A Transforming World - Businesses and Institutions | Bank of

Dynamic forces are sweeping across the globe, reshaping our

lives and creating a wave of new investment opportunities

A Transforming World

The U.S.An economic revival spurred by a surge of innovation in tech and energy

The MarketsBehind the “great rotation” to equities—and why it could herald a new era of growth

The WorldEmerging markets trigger fundamental shifts in global economic and political power

The linkages across financial markets and economies can present both opportunities and risks to you as an investor. Our global relationships give us insights into the most influential markets in the world. And, we are connecting all of our talent and capabilities to offer you insights and trends that can help you to be successful and stay one step ahead.

— Brian Moynihan Chief exeCutive OffiCer, Bank Of ameriCa

“ “

A TrAnsforming World

ithin 20 years, more than

half of the world’s population

rises out of poverty—while

the median age in developed

countries jumps by five years.

The U.S. heads toward energy

independence and natural gas prices plummet as

advances in technology drive a boom in extraction.

Climate scientists studying the rise in sea levels

revise their forecasts upward. Technological

innovations, such as low-cost 3-D printing, fuel a

resurgence in U.S. manufacturing. The U.S. Federal

Reserve extends a monetary easing policy that

could boost the economy but also risk inflation, as

central bankers around the world move markets with

unprecedented power.

Just a few years after a global crisis that threatened

to spin the world off its axis, the pace of change

continues to accelerate and should for the foreseeable

future. “Dynamic forces are right now reshaping

our financial lives. We’re at a rare inflection point,”

says Mary Ann Bartels, chief investment officer

of Portfolio Strategies at Merrill Lynch. “If we can

understand the larger patterns in the global economy

and see how those forces are coming together, we

can put ourselves in the strongest position to take

advantage of them.”

Sorting through the noise of today’s nonstop

A Transforming WorldDynamic forces are sweeping across the globe, reshaping our lives and creating a wave of new investment opportunities

Wnews cycle, economists, researchers and strategists

throughout Bank of America Merrill Lynch and U.S.

Trust have identified three major themes underlying

what they believe to be global transformation.

First, amid rapid strides toward energy self-

sufficiency, there is a surge in U.S. business and technological innovation that has the potential

to revitalize the economy and spark another long-

lived bull market. Second, there are far-reaching shifts in the world’s financial markets. Third, a massive rebalancing of the world’s economic, political and social power is under way. There

has been a rapid rise of a powerful middle class

in emerging market nations that had long been

stratified between rich and poor, alongside a global

need for essential resources that’s set to explode in

coming decades.

“The rebalancing of global growth from the

developed to the developing world is a trend we’ve

been discussing for some time,” says Chris Hyzy,

chief investment officer at U.S. Trust. “Demographic

changes—some that benefit the world economically,

some that increase risk—are creating imbalances

that are changing the nature of global growth.

So are the movement of capital around the world

and the related political pressures. In all these

developments, we see a number of megatrends

emerging.”

cover artwork by bryan christiewww.ml.com/insights • 3

4 • A trAnsforming world

an eCOnOmiC revival is taking hold in the U.S. Although no one expects easy

solutions to the problems facing the country’s economy, there’s a new optimism

about long-range prospects. An energy revolution, significant labor-market shifts

and massive technological innovation are raising hopes for the future.

energy independence For almost 70 years, the U.S. has had to depend

largely on imported energy. Now, even though the U.S. still imports roughly 25%

of its energy—chiefly in the form of petroleum—there’s a growing consensus that

the nation is on its way to becoming energy-independent. The impetus is the boom

in extracting oil and natural gas from shale rock formations, and the technological

innovation that has made it economically feasible. Called hydraulic fracturing, or

“fracking,” the environmentally controversial technology has already sparked an

energy revolution, with natural gas as its cornerstone. According to some estimates,

the country’s natural gas reserves could last an additional 100 years. Oil production

is rising too—in 2012 the nation’s supply increased by a million barrels per day, the

fastest growth of any non-OPEC country in the world.

