Portfolio managers reverse course on outlook

Portfolio managers were as shaken as individual investors by the recent market turmoil, according to the results of the latest Bank of America Merrill Lynch global survey of fund managers

Portfolio managers were as shaken as individual investors by the recent market turmoil, according to the results of the latest Bank of America Merrill Lynch global survey of fund managers.

The survey polled 176 fund managers who oversee a total of $551 billion in assets during the week of Aug. 5-11. It found that their views on the global economy and corporate profits had deteriorated dramatically from last month. Their average cash levels climbed to 5.2%, just slightly less than the recent peak of 5.5% at the depth of the financial crisis.

A net 30% of the group said they think that global corporate profits will deteriorate over the next 12 months. By comparison, in last month’s survey, a net 11% said that they thought conditions would improve.

The reversal of sentiment among managers was one of the sharpest that the survey has ever recorded. A net 1% of the group is now underweight in U.S. equities, compared with 23% overweight in July.

A net 14% of U.S. fund managers in the group now think that the U.S. economy will weaken, versus 29% who said two months ago that they thought that it would strengthen.

Europe, despite the continuing economic pessimism for the region, scored somewhat better with the respondents.

The percentage of global managers underweighted in European stocks dropped to 15% this month, from 21% in July. Seventy-one percent of European managers said that they think that the region’s economy will weaken, while 22% said the same last month.

Optimism continues to be highest for China and other emerging markets.

A net 11% of fund managers in those regions said that they think that the Chinese economy will weaken. By comparison, 24% felt that way last month and 40% in June.

The percentage of global managers overweight the region fell to 27%, from 35%.

“Flows out of equities into cash have reached capitulation levels, especially in the U.S., but it’s significant that a revival in optimism toward China has survived the global correction,” said Michael Hartnett, chief global equity strategist at Bank of America Merrill Lynch Global Research.

The large move to cash by portfolio managers is a contrarian “buy” signal, according to Bank of America Merrill Lynch. After periods in which cash levels have risen to these high levels, global equities have on average rallied 5.9% over the next four weeks.

The biggest sector allocation moves were out of cyclical stocks, especially industrials, energy and materials. With business cycle risk identified by three-fourths of the respondents as the biggest risk to market stability, allocation sentiments toward industrial stocks saw a swing of 27 percentage points from July to August.

Sixteen percent are now underweight industrials, compared with last month, when 11% were overweight the sector. The managers continue to be underweight banks and are less overweight in energy stocks than in July.

The biggest positive moves in sector allocations were into technology stocks (5%), telecoms (4%), and consumer staples (3%).

Some other items in the survey:

• The biggest “tail risk” seen by the portfolio managers was European Union sovereign-debt funding.

• The percentage of respondents who ruled out the prospect of another round of quantitative easing by the Federal Reserve fell to 22%, from 40%.

• Inflation expectations fell dramatically, with a net 6% of managers now believing that inflation will be lower in the next 12 months. Last month, a net 28% said they thought that it would be higher. Twenty-five percent of the group said they expect interest rates to rise; 72% said that last month.

• With gold surging for much of the last two weeks, a net 43% of the group said that they now think that gold is overvalued. A net 17% said that they thought that last month.

Email Andrew Osterland at [email protected]