FYI | Jul 19 2012
– Shares are cheap, bonds expensive, and cash is king
– Investors continue to be pessimistic
– Australia seen as an Underweight
– No reason to be too bearish
By Greg Peel
BA-Merrill Lynch has posted the results of its July global fund manager and Emerging Market & Asia fund manger survey results, assessing investor preferences. If we use the US stock market as a proxy for global investor sentiment, we note the end of April saw the 2012 peak and after a classic “sell in May” we bottomed as we headed into June, inspired by apparent progress on the European front. July saw a total of eleven central bank rate cuts across the globe and an extension of the Fed's Operation Twist.
As Russell Investments notes, global equities (USD terms) returned a net 20% over the December and March quarters before falling 10% in May and rebounding 5% in June. July has returned a largely square result to date, having first fallen and more recently recovered.
Globally, investor sentiment has deteriorated further in July despite the rally in equities of 4% and in commodities of 8% since June [grains an influence], Merrills' survey has found. A big drop in corporate profit expectations for the US June quarter season and fading hopes for QE3 provided pessimism, and a shift out of commodities into “safe assets” was apparent. However those looking to exploit sharp summer declines in risk assets were also disappointed which Merrills ascribes to ongoing high levels of cash in portfolios.
FNArena's own surveys have found consistently high levels of cash in retail investor portfolios – 20% or more – over the past year. In fund manager land, June's 5.3% cash proportion was “ultra-high” in Merrills words. That level has fallen in July, but only to 4.9%. In June there were hopes for more QE-style action in Europe and QE3 in the US in the September quarter but now those hopes have been pushed out to the December quarter. The greatest number of survey respondents in three and a half years has called global fiscal policy “restrictive”.
Global economic growth forecasts continue to fall, with 25% of respondents expecting a global recession ahead and only 5% expecting above-trend growth.
Relative to the past decade's results, the survey found portfolios remain “significantly” underweight equities and commodities and overweight cash. July commodity allocation levels have fallen to their lowest since February 2009 [just before the stock market turned and Chinese stimulus began to kick in]. July saw a rare shift out of tech, on a sectoral equity allocation basis, and out of industrials and consumer discretionary and into utilities and telcos. Relative to a decade's results, “significant” underweight positions are being held in resources, industrials and banks, and energy allocation dropped to its lowest level since January 2009.
US total equity allocations dropped to a nine-month low in July, Europe, unsurprisingly, remains Underweight, while emerging markets provide the highest regional Overweight. The June quarter saw ten straight weeks of emerging market fund redemptions from EM funds but the last two weeks saw inflows once more. For the fourth consecutive month, Merrills notes, Asia investors are more optimistic on expectations for Chinese growth. Merrills wonders whether that optimism might be a little naïve, or perhaps a case of a lesser of the evils regional investment.
Having said that, investors scaled back their Overweight on China in July to 27% from 47% while becoming more Underweight on Taiwan and Overweight on Hong Kong. For Australian investors reading this article, the clanger comes with this observation from Merrills:
“Beyond Greater China, Australia remains the consensus Underweight as it remains vulnerable to a China-related commodity/growth slowdown.”
Russell Investments currently believes, in simple terms, that “shares are cheap”. However as the risk on/risk off yo-yo continues, Russell would rather stay Neutral on the near-term market outlook. Attractive valuations are one reason to favour a more risk-on approach and from the contrarian (bad news is good news for QE3) point of view, worsening US economic data is another reason to seek risk, Russell suggests. However the risk-off side of the equation balances out the risk-on, with Russell believing European concerns will again escalate and that Chinese growth forecasts will be downgraded further.
As far as the eurozone is concerned, Russell believes what is required to resolve the issue is a fiscal union with some form of debt sharing (eg a euro-bond), a much larger bail-out fund to stop Spanish and Italian bond yields rising, a region-wide bank supervisor and a deposit guarantee scheme, and more aggressive easing from the ECB to head off deflation. However Europe only implements significant policy shifts in crisis conditions. This means it will probably take at least one more crisis, Russell suggests, before a necessary policy response is forthcoming.
For the third year in a row talk of a double dip has swept the US. However given a slow recovery in housing, negative real interest rates and extensive spare capacity in the economy, Russell believes the odds of another US recession are low. Aside from recent weak data, next year's assumed fiscal tightening in the US makes it more likely the Fed will act in one way or another.
With Beijing's social housing program offsetting the forced weakness in private sector property development, Russell does not believe the Chinese economy is collapsing but simply slowing. Like everyone else, Russell expects more expansionary monetary and fiscal measures from Beijing in the second half and thus while there is probably downside risk to the analysts' 8.1% 2012 growth forecast, a drop below 7.5% is not anticipated.
Australia's 4.3% GDP growth rate for the March quarter left the pessimists confounded but as Russell notes the breakdown showed the two-speed economy becoming even more entrenched. With substantial fiscal tightening planned for FY13 (return to surplus) there is downside risk to growth.
The RBA has lowered its cash rate by 125bps to 3.5% since November and interest rate markets are pricing in up to 100bps more of cuts over the next twelve months. Russell also sees further cuts, but only one or two more moves of 25bps.
Russell believes sovereign bonds to be extremely expensive, with the US ten-year at 1.5% and Australian equivalent below 3%. Russell also believes the Aussie dollar to be overvalued.
The good news is, however, that underlying the market volatility is a story about improving share market valuations and worsening government bond values, Russell suggests. These values will drive investment returns.
“This means that investors with a longer time horizon should resist the urge to get bearish”.
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