The shale-gas boom has already greatly reduced natural gas prices and sparked

a revival of the U.S. petrochemical industry, which uses natural gas as a raw

material. “In the past five years, the U.S. has gone from being the largest importer

of petroleum products in the world to the second largest exporter,“ says Francisco

Blanch, head of commodities and derivatives research at BofA Merrill Lynch

Global Research.

If future shale-gas extraction continues to pass muster with state and federal

environmental regulators, the impact may be felt across the economy. Says Hyzy,

“The number of jobs created over the long term could itself be transforming.”

And if electric utilities accelerate their shift from coal or oil to natural gas, “we

could end up with the cost of energy to U.S. manufacturers returning to what

it was in the 1970s or even the ’60s, adjusted for inflation,” says Christopher J.

Wolfe, chief investment officer of the Private Banking and Investment Group

at Merrill Lynch. Consumers, too, could potentially benefit through lower

utility bills, leaving them more money for discretionary purchases. And

because natural gas burns more cleanly than coal, the country could see

environmental benefits as well.

U.S. InnOvATIOn

“the number of new energy jobs created could itself be transforming.”

Chris HyzyChief Investment Officer, U.S. Trust

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Shifts in the labor market Not long ago, the big story about American

jobs was about how many were being outsourced to cheaper markets. That

narrative has changed dramatically. During the recession and the sluggish

recovery of the past few years, labor costs have dropped significantly. While

this has been painful for the American worker and has not yet helped reduce

unemployment, it has enabled U.S. corporations to become more profitable. For

manufacturers in particular, the ability to control labor costs has helped spur a

renaissance. U.S. manufacturing is now “very, very competitive, if not the most

competitive we’ve ever seen,” Hyzy says. According to Ethan Harris, co-head of

Global Economics Research at BofA Merrill Lynch Global Research, workers will

likely regain leverage only when the jobless rate dips below 6%.

a new era of innovation In addition to lower energy and labor costs,

there’s another important element to the U.S. economy’s new story: a series of

what Hyzy terms “mega-innovations.” Cutting-edge technologies like robotics,

personalized medicine based on genetic testing, cybersecurity, big data, cloud

computing, digitization, custom manufacturing and quick time-to-market design,

among others, are bringing new life to the U.S. economy.

A recent BofA Merrill Lynch Global Research report on the state of the American

innovation economy, which stretches from social media to software to industrial

engineering, uncovered compelling evidence that “innovation in the U.S. is alive

and well,” says Savita Subramanian, head of U.S. equity and quantitative strategy at

BofA Merrill Lynch Global Research and author of the report. “It could continue to

serve as an engine for growth for some time to come.” The report said that the U.S.

spends more on research and development (R&D) than China, Japan, South Korea

and Taiwan combined, or even the entire European continent. Meanwhile, American

firms account for 75% of the global venture capital market.

U.S. InnOvATIOninvested in innovation One critical measure of an economy’s vitality is the amount it spends on research and development of new and innovative products. By this yardstick, the U.S. still leads the world by a sizable margin.

United States $408.7

China$179

Japan$140.8

Germany $86.3

$ in billions

Sources: Organisation for Economic Co-operation and Development, UNESCO

www.ml.com/insights • 5

BUIldIng InflUenCethe rebounding housing market could boost the economy—and innovation—for years to come

The housing revival could be a long-term force in helping re-shape the U.S. and global economies. In the U.S., 2013 prices are expected to rise 8%, says Michelle Meyer, senior U.S. economist at BofA Merrill lynch global Research. In the next decade, housing could appreciate by as much as 40%.

That bodes well for the broader economy over the next sev-eral years. “Increasing construction will have a powerful effect,” Meyer says, pointing out that with 27,000 construction jobs being created each month, U.S. gross domestic product growth could be boosted by almost half a percentage point in 2013.

