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Stocks are down, Treasuries are up, and the economy is in a funk. To get a fix on what's ahead, TIME talked to two top strategists at Merrill Lynch: Richard Bernstein, who plots U.S. investment strategy, and Michael Hartnett on international. Both spoke with TIME contributing editor John Curran.

TIME: We're coming out of a pretty tumultuous year. What landscape awaits investors in 2009?

Richard Bernstein: We've really stuck our necks out on this one and said that 2009 is going to be better than 2008.

Michael Hartnett: And by the way, 2009 is the year of the bull, the Chinese year of the bull. Thank God 2008 wasn't the year of the bull. People would never believe in China again.

Bernstein: Seriously, we think there's a metamorphosis under way and the credit mania stories that we saw in the last three, four, five, six years are unlikely to come back. We think overall we're going to be moving away from these credit-driven stories and much more towards self-financing stories.

TIME: Flesh that out a little.

Bernstein: Well, that could be anything from very high quality bonds as opposed to, kind of, the junk that has been sold over the last several years and performed well. It could be the stocks of high quality companies as opposed to the riskier stuff. Our focus is on sustainable and demonstrable growth.

TIME: And as we go into 2009, are we going to be having more of the same economic trouble?

Bernstein: Our U.S. economist, Dave Rosenberg, is not the most bullish economist you'll meet — he's still thinking the GDP's going to continue to decelerate pretty much through 2009 followed, maybe, by slightly better growth in 2010. When the recovery does come it will be somewhat anemic relative to past recoveries. So, he's still looking for what people call a saucer-shaped recovery as opposed to the V-shaped recovery that a lot of people like to talk about.

TIME: What investing theme works best in that scenario?

Bernstein: We have several themes. The infrastructure theme is one of them but we put a little twist on that because we don't think people have really thought about it all the way through. A lot of infrastructure-related companies are going to see pretty substantial declines in their revenues and earnings because they've been so exposed to the energy sector, and energy-related capital spending is being cut back pretty dramatically here. So our analysts are focusing on those companies that are more related to water projects and highway projects and have minimal exposure to the energy and commodities side of the economy.

TIME: What about the fallen stars, the real estate sector or the oil sector? Are these going to see rebounds in 2009?

Bernstein: What you just mentioned are two sectors — especially real estate — that are very, very credit-driven. And one of the reasons we don't think you'll see a V-shaped recovery in the United States is that the early portions of the economic recovery cycle are always very, very dependent on credit. Things like housing, autos, big-ticket retailing. And we doubt that credit creation is going to see the kind of dramatic recovery that would cause a significant upturn in the economy.

Take real estate. Nobody buys a home for cash, or at least very few people do. Certainly on the commercial side people don't buy buildings for cash, they all finance it. Those financing rates are really still quite prohibitive right now.

TIME: For people willing to invest, is it better to be in growth funds or value funds?

Bernstein: We do not think that people should be looking at value funds yet. Value stocks are very dependent on credit, that is, their performance is very related to the upturn in the economic cycle. We really don't have a lot of evidence right now to support an emphasis on value stocks. We prefer growth stocks, though there's more than one type of growth stock. There are the companies offering stable growth, where the stocks sell at a reasonable price, and then there's kind of the momentum growth. And growth mutual funds follow one or the other — they rarely follow both. We prefer growth at a reasonable price, not the momentum fund.

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TIME: When talking about fallen stars, it's hard to ignore China. What's ahead?

Hartnett: Pure and simple, emerging markets go up when people get more optimistic on the global economy and they go down when people get more pessimistic. And certainly the deep, deep losses you've seen particularly in the second half of 2008 coincided with a very, very big downgrade to expectations for future economic activity. Our outlook for 2009 and 2010 is for an L-shaped recovery in economic activity [an L implies a prolonged period of no growth.] And that would be consistent with a trading range going forward for emerging markets, rather than the quick resumption of a vigorous new bull market.

TIME: Is China just lumped in with the emerging markets or is it on a different trajectory?

