Risk is well and truly back, and you can blame the Fed and its tortuous move towards another bout of quantitative easing for that, judging by the results of the October survey of global and regional fund managers by Bank of America/Merrill Lynch.
The report shows a very basic contradiction in fund management circles.
Fund manager optimism about emerging market (EM) equities is “stratospheric”, according to the survey, but the same managers increasingly think those same equities are overvalued.
So why aren’t they worried and selling off their EM shares?
The monthly report, which surveys 194 fund managers with portfolios worth $US492 billion, showed its highest reading since November 2009 for investors overweight EM equities.
In October, a net 49% of investors were overweight EM, up by 17 percentage points from September, as an expected new round of quantitative easing from the US Federal Reserve helped investors increase their risk appetite.
But one question asks global investors to name the equity region they feel is the most overvalued. Here EM clearly stands out with a net 21% choosing EM followed by US at 11%, Japan at -5%, UK -8% and the eurozone 20%.
But it gets even more confusing. Another question asks fund managers whether they think EM is overvalued. Here we still have a net 13% saying ‘undervalued’, but two months ago a net 50% said ‘undervalued’.
Go figure, as they say in the movies. Emerging markets might be overvalued, but investors are still hanging in for the ride.
Looking at China, where confidence in its growth rises (would the rate rise on Tuesday hit that growing level of optimism?), a net 19% of managers expect China’s economy to strengthen over the next year, up from a net 11% in September.
And the rising appetite for more risk also fostered a move into commodities.
In October a net 17% of those surveyed were overweight in the asset class, up from a net 4% in the previous month.
“While improved risk appetite is to be welcomed, one proviso is just how narrow the investor focus on global emerging equities is at this point,” said Michael Hartnett, chief global equities strategist at BofA – Merrill-Lynch in the statement.
Managers showed less trepidation about UK shares as they moved from a net underweight position in September to a neutral one this month. There was a stable appetite for the US, eurozone and Japanese equities.
“European stocks, especially in cyclical sectors, are riding on the coat tails of quantitative easing expectations with as yet no sign of a pick-up in underlying macro fundamentals,” said Gary Baker, head of European equities.
But managers are now very bearish on bonds, with a net 71% of surveyed investors, the highest number since September 2005, believing that bonds are now overvalued.
Despite the increased optimism about emerging markets and China, the surge in confidence has not been even.
In terms of the sectoral breakdown in EM, investors extended their overweight bet in the consumer discretionary sector, while increasing the underweight bet on utilities. Other sectors remained neutral.
The survey’s risk and liquidity indicator also rose from 37 to 43, cash balances fell, and the proportion of asset allocators overweight in equities nearly tripled from a net 10% in September to a net 27%.
However, as risk levels hit the highest level since the onset of the first phase of quantitative easing, Gary Baker, the head of European equities strategy at BofA – Merrill Lynch Global Research, says investors are staying on the sidelines.
“Judgement is being reserved of the effect of QE2 on the underlying economy,” says Baker.
“This month’s survey saw no big increase in expectations for global growth and profitability, although the danger of a double-dip recession has now been largely dismissed.”
According to the survey, a net 15% of managers now expect higher growth over the next year versus 0% in September. However, only 9% expect above trend growth in the coming 12 months.
Inflation expectations moved sharply higher in October, with the proportion of investors predicting higher inflation rising from a net 9% in September to a net 27% in October, hence the sell-off in bonds, especially in the US, until Tuesday’s Chinese rate rise.