Rising home prices can have a powerful effect on con-sumer sentiment, and whole sectors are likely to benefit

from increasing strength in home sales—among them home-improvement retailers, appliance manufacturers, credit card companies and other consumer discretionary businesses. Homebuilders and gdP-sensitive sectors such as technol-ogy and industrials could also do well, along with real estate investment trusts (ReITs) and regional banks responding to an increasing demand for loans.

Meanwhile, with interest rates still low and prices remain-ing well below their 2006 highs, a growing number of poten-tial buyers are getting the idea that this is a suitable time to become homeowners. Says Meyer: “We don’t expect to see a drop in home prices anytime soon.”c

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the SignalS are getting StrOnger: Stocks have entered the first

stretch of a period of growth that could last a decade or more, according to

analysts and researchers at BofA Merrill Lynch Global Research. Pullbacks,

corrections and moments of doubt are always part of any such protracted upward

trend, of course. But a series of powerful market-based shifts appear poised to

help drive equities through that turbulence.

a movement to stocks from bonds Market highs early in 2013

clearly demonstrated that at least some investors are bolstering stock portfolios.

Less certain is who is participating in this return to equities and how long

the surge will last. A recent report from BofA Merrill Lynch Global Research

expressed the idea that U.S. stocks are “in the early stages of a new secular bull

market.” The shift back to stocks has been described as a “great rotation” or a

“rebalancing,” in which investors gradually move away from the conservative,

bond-heavy allocations they’ve favored since the financial crisis and devote a

higher percentage of their assets to equities. Yet for now, according to a recent

BofA Merrill Lynch Global Research report, investors remain “structurally

underweight” when it comes to the proportion of stocks in their portfolios.

interest rates and inflation Persistently low interest rates are one

reason for the surge toward equities. Those looking primarily for income have

found themselves gravitating toward the higher risks and potential rewards of

dividend-paying stocks and high-yield corporate bonds. “If you keep interest

rates low for long enough,” Wolfe says, “it forces you into a higher risk profile,

whether or not that’s aligned with your goals.”

But low interest rates won’t last indefinitely. As prospects for the global

economy brighten, inflation will almost certainly follow, and the U.S. Federal

Reserve and other central banks around the world will inevitably force rates

higher as a counter measure. Timing rate increases is a delicate business,

Wolfe notes. Still, there’s no guarantee that central bankers will get it

right, increasing rates enough to forestall inflation without slowing growth

significantly. A serious policy mistake could send interest rates higher and bond

prices even lower.

2%The projected inflation rate for the next two years, according to BofA Merrill lynch global Research

gReAT MARkeT SHIfTS


There’s little doubt that inflation will increase to some degree. The Federal

Reserve’s policy of quantitative easing has pumped so much cash into the

system that a rise in prices is more or less inevitable. Michael Hartnett, chief

investment strategist at BofA Merrill Lynch Global Research, sees an inflection

point approaching—yet far from ending recent advances for equities, he believes

it “should prove very bullish for stocks.” Nor does he expect inflation to get out

of hand, and that could be more good news for stocks. “During the past 50 years,

when inflation has remained between 1% and 4%, that has marked a sweet spot

for equity returns compared with bonds,” Hartnett says.

Indeed, economists at BofA Merrill Lynch Global Research project inflation of

just 2% for the next two years, with price increases held in check by continuing

weakness in the labor market and continued “slack”—unused production capacity—

in the economy. “We’re a long way from inflation being detrimental to equity market

performance,” Subramanian agrees.

“We’re a long way from inflation being detrimental to equity market performance.”

Savita SubramanianHead of U.S. Equity and Quantitative Strategy, BofA Merrill Lynch Global Research

THe BegInnIng Of A TURnAROUnd?for several years, investors moved out of equity funds and into the perceived safety of bonds. in 2013, we are seeing the first signs of a reversal—with a growing number of people starting to believe in equities again.

Cumulative fund flows since 2006 in billions.

