head of global commodities, illustrated how much faster money supply is increasing than gold (in 2008 the U.S. dollar increased by 9.4%, while gold increased by only 1.2%). He expects gold prices to hit $1,500 per ounce over the next three years.
• Alternative energy: “Truly economical renewable may be years away, but investment in alternative energy is an important secular theme that will continue to gain ground,” the firm said. The research pointed to alternative energy ETFs as offering exposure to the industry while providing diversification across multiple technologies and business models.
• The return of active management: As volatility comes back down, the firm said the environment favors active over passive management. BofA Merrill contended that “such a stock-picking environment should result in high-quality best-of-breed stocks outperforming in 2010.”

In summary, the RIC is optimistic, with a bullish outlook for equities and commodities. “The unprecedented mix of quantitative easing, zero interest rates and near-record-high peacetime budget deficits will engineer and economic recovery in 2010. We will begin the year with substantial spare capacity in the economy, which should keep core inflation low.”