European and Japanese equities retain positive sentiment – Merrill Lynch survey

Investor optimism over the global economic recovery and corporate profits has been dented as the tail risk associated with the US economy has escalated, though sentiment towards Europe has improved, according to the BofA Merrill Lynch Fund Manager Survey for October.

The survey taken from 4 October to 10 October showed that the number of investors believing the global economy will strengthen had fallen to a net 54%t from a net 69% in September, albeit still at historically strong levels. A net 71% expect the economic growth to remain “below trend” in the coming 12 months, up from a net 61% a month ago. Concern about US fiscal tightening is now the number one tail risk for 24% of the panel, up from only 6%in September.

Expectations for a recovery in corporate profits have also fallen. Last month, a net 41% said they expected corporate profits worldwide would improve in the following 12 months – that figure has tumbled to a net 28% in October. A net 18% believes that corporate profit margins will decrease in the coming year, up from a net 11% a month ago.

Asset allocators have scaled back their equity holdings. A net 49% of global asset allocators are overweight equities, down from a net 60% in September. Over the past month, investors have reduced their positions in eight out of the 11 sectors monitored by the survey. Last month, a net 9 percent of the panel remained overweight US equities, and this month, that measure has dropped to zero percent. At the same time, investors have shifted back towards fixed income, scaling back their underweight positions in bonds and portfolio cash levels rose.

“Events in Washington clearly caused investors to shift back towards their benchmarks, but asset price gains can still be driven by high cash levels,” said Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research. “Strong flows into Europe would call for a touch of near-term caution, but solid macro momentum in the region suggests that any dips in EU equity markets would be enthusiastically bought,” said John Bilton, European investment strategist.

Rising conviction about European equities

Europe has been able to avoid the downward shift in global sentiment with equity allocations reaching a six-year high. A net 46% of asset allocators are overweight European equities, up from a net 36 percent September and representing the highest reading since 2007.

Global investors’ outlook for European corporate profits has continued to rise uninterrupted by events in Washington. It is now at its most positive level since September 2007. A net 10%of the panel says the eurozone is the region with the most favorable outlook, up from two months ago when a net 5 percent forecast falling profits.

Japanese equities have also resisted the global trend in October to record a second successive month of improvement. A net 30% of global asset allocators are overweight the region, up from a net 22% in September.

Emerging market confidence starts to rebuild

Investors and asset allocators have increased allocations towards global emerging market equities and have indicated in October’s survey that they see value in the region. The signals towards global emerging markets are not universally positive, however.

Asset allocators scaled back their underweight positions. A net 10% of the panel was underweight emerging markets equities in October, improved from a net 18% underweight a month ago. On average, a net 26% of investors have been overweight the region.

At the same time, however, the outlook for China’s economy worsened. A net 5% of regional fund managers expect the Chinese economy to strengthen in the coming year, down from a net 28% in September. And asset allocators further reduced their exposure to commodities – an important proxy for emerging market sentiment. A net 28% of asset allocators are underweight commodities, compared with a net 16% in September.

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