Allocations finally catch up with improved sentiment

Investor optimism about the global economy has soared to its highest level in nearly six years, with portfolio managers putting their cash back into equity markets, according to the latest Merrill Lynch survey of fund managers for August.
 
A net 75% of survey respondents believe the world economy will strengthen in the coming 12 months, the highest reading since November 2003 and up from 63% in July. Confidence about corporate health is at its highest since January 2004. A net 70% of the panel respondents expect global corporate profits to rise in the coming year, up from 51% last month.   

The survey, which takes the balance between the bullish and bearish views for each survey question, was conducted by Banc of America Securities-Merrill Lynch Research with the help of market research company TNS. This particular survey was conducted between August 7 to August 12, with a total of 204 fund managers responding, representing $554 billion in combined assets under management.

Up until this point, previous Merrill Lynch fund manager surveys were showing a marked improvement in investor sentiment, but that sentiment was not accompanied by corresponding actions.

August's survey shows that investors are matching their sentiment with action, by putting cash to work, Merrill Lynch says. Average cash balances have fallen to 3.5% from 4.7% in July, which was their lowest level since July 2007. Equity allocations have risen sharply month-over-month with a net 34% of respondents overweight the asset class, up from a net 7% in July. Merrill Lynch's risk and liquidity Indicator, a measure of risk appetite, has risen to 41, the highest in two years.
 
"Strong optimism in August represents a big turnaround from the apocalyptic bearishness of March. And yet with four out of five investors predicting below trend growth for the year ahead, a nagging lack of conviction about the durability of the recovery remains," says Michael Hartnett, New York-based chief global equities strategist at Banc of America Securities-Merrill Lynch Research. "The equity rally has been narrowly led by China and tech stocks. We have yet to see investors fully embrace cyclical regions such as Japan or Europe, or Western bank stocks."

Merrill Lynch is staying on the safe side and remaining cautious.

"Short-term pullbacks often coincide with a bullish fund manager survey. That's happening," Merrill Lynch notes in a report about the survey. "But August optimism feels grudging and only skin-deep to us. We remain cyclical equity bulls and buyers of dips."

Global emerging markets led by China, and technology stocks, are the strongest engines behind the early recovery, Merrill Lynch notes. Investors would rather be overweight emerging markets than any other region. A net 33% of the panel prefers to overweight emerging markets while investor consensus is to remain underweight the US, the Euro zone, the UK and Japan.
 
Technology remains the most favoured sector, with 28% of the global panel overweight on the industry. Industrials and materials lag with global fund managers holding overweight positions of 11% and 12%, respectively. Banks are lower on the list of preferred sectors.

Confidence in China's role in steering the global economy isn't keeping sentiment for its shares afloat, however. Within global emerging markets, Merrill Lynch has seen a switch away from China in favour of growth and liquidity plays such as Russia, Indonesia and Turkey.

Merrill Lynch notes that China growth expectations slipped again in August to a net 49% from a net 62% in June, and any data disappointment in the coming months from the mainland would translate to a negative development for global emerging markets as a whole. Malaysia, Israel and Chile are the least favoured emerging markets this month.