While positive sentiment towards the global economy and equities continues to repair, concerns are growing about the impact of the US fiscal cliff, according to the BofA Merrill Lynch Fund Manager Survey for October.
Nearly three-quarters (72%) of global investors believe that the fiscal cliff is not substantially priced into global equities and macroeconomic data. The fiscal cliff is identified as the number one tail risk by 42% of respondents – up from 35% in September and 26% in August. EU sovereign debt funding risk is seen as less of a threat. A net 27% of the panel sees it as their number one risk, down from a net 33% a month ago and far lower than the reading of 65% in June.
Investors have otherwise become more positive, building on growing sentiment since the summer. A net 20% of investors now believe the global economy will strengthen in the coming 12 months – a rise of three percentage points month-on-month. Concerns about the outlook for corporate profits have eased noticeably. A net 11% of investors say corporate profits will fall in the coming year, down from a net 28% in September. However, expectations of a sharp bounce in earnings fell back with a net 58% saying double digit earnings gains are unlikely in the next year, up from 55% in September.
Equity allocations rose significantly month-on-month. A net 24% of asset allocators are overweight equities, up from a net 15% in September. Fund managers increased allocations to seven of the 11 global sectors, including banks and industrials. Allocations to the eurozone and global emerging markets increased, but allocations to Japan fell to a three-year low.
“While the US fiscal cliff is a hurdle, growing belief in the global economy could spur a more ‘risk on’ stance from investors,” said Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research.
“The outlook for European equities is improving, eurozone fears are receding and appear largely priced into equity risk premia; core government bonds offer negative real yields so the impetus to rotate into stocks in Europe, as the outlook stabilizes, is profound,” said John Bilton, European investment strategist at BofA Merrill Lynch Global Research.
Gap in Popularity Between US and Europe Disappears
Two months ago, the gap in popularity between US and European equities was substantial – but now the two regions viewed equally in the eyes of allocators. October’s Fund Manager Survey shows a net 10% of the panel is overweight in both regions, a market change from August when a net 13% of asset allocators were underweight eurozone equities versus a net 13% overweight for the US.
Furthermore, the outlook for the two regions is also identical. The US and the eurozone both receive a net 3% of investor votes for the region they would most like to overweight over the coming year.
Japanese Risk Rising
Investors have become more bearish on Japan as concerns grow over a dispute with China over the Senaku Islands and its impact on trade. A net 38% of global asset allocators are underweight Japanese equities, the lowest reading since March 2009 and up from a net 23% a month ago. The outlook suggests no improvement. For the second consecutive month, a net 24% of investors say Japan is the region they most want to underweight.
Pessimism within Japan has risen acutely in the past month. A net 30% of the regional panel believes the Japanese economy will weaken in the coming year, up 26 percentage points since September. A net 22% expects Japanese earnings per share to decline, up from a net 9% a month ago.
Sovereign Bonds Tipped to make Way for ‘Risk on’ Investments
As well as increasing equity allocations, investors are shifting towards higher risk sectors. A net 7% of investors are overweight industrials, a highly cyclical sector, this month compared with a net 8% underweight in September.
Riskier sectors such as banks, insurance and materials also saw positive shifts. Within the banking sector in particular, valuations have fallen sharply despite improving sentiment. A net 18% of the panel believes banks is the most undervalued sector, up from a net 11% in September and double the reading of the second most undervalued sector, materials, at a net 9%.
This month, we asked investors for the first time what they would sell to fund the purchase of high beta equities. The number one pick (37%) was to sell government bonds. One-third of the panel believes investors will use cash and 19% opted for defensive equities. Significantly, only 4% opted for corporate bonds as the asset class they expect to be sold.
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