Hartnett: It's both. I mean, it's clearly part of the emerging market story because it's so integral to Asian economies. It is the odd man out in that we feel that the growth slowdown there can be cushioned much more dramatically than it can elsewhere thanks to the policy tools that the state has in China and the big share of the economy that's taken by the state. So we think that Chinese growth is going to weaken, particularly via exports and to a lesser extent investment, but we are pretty confident that the consumption side of the Chinese economy is going to remain fairly robust.

For example, there's an emerging middle class story in China. The one child policy has produced a lot of disposable income for young consumers. Also, you've got policies in place to encourage consumption in the rural areas, including the recent liberalization of land ownership. All of that is trying, at least, to reduce savings in China, which we know are very, very high. So, we think that will cushion some of the growth slowdown in China, but you can't reverse it.

TIME: Back in the U.S., many stock-fund managers think corporate bonds are the smart buy today. Are you of that camp?

Bernstein: Well, I may be the biggest Treasury bull in the free world. I think we are in just an amazing bull market for Treasuries and nobody wants to take part. To me this is one of the most astounding things I've seen in my career. You have major bond managers talking about how we're in a bubble for Treasuries, but bubbles don't occur when people think there's a bubble, right? Bubbles occur when people are starting new Treasury funds, and that's not happening. So I don't think we're in a bubble, I think this is actually quite fundamentally based. Plus, we now have the Fed who's going to be buying Treasuries on top of everything else. So there's every reason to stay in Treasuries.

As for corporate bonds, I personally think over the next couple of quarters we are going to see pretty poor earnings reports and pretty poor cash flow reports in the United States. And that could cause some downgrades in terms of corporate bonds. I don't think people are thinking about that because they say that these bonds are so incredibly cheap.

TIME: Does your bullishness extend to the Treasury's inflation-protected securities, known as TIPs?

Bernstein: If you want to hold TIPs to maturity for five or 10 years, there may be something there because the odds are we're going to have a little bit of inflation in the next five to 10 years. But if you're looking at this for a one or two year time frame, I'm not sure inflation protection is the best theme for your portfolio.

TIME: What could be the big surprise for 2009?

Bernstein: Many people think the stock market is going to muddle along. I think that in the U.S., 2009 will either be big up or big down. We're not going to muddle. Also, volatility's going to stay. That's going to be a surprise for people.

Hartnett: On the international side, the number one surprise could be this: China doesn't recover and the Chinese are thereafter forced to dump a lot of exports internationally, worsening the bias towards deflation, and that ends up causing some flare-up in terms of protectionism towards the end of next year. I think trade politics could surprise.

TIME: I didn't mean to limit you to one surprise. Do you have others?

Bernstein: If I could add one. It's not mine, but my colleague Dave Rosenberg (Merrill Lynch's chief economist) has noted that people forget that Japan did just about everything we're doing: huge infrastructure projects, lots of liquidity of the banking system, things of that nature. And Japan's economic slump lasted for many years. We're doing it a little more quickly than they did. But there's nothing that says that infrastructure is going to save the day. As Dave points out, it's a cushion, not a remedy. It's a cushion and people are looking at it maybe as a remedy.

TIME: Ouch. So the downside has more chapters?

Bernstein: It could. I personally think — this is not shared by everybody in my building — but I personally think that one of the keys to recovery that has not happened is you have to have massive consolidation of the financial sector here in the United States. We had some pretty notable ones — one I don't particularly want to talk about — but in terms of overall capacity to lend in the United States, it's really not gotten much smaller.

TIME: Let's end on a truly speculative question. At the end of 2009 we can look back and see how every asset class performed. What will be at the top of that list?

Bernstein: Personally, I'm going to say Treasuries because it's still the most hated asset class in the world and that usually is good news.

Hartnett: Chinese equities, just because they were so beaten up. They could go up 50 % next year and still be in a bear market.

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• John Curran
• Stocks are down, Treasuries are up, and the economy is in a funk. To get a fix on what's ahead, TIME talked to two top strategists at Merrill Lynch