Equity Markets Shrug Off Credit Crunch but Questions Remain Over Fundamentals
NEW YORK and LONDON.— Stock markets are reaching new highs but market fundamentals are weaker than before the recent turmoil in world markets, according to Merrill Lynch’s Survey of Fund Managers for October.
Global equities at the time of October’s poll were 3 percent higher than in July — a result that vindicates investors’ decision, expressed in August’s and September’s surveys, to stick with equities despite market turbulence. The macro-economic outlook has improved in the past month but is less bright than three months ago. The net balance of respondents expecting global growth to deteriorate increased to 55 percent in October from 5 percent in July. The net balance expecting a worsening of corporate profits (44 percent) improved from September — but is much higher than in July (12 percent).
“Investors are preparing for a new environment in which earnings growth will become increasingly scarce,” said David Bowers, independent consultant to Merrill Lynch. “When it comes to investment style respondents are expressing a marked preference for growth over value. The trouble is that investors can identify only three sectors with strong growth characteristics; technology, materials and industrials.”
Fed Cut Boosts Risk Appetite but Prompts Inflation Jitters
The U.S. Federal Reserve’s interest rate cut played an important role in fuelling the recent equity rally. However, risk appetite has yet to recover to levels seen in July. The 50 basis-point cut has also reignited inflation fears.
Risk appetite has improved since July. The FMS Composite Indicator for Risk & Liquidity has moved back up to 39 from 33 in September. However, it remains three points off the level of 42 taken in July. Cash is a case in point. Cash levels in October at an average of 4 percent of a portfolio were down from September (4.3 percent) but significantly higher than the 3.4 percent recorded in July. Investment time horizons are shorter, portfolio risk is lower and liquidity conditions remain weaker than in July.
Inflation concerns resurfaced in October but remain below levels three months ago. The net balance of respondents expecting core inflation to rise over the next 12 months leapt to 33 percent in October from 4 percent in September. These concerns have prompted a bearish outlook for long term interest rates — the net balance expecting higher bond yields rose from to 43 percent from 26 percent in September.
Asset allocators remain overweight equities, however. “Even if macro economic fundamentals have been slower to respond to easing by the Fed, equities remain the asset class of choice,” said Karen Olney, chief European equity strategist. “We still see an excess of liquidity and the market has yet to re-rate the value of equities the way it has re-rated other asset classes during the credit bubble.”
Emerging markets have been the biggest regional beneficiary of the rate cuts and market rally. The region is home to many companies in technology, materials and industrials — the three sectors identified by respondents as the most likely sources of earnings growth.
Rate Cuts Help Commodities
The Fed’s interest rate cut is also helping to boost commodity prices and set the stage for further strength. “While the U.S. economic outlook remains bleak, further rate cuts by the Federal Reserve could help spur an Asian liquidity boom in 2008, supporting investment, infrastructure spending and raw materials consumption,” said Francisco Blanch, head of Commodity Research at Merrill Lynch.
Commodities, as an asset class, tend to work as a hedge against inflation. Metals, which largely escaped the credit crunch unscathed, are performing well with precious metals profiting from growing risk aversion and a weaker U.S. dollar. Merrill Lynch recently revised its fourth quarter WTI crude oil price forecast to U.S. $80 per barrel from U.S. $67.50 on the back of slower-than-expected supply growth.
A total of 209 fund managers participated in the global survey from October 5 to October 11, managing a total of U.S. $671 billion. A total of 180 managers participated in the regional surveys, managing U.S. $458 billion. The survey was conducted with the help of market research company Taylor Nelson Sofres (TNS). Through its international network in more than 50 countries, Taylor Nelson Sofres provides market information services in over 80 countries to national and multinational organizations. It is ranked as the fourth-largest market information group in the world. Survey results were analysed by David Bowers, who is joint managing director of Absolute Strategy Research Ltd, a financial services consultancy.
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