Risk is back, but not quite with a bang, shows the October Bank of America-Merrill Lynch Fund Managers Survey. The investment bank’s monthly report revealed an improvement in confidence levels on the back of high expectations for a second round of quantitative easing from the Fed. With investors’ appetite for risk restored, global asset managers now have a clear preference for emerging markets, are largely neutral towards Europe and the US, but remain notably underweight Japan.
A Little Bit of History Repeating?
The survey, which during the second week of October surveyed 194 fund managers who manage a total of $492 billion, showed a marked increase in risk appetite both at the European and global levels. The main driver behind the rise in asset managers’ confidence is the prospect of a second dose of quantitative easing in the US.
The survey’s Risk and Liquidity indicator, which measures risk appetite, investor time-horizons and cash weightings, saw its biggest hike since the first round of US QE in April 2009, and is now set three points above the long term average of 40. Reflecting this re-found appetite for risk, hedge funds’ gearing levels have hit their highest since March 2008.
The main beneficiary of this improvement in investor sentiment is global emerging markets. Virtually one in two managers surveyed are overweight GEM—the strongest reading on this statistic since November 2009. Japan, on the contrary, continues to be a captive of its strong currency and saw the highest underweight levels (35% in October versus 32% last month) since November 2009.
This extreme preference for emerging markets over Japan triggered a contrarian trading rule in October—a signal to contrarian investors that bucking the market trend could present a lucrative opportunity. The last time a similar trend was observed Japan outperformed GEM by 9% in the following three months, according to the B of A-Merrill Lynch global research report. However, this time around, the injection of market liquidity and boosting of equity demand associated with quantitative easing may upset the chances of this relationship being repeated.
Portfolio Effects
The most marked change in portfolio allocation is out of cash and into equities—in line with other indicators of increased risk appetite seen in this survey. Investors strengthened their consensus that bonds are overvalued, with net 71% subscribing to this view. The number of asset allocators that are now overweight equities increased markedly to net 27% from 10% in September, while net 17% are now overweight commodities versus 4% previously.
Cash holdings saw a particularly sharp drop: last month a net 22% of European portfolio managers had an overweight holding in cash but this trend has been reversed in recent weeks, with net 2% now underweight holding cash. On the global stage, 6% of money managers are now overweight cash, compared to 18% last month.
Europe Vs the World
As investors look forward to the Fed setting up the terms of QE2, the B of A-Merrill Lynch note highlights that global investors appear to be betting on this providing a short term relief rather than a long term cure. While the proportion of global asset allocators forecasting economic growth over the next 12 months has jumped in October to net 15% from 0% last month, only 9% anticipate above-average growth over the next year. Nearly a fifth of Europe investors expect the economy to firm over the coming year, a substantial turnaround from -17% in July.
Corporate earnings expectations are also more upbeat for Europe than they are globally. The turnaround in profit outlook in Europe has been sharp, with net 28% of managers now seeing stronger profit growth over the coming year, in comparison to last month’s net 13% that expected a deceleration in profit growth. Globally, the switch was much less remarkable but still apparent: a net 11% anticipate stronger corporate profits, up from 2% in September. When it comes to corporate governance, net 43% (from 35%) of global managers see corporate balance sheets as underleveraged, 60% (up from 55%) would like to see CFOs invest more in their businesses, and 41% (versus 34% previously) favour returning cash to shareholders rather than increasing capex (40% in October from 37%).
Currency Standoff
Amid various signals for currency wars at the government level, investors are cautious in their prediction of forex dynamics. With looming quantitative easing, managers are reluctant to translate their current views into future predictions. A net 45% believe the euro is overvalued and the dollar undervalued. However, just 7% name the euro as the currency that will depreciate the most over the next 12 months, and only 12% see the dollar strengthening in this period.
This currency uncertainty has fed into regional preferences. Views of the US, the UK and the Eurozone are almost completely neutral, coming in at net 4% underweight, net 1% underweight and net 3% overweight, respectively. The UK experienced the greatest change and is now at its most positive reading in over three years, having risen from 10% underweight in September.
Sectorial Preferences
While there is a shift away from defensives and back towards cyclical and growth stocks, asset allocators are still not committing fully to a certain set of sectorial preferences, particularly in Europe, as uncertainty of the effects of QE2 is factored in.
For European asset allocators, the biggest gainers from a sector point of view over the past month have been Construction, Industrials, Insurance and Banks, though the latter still remains a notable underweight holding, along with Financial Services, Utilities and Real Estate. The only overweight holding of significant size for European asset managers was in the Technology sector.
Technology is still in the lead for global investors as well. The flight to emerging markets yielded a few more distinct sartorial preferences. Among the global favourites this month were Energy, Industrials and Materials. Consumer Discretionary saw its first ever positive reading since the inception of the Merrill Lynch survey more than five years ago. Investors are underweight Banks and Utilities in all developed markets.
Though this month’s surveys have registered an improvement in confidence and risk appetite levels, the overall outlook is not yet one of absolute optimism. However, fund managers may have a clearer view of central bank policy and be better placed to form investment preferences next month, after the Federal Open Market Committee’s November meeting.
