Merrill Lynch Urges Caution in New Institutional Strategy
By Cindy Christ

With an eye toward rising interest rates, Merrill Lynch announced revisions Friday to its asset allocation model for its biggest U.S. clients.

In his first strategy call since coming to the Nation's No. 1 brokerage late last year, chief global investment strategist David Bowers introduced a new 12-month model for institutional investors, which weights stocks 50 percent, bonds 30 percent, commodities 5 percent and cash 15 percent.

The model is different from the strategy Merrill recommends for individual investors, which consider a person's overall investment objective and risk tolerance over a three- to five- year period.

"As you can see, our largest weighting, 50 percent, in is equities," said Bower in a research note.

"While growth and inflation expectations are still rising, we think it is too early to overweight bonds and therefore we believe it is prudent to maintain 15 percent in cash in the event that monetary policy may be tightened more than expected," he said.

Bowers said he based the call on a new "investment clock" created by Merrill that looks at conditions in the business cycle to find the most promising asset classes and industry sectors for a given time period.

The clock is divided into four phases, where one asset class -- either stocks, bonds, cash or commodities -- outperforms the others.

Bowers said that the market is out of sync with the economy, behaving as if there were no threat of inflation when business factors prove otherwise.

"The recent sector rotation in the market leaves little doubt that the market is convinced it is in Phase II with its emphasis on economically sensitive growth stocks, epitomized by the outperformance in telecom-media-technology and the chronic underperformance of many of the traditional defensives," Bowers said.

Macroeconomic indicators show that the economy has moved on to the next phase, marked by strong commodity prices and a tightening in monetary policy, said Bowers.

To bolster his view, Bowers notes that commodities have outperformed stocks, bonds and cash over the past 12 months.

"This could be a growing source of tension in the marketplace," he said.

In an interview with CNBC financial television, Bowers said that the tactical model represents a shift from previous strategies in that its view on stocks is "slightly cautious."