BofA Merrill: Stocks to trade sideways

NEW YORK (Reuters) - Stocks are likely to trade sideways over the next 12 to 18 months, with investor confidence dependent on growth in revenues, the chief global equity strategist at Banc of America Securities Merrill Lynch said on Wednesday.

Michael Hartnett, who was named to the post on June 1, said the coming earnings season will be crucial in determining whether companies are finding real demand for their products and services.

"Markets will be liable to very violent rallies but the broad directional theme for the next 12-18 months will be sideways rather than decisively upward and decisively downward," Hartnett said at the Reuters Investment Outlook Summit in New York.

"For us it means you are likely to see a big fat trading range. I'm just putting numbers out there, 800 to 1000," he said, referring to the Standard & Poor's 500 stock index. "The muddle-through view would be very much consistent with a trading range."

The S&P 500 .SPX closed at 910.71 on Wednesday. It has gained more than 30 percent since its March lows.

"If you can get evidence that margins are expanding because there is some top line growth, that is huge. That is a huge inflection point for the market," Hartnett said. "The market is going to feel so much more comfortable being overweight equities if that pans out."

Banc of America Securities Merrill Lynch's June fund manager survey showed that fund managers moved to an overweight position in equities for the first time since December 2007.

And without evidence of margins expanding on revenue growth? "Very simply, the market will conclude there is not much of an economic recovery," Hartnett said.

U.S. corporate earnings have been slow to recover since the recession. Data compiled by Thomson Reuters shows S&P 500 earnings declining 34 percent in the second quarter, compared with a 67 percent fall in earnings in the last quarter of 2008, in the depths of the financial crisis.

The economic stimulus that governments have pumped into their markets is starting to show some results, though Hartnett said inflation is not a near-term worry.

"But it is certainly a risk over the medium term. ... The markets are going to beg for stimulus for a long period of time and the longer that stimulus runs then the riskier it becomes for inflation," he said.

TACTICAL TRADES

For now, Hartnett said technology- and energy-related shares appear overbought, while health care/pharmaceuticals and utilities are oversold, according to the firm's June fund manager survey.

This trade is for investors with a time horizon of weeks rather than months, he said.

In addition, Hartnett said emerging markets look overbought in the short term. The MSCI emerging market stock index .MSCIEF has soared nearly 60 percent since March.

He said he would not be surprised to see some underperformance versus developed markets for a period of time.

"I think they have run very hard but probably too hard given where we are in the economic cycle. I would, however, be looking to buy on a dip or a period of underperformance by emerging markets because I still believe in the secular story," he said.

He cited the potential for China's economic growth, steadier banking systems and a reduction in risk associated with the sector as reasons that emerging markets over the long-term will continue to be attractive for investors.

(Additional reporting by Caroline Valetkevitch and Walter Brandimarte; Editing by Leslie Adler)