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Risk Aversion Reaches New Highs



NEW YORK and LONDON. — Institutional investors are more risk averse now than they have been in seven years, according to Merrill Lynch’s Survey of Fund Managers for February. About 30 percent of the panel say they have hedged against further falls in equities over the next three months.

Fears over the economy and corporate profitability have stimulated a rise in portfolio cash levels to an average of 4.7 percent, up from 3.9 percent in January. A net 41 percent of fund managers are overweight cash, the highest since September 2001’s terrorist attacks on the United States. Investors have a shorter-term focus than at any time since March 2003. Risk appetite has plunged to new lows with a net 40 percent taking a lower level of risk than normal. The FMS Composite Indicator for liquidity and risk has fallen to 31, its lowest level since the survey first tracked risk appetite in April 2001.

“Risk aversion is so extreme and cash levels are so high, that the challenge is now to identify the catalyst that prompts money to return to the stock market,” said David Bowers, independent consultant to Merrill Lynch. “While it’s not clear what that catalyst will be, there’s no doubt that the ability to draw a line under the credit crunch will be an important step.”

Equities Bias Remains Embedded
Deep down, investors remain predisposed toward equities. Holding them back is concern over the credit crunch’s impact on corporate and economic health. A net 25 percent of respondents believe that equities are undervalued — three months ago that figure was a net 5 percent. A net 48 percent of respondents view bonds as overvalued.

The number of respondents who forecast a deterioration incorporate profits over the coming 12 months has risen to a net 68 percent, up from 57 percent in January. The percentage of managers who believe the global economy is in recession has doubled for the second month running to 16 percent, while the number who think a global recession is “likely” in the next 12 months rose to 28 percent, up from 19 percent in January. Asset allocators are now unwinding their long-running strategy of being long equities, short bonds. This month, a net 8 percent said they were underweight equities, the first underweight reading since March 2003. Overweight positions in emerging market equities are starting to be pruned back.

ML FMS Composite Indicators Feb Jan Dec Nov
Growth Expectations Composite 23 23 20 25
Monetary Stance Composite 46 49 49 60
Perceptions of Equity Overvaluation 38 43 44 48
Risk Appetite & Liquidity Composite 31 34 36 38

Love Affair With Eurozone Equities Is Over
Investors’ four-year love affair with continental European stocks has ended. Only 7 percent of asset allocators are overweight eurozone equities compared with 23 percent in January. Sentiment within the eurozone itself is weakening with a net 87 percent of respondents to the Regional FMS expecting growth in earnings per share to fall, while a net 25 percent believes inflation will fall.

“Eurozone investors are asking for rate cuts, worried not by inflation, but by a potential collapse in growth,” said Karen Olney, chief European equities strategist at Merrill Lynch. “Investors are sending a clear signal that they expect a raft of downgrades to consensus earnings forecasts — 96 percent of respondents say these forecasts are too high.”

Second Half Upturn in Store for Eurozone Economy
Eurozone investors believe the European Central Bank’s focus on inflation is overdone. A net 49 percent say that the bank’s monetary policy is too restrictive. Merrill Lynch, however, believes that while market turmoil might dampen consumer confidence in the short term, the eurozone’s economic fundamentals are strong with forecasts for GDP growth of 1.9 percent in 2008 and 2.1 percent in 2009. Furthermore, inflation should remain a concern for the ECB. Merrill Lynch forecasts inflation to rise to 2.7 percent in 2008, above the ECB’s target (less than, but close to 2 percent) before falling to 2.0 percent in 2009.

“The market is pricing in 75 basis points of interest rate cuts, but given the inflationary outlook we simply do not believe that the ECB has room to manoeuvre and deliver these cuts,” said Guillaume Menuet, European economist at Merrill Lynch.

A total of 190 fund managers participated in the global survey from February 1 to February 7, managing a total of U.S. $587 billion. A total of 171 managers participated in the regional surveys, managing U.S. $393 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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