Volatility to Continue in 2012

Terry Flanagan

BofAML warns market participants to be wary of continued market volatility in the coming year.

“The U.S. comes into the new year with a lot of momentum,” said Ethan Harris, co-head of global economics research at Bank of America Merrill Lynch. “Unfortunately, we will see a slowdown into the next year. Not only will the European debt crisis be spilling over, but there will be two homegrown shocks to deal with. There will be new fiscal actions, which could be worth 1.5% GDP, constraining growth in the beginning of the year. Furthermore, there will be policy uncertainty. At the end of next year, we get $150 billion in fiscal spending cuts and the expiration of all the Bush tax cuts. We will also hit the debt ceiling sometime in 2013. The economy will slow further into the election next year. There will be a pattern of gradual declining growth.”

As the ongoing debt crisis in Europe continues to weigh down investor confidence, amid a backdrop of a still-struggling U.S. economy, BofAML warns investors that volatile times lay ahead. The bank also says that political uncertainty, high oil prices, slowing growth and low interest rates will continue to weigh down investor confidence and stifle investment returns.

Despite the grim forecast, BofAML asserts that the potential for growth is there.

“We anticipate that global equities could rally by 10% next year from current levels, aided by liquidity, modest earnings growth and cheap valuations,” said Michael Hartnett, chief global equity strategist and chairman of BofAML research investment committee.

Volatility has been on a wild ride in 2011, as the CBOE Volatility Index has shown. Two and three percent intraday swings have become the norm. The surges have come in the wake of a slew of macroeconomic events, including the European debt crisis, the U.S. debt downgrade, and the collapse of MF Global. The VIX reached a high of 48 on Aug. 8, as the markets reacted to the lengthy U.S. debt ceiling negotiations and the Standard & Poor’s downgrade of U.S. debt. It then fluctuated from the low-30s to the mid-40s in the following months, surging as European debt concerns weighed on investors and declining as hopes for a potential resolution surfaced. In late October, the VIX had declined to as low as 25. As of mid-day Dec. 15, the VIX was trading at about 25.

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