LO Equities (long only)All Bonds

'06 '07 '08 '09 '10 '11 '12 '13 '14

900

400

-100

-600

-$536 billion

$896 billion

Sources: BofA Merrill Lynch Global Research, EPFR Global


SOme Of tOday’S mOSt prOfOund long-term transformations involve

demographics, shifting alignments of global power and the often unintended

consequences of those changes. Much of what is occurring now is driven by the

economic growth of emerging markets.

the rising emerging market middle class According to some

forecasts, in less than 20 years, a majority of the world’s population will have

risen out of poverty. By 2030, even by conservative estimates, the number of

people worldwide defined as middle class will likely double to 2 billion. “This

is the largest demographic wave we’ve ever witnessed,” Hyzy says, “in terms of

both the sheer number of people heading into the middle class and also in the

collective spending power this group will have.”

Because a disproportionate amount of that middle-class expansion is taking

place in developing and frontier markets, those nations should account for an

even larger portion of global economic growth than they already do. Emerging

markets are now responsible for more than half of global gross domestic product

(GDP) growth and 40% of investment worldwide. According to the World Bank,

China alone could provide a third of the world’s economic growth by 2025.

This trend presents huge opportunities for certain kinds of companies in the

developed world. In particular, manufacturers of high-end, highly engineered

durable goods—including engines, turbines and medical devices—should see

increasing exports to emerging markets. “Our competitive ability to produce

things they need has never been better,” Hyzy says. But this boom in exports

may not extend to makers of lower-cost retail goods. Emerging market

consumers are more likely to turn to local companies for those products.

aging populations Many emerging markets are helped by comparatively

young populations of workers and consumers. In contrast, by 2030 the median

age in the wealthy countries that belong to the Organisation for Economic Co-

operation and Development is expected to jump to nearly 43, up from 38 in 2010.

Already, the median age has eclipsed 45 in Japan and Germany. In the U.S., where

the demographic swell of the aging baby-boomer generation could be fiscally

$1trillionThe projected value of the market for water-related industries by 2020

THe neW geOPOlITICS


destabilizing, the median age is 37—and within the next 17 years, 20% of the

U.S. population will be older than 65. Meanwhile, China’s aging population has

prompted public discussion of ending the nation’s one-child policy.

Relatively old populations put enormous demands on government health care

and pension systems, such as Japan’s and Germany’s. What’s more, says Wolfe,

“graying nations tend to be at a competitive disadvantage to youthful countries,

whose more vigorous, productive labor forces tend to generate faster economic

growth.” These younger countries include Indonesia and many nations in sub-

Saharan Africa. There are also more subtle disadvantages to having an older

population. By 2020, the U.S. is projected to have more than twice as many

workers over age 55 than those 24 and under. Notes Wolfe: “If that ratio doesn’t

change, within two decades we’re going to have a lot

of 25- and 35-year-olds who don’t have the level of

work experience, job skills or compensation as their

parents at the same age.” That could lead to reduced

tax revenues, lower consumer spending and a

potentially weaker economy.

resource sustainability Another consequence

of a global middle class that is ballooning and

growing richer is an inevitable rise in consumer

consumption. That will put unprecedented

strain on the planet’s resources, with

surging demand for food and water in

particular. Indeed, water scarcity is

already a global reality—more than

780 million people lack access to clean

drinking water, while 2.6 billion have

no access to proper sanitation. One

major source of stress on resources

involves changing diets: The higher the

household income, the more often people

“graying nations tend to be at a competitive disadvantage to youthful countries, whose labor forces tend to generate faster growth.”

Christopher J. WolfeChief Investment Officer, Private Banking and Investment Group, Merrill Lynch



eat meat—and that requires more water. “It takes 15,500 liters of water to produce

a kilogram of beef. It takes 1,500 liters to produce a kilogram of grain,” notes

Sarbjit Nahal, equity strategist, Thematic Investing, at BofA Merrill Lynch Global

Research. “This puts increasing pressure on global food security and water security.”

