Fifty-five percent of European fund managers now see the region suffering two quarters of negative real gross domestic product (GDP) growth over the next year, according to the BofA Merrill Lynch Global Research survey completed between 1-8 September. This compares with only 14% expecting the same fate as recently as July.
Europe’s sovereign and banking challenges dominate risks identified by global asset allocators. Sixty-eight percent of survey respondents now view the eurozone debt crisis as the largest of these risks, up from 43% in June and 60% in August. Sentiment towards European banks is at its lowest since the survey began asking about it in January 2003.
These negative views of Europe are reflected in investors’ stance on eurozone equities. While the weaker growth outlook is reflected in global fund managers’ first net underweight (5%) on equities in over two years, a net 38% are now underweight European stocks – up from a net 15% last month.
While other regions also suffered, sentiment towards the US improved somewhat. Only a net 9% of US fund managers now expect the economy to weaken in the next year. Global investors also restored an overweight position in US equities.
“The survey shows that sentiment on Europe is now so negative that contagion risk to the rest of the world has risen significantly,” said Gary Baker, head of European equities strategy at BofA Merrill Lynch Global Research.
“The current very extreme levels of risk aversion indicate that it is time to look for contrarian trades,” added Michael Hartnett, chief global equity strategist at BofA Merrill Lynch Global Research.
Risk Aversion Soars
As measured by the ML Risk & Liquidity Composite Indicator, investors’ aversion to risk has soared to levels last seen in March 2009 in the wake of the global financial crisis. A net 45% of investors are taking lower risk than normal relative to their benchmarks, up nearly 20 percentage points from August.
Cash holdings remain notably high at an average 4.9% of portfolios, with more than a third of investors overweight cash.
Reduced risk appetite is also evident in hedge funds’ exposures. The sector has cut its net long position to 19%, down from 33% a month earlier. Investors’ assessment of market liquidity has also turned to a net negative.
Sentiment towards bonds has improved as investors have turned negative on equities. Global asset allocators have halved their underweight in the asset class in just two months – from a net 45% in July to a net 21% now. Other asset classes also benefited from a shift out of equities. Most notably, the global underweight in real estate halved month-on-month, to a net 7%.
The growth slowdown has altered investors’ view of oil. A net 14% of respondents view the commodity as overvalued, up from a net 0% in August.
Within equities, the story is not one of a simple rotation into defensive sectors. While consumer staples, pharmaceuticals and utilities all benefited from the exodus from banks – to a net 47% underweight – so did industrial and technology shares.
Japan, China Take Eurozone Knock-on
As Europe’s outlook has weakened, investors have lost confidence in other regions too. Views of the Japanese economy have soured significantly, for example. A net 42% of Japanese fund managers expect it to strengthen in the next year, down from a net 75% a month earlier. A net 0% expects Japanese corporate earnings to improve in the period, compared to a net 58% in August.
Similarly, a net 30% of regional fund managers expect the Chinese economy to weaken over the next 12 months. August’s figure was a net 11%.
This is reflected in a sharp decline in asset allocators’ enthusiasm for Chinese equities. Having ranked as their net most preferred BRIC stock market for the previous three months, China plunged almost 30 percentage points on this measure in September. It now has the same net 18% reading as Russia.
Fiscal Policy Finds Focus
With inflation fears having largely receded, investors have turned their focus to fiscal policy. A net 235 view it as too restrictive for the current phase of the business cycle, compared to the net 19% who viewed it as too stimulative just two months earlier.
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