Fund managers’ fears of inflation have all but evaporated to reach their lowest level since the downturn of late 2001, according to Merrill Lynch’s Survey of Fund Managers for August.
The survey captures an extraordinary reversal in investors’ attitude toward inflation. A net 18% of the 193 respondents expect global core inflation to fall in the coming 12 months. In June’s survey, a net 33% thought inflation would rise. A falling oil price and growing evidence of recession have prompted this rethink. More investors believe that the global economy has already entered recession 24% of the panel take that view this month compared with 20% in July and 16% in June. During the credit boom, investors urged companies to borrow more, but, with the credit crunch biting, they are now concerned about leverage. The net percentage of investors who believe corporates are under leveraged has tumbled to 9%, down from nearly 40% at the end of 2007.
“The message from investors to corporates is that if we are headed for a recession, they should clean up their balance sheets and prepare a financial buffer,” says Karen Olney, chief European equities strategist at Merrill Lynch. “As banks de-lever, nonfinancial corporates will have to wake up to far less flexible world of credit.”
With the economic downturn spreading to the eurozone and certain emerging markets, investors are starting to view US assets as attractive. The net balance of asset allocators overweight US equities stands at 12%, its highest level in more than six years. Supporting this view is the widely held belief that the US dollar is undervalued. A record net 58% say this month that the dollar is undervalued, while a net 71% say the euro is overvalued. Investors believe that the U.S. has a better corporate profit outlook and higher quality earnings than the eurozone.
European investors have responded to the fall in the oil price by selling oil producers and buying into discretionary consumer stocks. The percentage of European investors overweight oil & gas stocks collapsed to 11% in August from 52% in July. Investors have also significantly scaled back large underweight positions in travel & leisure, personal & household goods and retail companies. Technology and media sectors, both with significant exposure to consumer demand, also swung back in favour.
At the same time, inflation fears among the European panel have fallen to levels even lower than in the Global Survey. A net 45% of European fund managers expect the region’s core inflation to fall over the next 12 months. In June, 32% of the European panel were predicting rising inflation.
“The market appears to have overreacted to a fall in the oil price, and investors have turned a blind eye to second round effects of inflation, such as rising wages,” says Olney. “It will take several months of slowing global growth to be sure that the inflationary dragon has been slain.”
One consequence of the recent fall in the oil price has been a rapid unwinding of what the survey has highlighted as a highly crowded trade: Investors have reduced ‘long’ or overweight positions in energy and started closing underweight positions in financials. But have they lost sight of the fundamentals in unwinding this position?
Merrill Lynch believes that the energy sector will continue to be supported by a strong oil price. The firm forecasts oil at US $119 in the fourth quarter, underpinned by low, real global interest rates. Francisco Blanch, head of global commodities research, stated, “While we have started to see some demand for oil curtailed in OECD economies, the economic fundamentals in China and other emerging markets support oil at more than US $100 a barrel into 2009.”
Investors have moved to close underweight positions in European financials after second quarter results suggested banks are on the road to improvement. According to Stuart Graham, head of European bank equity research, toxic write-downs are coming to an end and banks have completed more than half of their capital raising. However, although earnings downgrades for banks are well under way, doubts remain about the sector’s ability to bounce back quickly.
“Banks are highly unlikely to see a V-shaped recovery in their share price given the uncertainties in the market,” says Graham. “Apart from the economic outlook, a key question is how stringent regulators will be in setting new rules to govern banks’ capital ratios. No one yet knows what the appropriate capital structure of the future is.”
A total of 193 fund managers participated in the global survey from 1 August to 7 August, managing a total of US $611 billion. A total of 161 managers participated in the regional surveys, managing US $432 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.
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.