If current trends continue, water demand will exceed water supply by 40%

within the next 20 years, by some estimates. And without efficiency gains, a

diminished freshwater supply could cut the forecast for 2050 global GDP almost

in half, Nahal adds.

For investors, however, increased demand for water could generate potent

investment opportunities. Water-related industries working to address such

problems already represent a roughly $500 billion market, Nahal says. “We think

it will double to $1 trillion by 2020,” he adds. One major source of growth will be

new technologies and infrastructure that make it more efficient and less costly to

treat and reuse water, both in the residential and industrial sectors. Meanwhile,

the demand for water and resource conservation will potentially benefit a

In need Of WATeRin theory, the world has sufficient water to meet human needs, but it is unevenly distributed.

Sources: Aquastat, BofA Merrill Lynch Global Research

783 million people lack access to clean drinking water.

1.2 billion people live in areas where water is physically scarce.

1.6 billion people face economic water shortage—where the infrastructure can’t provide a sufficient supply.

43% is distributed among the world’s 189 other major countries.

57% of the world’s freshwater resources are concentrated in 10 countries: Brazil, Russia, U.S., Canada, China, Colombia, Indonesia, Peru, India and Congo.


range of sectors and industries, including crop science and fertilizer producers,

engineering firms that design cutting-edge irrigation systems, manufacturers of

water-treatment equipment and producers of the next-generation of biofuels.

government austerity and central bank policy Amid the profound

changes playing out on today’s geopolitical stage, one source of influence

and power has risen to unaccustomed prominence. Central banks today have

a greater influence on financial markets than does any other single factor

or set of institutions—and hold more sway, arguably, even than national

governments. The U.S. Federal Reserve paved the path that many other central

banks around the world have followed by keeping interest rates near zero and

instituting large-scale bond-buying programs. Much the same has been done

in Europe, the U.K. and a handful of emerging market nations. Most recently,

Japan has started to pursue an extremely aggressive easing policy designed to

shock its economy from decades-long doldrums. The central bankers often act

much as governments have in the past, attempting to combat unemployment

and prop up economies and markets.

At the same time, a number of nations around the world have launched

austerity programs—including the U.S., with the automatic cuts that began in

2013 as a result of government sequestration. And they are doing so during

recessions or slow-growth periods that would normally be met with stimulus

spending. That’s certainly happening in Europe, which still faces a long road as

it attempts not only to repair government and bank balance sheets but also to

create fiscal and banking systems that can support sustainable growth.

But how long will a central banker–dominated world continue? Although

U.S. Federal Reserve officials have said they could keep interest rates low for an

additional two to three years, the influence that it and other central banks have

wielded since the beginning of the global economic crisis will eventually wane,

only to be replaced by other forces both expected and unforeseen. And so the central

challenge of charting and understanding a constantly shifting world will continue.

The good news is that the signals indicating how the world is changing

can be discerned. The even better news is that the extremes characterizing

the years during and just after the financial crisis are at last giving way to

something else—a period that will come with its share of serious risks and

problems, but that on the whole offers a great deal of promise.

“For a lot of understandable reasons, clients have been rooted in a defensive

posture—behaviorally, emotionally, financially,” Wolfe says. “But there’s a

new dynamism taking hold, both in the U.S. and globally, and that dynamism

means opportunity.” ■

in a world of accelerated change, being a disciplined investor means paying stricter attention to the markets.


Unless otherwise indicated, statistics come from: OECD; National Intelligence Council’s Global Trends 2030 report; U.S. Energy Information Administration; International Energy Agency; U.S. Bureau of Labor Statistics; U.S. Census Bureau; BofA Merrill Lynch Global Research as of May 2013.

All information is as of May 2013.

Investing involves risk, including the possible loss of principal. All opinions are subject to change due to market conditions and fluctuations. Past performance is no guarantee of future results.

Any information presented in connection with BofA Merrill Lynch Global Research is general in nature and is not intended to provide personal investment advice. Investors should understand that statements regarding future prospects may not be realized.

This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any information in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.

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