Fund managers rotate


There are growing signs of pessimism amongst fund managers globally, a point that has already been well covered on MacroBusiness. How is this affecting trading strategies and asset allocations? Merrill Lynch’s May fund managers survey sheds some light. It says that investors are questionnig global growth prospects. Only 10% expect stronger global growth in the next year, down from 58% in February. But because liquidity is high, the appetite for risk is remains reasonably strong. Equities are seen as a better risk than bonds. There is limited rotation across asset classes, but some rotation within asset classes towards more defensive positions. Given the importance of foreign investment to the ASX — it is about two fifths of the market — this suggests that the All Ords may not be subject to much selling pressure from international sources in the short term. But there may be a move away from some of the more risky stocks.

Having said that, the industry sectors that dominate in Australia, resources and banks, are losing support:

The clear trend in sector moves this month is defensive rotation out of resources, energy and banks into defensives and consumer discretionary. There is now little to distinguish between aggregate cyclical vs. defensive relative preference.

The Merrill Lynch survey suggests fund managers are most worried about Europe:

Growth fears see EU debt issues again ranking as the main investment risk. A slightly lower EU growth outlook (49 vs. 52) is being offset by US resilience and a rebound in Japan sentiment (74 vs. 42). A bigger concern is the deeper decline in China optimism with a net 28% seeing weaker growth compared to 15% in March.

Emerging markets are preferred:

Asset allocation saw modest rotation into bonds (48% UW from 58%) funded by lower commodities (12% OW vs. 24%) and equities (41% OW vs. 50%). GEM regains its position of most preferred region (29% OW vs. 22%) replacing US (26% OW). Consensus is UW Europe (-1%) and Japan (-17%). USD sentiment (48% undervalued) is one of the highest readings since 2002.

These are some of the sector rotations:

Sharp falls in energy (to 19% OW from 40%) and materials (2% UW from 17% OW) accompanied a sharp defensive rotation into staples (8% OW from 6% UW), pharma and telecoms. Banks are once again the most unpopular sector (26% UW down from 15%) with technology by far the most popular (35% OW).

How to trade the risk scenarios if the summer sees stronger-than-expected growth: long banks, short pharma; long commodities, short bonds. If the summer sees weaker liquidity: long bonds, short equities; long US$, short EM.

The massive stresses in the bond markets has investors preferring equities. Reasonable enough, but it is also leading to some overly bullish equity valuations. In a sense, it is not a good time to be comparing equities and bonds, because the cost of capital in most developed economies is so low:

The spread between equity and bond valuations contracted this month but still represents an enormous gap in relative value perception. A net +61% view bonds as overvalued, unchanged from last month, but now only a net 11% see equities as undervalued compared with 15% in April.

The overall impression is of confusion. There is not enough gloom to rush to the exit doors, and in any case few of the options on the other said of that exit door look especially strong. The post-GFC muddle-through continues on.

Merrill Lynch

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  1. Good piece SON.

    I’m seeing sector rotation play out on the ground – financials (AMP ASX ANZ CBA WBC) and non-discretionary (WOW WES) are being bid up.

    And telcos are going nuts – TLS is soaring, as is NZ’s TEL.

    But energy/resources seem to be the bad boys for the moment.

    I don’t look at sectoral indicies as part of my trading, but its pretty obvious where the hot equity money is going at the moment. In Australia at least…

  2. The AFR carried a piece today about the big 4 banks, indicating that they face significant head winds as home lending dries up. No doubt a familiar story to MB readers or anyone who’s listened to The Prince and I bang on about the banksters.

    Interesting comment about financials being bid up Prince – the muddling continues.

    • Its just trading the dips at the moment Q – me included.

      Retail stocks are still being left well alone – most are in trading ranges/channels or being bid down (HVN) or left well alone.

      Still need to remember that the majority believe that banks are cheap – low P/E, high dividend yield, low “risk”. Pascoe et al lead this charge.

      ASX is being bottom picked by monkeys and traders (I repeat myself). The Chi-X competition has probably been factored in to the price as well as the SGX takeover failure.