Merrill Lynch Fund Manager Survey Finds Investors Most Underweight Equities in a Decade

NEW YORK and LONDON. — Asset allocators have taken their most negative stance towards equities in a decade, with a net 27 percent underweight the asset class in June, according to this month’s Merrill Lynch’s Survey of Fund Managers.

Investors’ fears of stagflation have crystallised as they face up to the possibility that interest rates might have to rise as the global economy slows. They have acted by reducing exposure to both equities and bonds and moving into cash. This month’s survey reflects a world where global growth and profit expectations are deteriorating. At the same time, fears of higher inflation, and subsequent higher interest rates, are rising. Just 1 percent of respondents believe equities are undervalued, down from 25 percent in March. A net 81 percent of the panel believes consensus earnings estimates for the next 12 months are too high. A net 42 percent of asset allocators are overweight cash, up from a net 31 percent in May.

“The market is waking up to the idea that global interest rates are too low, in fact they remain below inflation,” said Karen Olney, chief European equities strategist at Merrill Lynch. “Negative real rates are hardly an antidote to inflation. Merrill Lynch expects a double rate hike from the European Central Bank (ECB) by October and would expect other central banks to follow.”

Sentiment Towards Eurozone Turns Around
Europe has taken the brunt of investors’ shift away from equities. Over the past 12 months, the Eurozone has moved from most to least favoured. A net 29 percent of investors said this month that the Eurozone is the region they would most like to underweight on a 12 month view.

Asset allocators have already moved aggressively out of Eurozone equities. A record net 22 percent said they are underweight — the most negative stance taken in the past 10 years. Not only has the Eurozone the least favourable corporate profit outlook, but the quality of earnings has been slipping, too. This, in turn, is reducing any perceptions that Eurozone equities are undervalued. Also fuelling their negative stance are concerns about the currency. A net 71 percent of asset allocators believe that the euro is overvalued — a particular concern for a region heavily dependent on exports.

Amid these concerns, European fund managers have been moving into cash. A net 34 percent of European investors said they were overweight cash in June’s regional survey, up from 3 percent in April. Furthermore, a growing number recognises that higher interest rates are likely. In February, half of European respondents believed ECB monetary policy to be too restrictive. That number fell to a net 10 percent this month.

Any bearish tendencies towards the Eurozone are, however, dwarfed by the negative stance global investors are taking towards the U.K. A net 38 percent of asset allocators are underweight U.K. equities, again the most negative stance in a decade. Investors’ attitudes towards the U.K. are also shaped by fears over sterling. Even after an 11 percent fall in sterling’s trade weighted index over the past 12 months, a net 56 percent of asset allocators still believe the currency to be overvalued.

Europeans Go Long Oils, Short Banks
The popularity gap between the booming oil industry and the beleaguered banking sector has reached unprecedented levels in the eyes of European investors. A net 62 percent of respondents are overweight Oil and Gas (up from a net 29 percent in April). At the other end of the spectrum, a net 62 percent are underweight Banks (up from a net 21 percent in April).

“The burning question is when to sell oil companies and move back to banks,” Ms. Olney said. “Fundamentals absolutely support Oils over Banks. The sector has the strongest earnings momentum in Europe and is also among the cheapest.” Merrill Lynch forecasts an average price of U.S. $121.50 per barrel in the second half of 2008 and an average price in 2009 of $107 per barrel.

Aftershock of Credit Crunch Takes Grip
The credit crunch is losing its sting as the greatest single threat to financial market stability. The net percentage of investors citing “credit risk” as the number one threat has fallen from 95 percent three months ago to 81 percent in June. But inflation is the fastest growing concern. A net 65 percent of respondents cite “monetary risk” as the greatest threat, up from a net 23 percent in May.

“For the first time in our memory, inflation, not growth is the primary macro driver at the global level, in our view. The inflation shock has already happened,” said Alex Patelis, head of international economics at Merrill Lynch. “What matters now is how persistent it is and how markets and policymakers react; at a global level this begs for an accident that will awaken markets and policy makers to the risks.”

A total of 204 fund managers participated in the global survey from June 6 to June 12, managing a total of U.S. $718 billion. A total of 185 managers participated in the regional surveys, managing U.S. $454 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 multi-national 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.

Merrill Lynch Global Research has consistently achieved high rankings for its equity and fixed income research in numerous regional and global investor surveys, such as Institutional Investor, The Wall Street Journal, LatinFinance, Asiamoney, Euromoney, Extel and Reuters.