Investors' confidence in the outlook for global growth and corporate profits has dipped, according to the BofA Merrill Lynch Survey of Fund Managers for May.
The proportion of the panel believing that the world economy will strengthen in the next 12 months has fallen to a net 10 percent, down from a net 27 percent in April and a net 58 percent as recently as February. Similarly, only a net 9 percent of respondents now look for corporate profits to improve in the coming year.
Participants' lower conviction is most evident in Europe, where expectations turned negative in May with a net 8 percent expecting the region's economy to weaken in the next year. Just two months ago, a net 32 percent forecast that it would strengthen. This reflects investors' identification of the eurozone sovereign debt crisis as the largest tail risk globally (up to 36 percent, from 21 percent in April).
With prospects for growth more challenging and inflation fears receding, asset allocators have postponed their expectations of a rise in U.S. interest rates. In the April survey, 69 percent of participants anticipated the Federal Reserve first hiking rates by the end of this year; now 73 percent sees this occurring in 2012.
Against this accommodating background, risk appetite has fallen only modestly. Fund managers trimmed exposure to equities and commodities, while adding to cash and bond holdings slightly.
Risk aversion is more evident in strong sector rotation into more defensive areas, such as consumer staples and pharmaceuticals, and out of more volatile and growth-dependent sectors, such as energy and materials.
"A triple dip in growth expectations is reshaping investors' stance on risk," said Michael Hartnett, chief Global Equity strategist at BofA Merrill Lynch Global Research. "A risk for investors is that pessimism on Europe now looks to be overdone, particularly in light of strong recent GDP data," said Gary Baker, head of European Equities strategy at BofA Merrill Lynch Global Research.
Emerging Markets Equities Favored Despite Lower BRIC Conviction
A net 28 percent of regional fund managers expect China's economy to weaken in the coming year, up from a net 15 percent in March. Despite this and lower confidence in other important BRIC economies, such as Brazil, allocations to emerging market equities continue to rise.
A net 29 percent of the panel now has an overweight position in EM equities. This represents the highest reading in any region this month and compares with a net zero percent two months earlier.
This positive stance partly reflects the earnings outlook in emerging markets. A net 19 percent of respondents believe that EM corporates are most favorably positioned to grow profits (second only to the U.S.). It also reflects growing optimism on domestic demand in emerging markets. A net 42 percent sees this as the most important driver for EM equities, up from a net 5 percent in March.
Belief in Japanese Growth Rebounds
Two months after the earthquake and tsunami in the northeast of Japan, investors have scaled back their initially negative views of the events' impact. In April's survey, respondents were divided evenly between those expecting the country's economy to weaken in the next year and those expecting it to strengthen; this month, a net 59 percent sees it strengthening over the period.
Moreover, a net 38 percent expects Japanese companies to improve earnings per share in the next 12 months. This compares with a net 33 percent in April seeing EPS declines. Sentiment towards Japanese equities began to repair, with April's net underweight (18 percent) improving by a percentage point in May.
The panel continues to avoid exposure to the yen, however. A net 64 percent regards the currency as overvalued - little changed from the previous three monthly readings.
Currency Contrasts - Euro Overvalued, Dollar Undervalued
In contrast to their views on the yen, respondents have intensified strong views on the world's other key currencies. Underscoring lower confidence in the eurozone's prospects, a net 60 percent now views the euro as overvalued versus a net 40 percent one month earlier and a net 25 percent in February. This represents the highest reading since December 2009.
A net 48 percent views the U.S. dollar as undervalued, up from a net 36 percent in April. This accords with participants' constructive stance on the U.S. outlook. Besides the profit picture for U.S. companies, this is also visible in respondents' selection of the U.S. as the regional equity market they most favor for overweight positions in the next year.
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