Fund manager optimism hits five-year high

The recession is not over but investor pessimism from professional money managers appears to have passed. According to the August edition of the Merrill Lynch Survey of Fund Managers, more than three quarters of the world’s fund managers believe the global economy is poised to strengthen over the next year, marking the highest level of optimism since 2004.

August’s survey of more than 204 fund managers, who manage a total of US$554 billion in assets, shows a huge increase of managers deploying their cash reserves into equities, with an particular focus on emerging markets.

According to the survey, average cash balances have fallen to 3.5% from 4.7% over the last month — the lowest level since July 2007. Equity allocations have risen dramatically over the last month with a net 34% of managers overweight the asset class, up from a net 7% allocation in July.

Bond allocations have been drastically reduced, to their lowest levels since April of 2007.

Merrill Lynch’s Risk and Liquidity Indicator, a measure of risk appetite, has risen to 41%, the highest in two years.

Strong optimism is being tempered with relatively muted outlook for medium-term growth. Managers acknowledge that the recession lingers and therefore so to do weak earnings outlooks.

“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,” said Michael Hartnett, 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.”

Apart from emerging market equities, asset allocation strategists are underweight every other equity region. The same strategists remain underweight in bank stocks. According to the survey the rally in equity markets is nudging the asset class ever so slightly into “overvalued” territory. This would suggest there is a view that short-term growth for equity valuations is limited.

The study’s authors point out that similar sentiment in the past has resulted in short-term pullbacks that offer good buying opportunities.

“Short-term pullbacks often coincide with a bullish fund manager survey (FMS). That’s happening. But August optimism feels grudging and only skin-deep to us. We remain cyclical equity bulls and buyers of dips. August FMS resembles June 2003 FMS, when big reduction in cash balances (4.9% to 3.9%) and increase in equity allocation (3% to 22%) caused a nascent cyclical bull market to pause for breath. The bull market resumed a few months later,” the study says.

Economists weigh in on recovery

A number of economists also released reports on Wednesday that suggested the North American economy is now firmly in recovery.

IHS Global Insight’s chief U.S. economist Nigel Gault, says data shows the U.S. recession was much deeper than observers first believed, however the pace of recovery is also expected to quicker than expected.

“Recent data revisions have shown us that the recession was deeper than first thought, in GDP terms, with a 3.9% decline in real GDP from the second quarter of 2008 to the second quarter of 2009,” he says. “But even though we still expect the recovery to be a slow one, the incoming evidence suggests that the pick-up in growth in the second half of the year will be more rapid than anticipated. We have raised our growth forecast for the second half to an average 2.2% pace, from 0.9% in our July forecast.”

The major concern for many economists is consumer spending. Unemployment is expected to remain high and an offshoot of that is limited spending.

“Consumers will spend when the deal is attractive enough, as shown by the success of Cash for Clunkers. But incomes have taken a beating from declining employment, low wage increases or wage cuts, and short working hours, while debt burdens remain high, and wealth losses remain heavy despite the recent improvement in the stock market,” Gault says. “Spending fell 1.2% in the second quarter, and although we expect it to rise 2.5% in the third, that is almost all due to Cash for Clunkers. Excluding new vehicles, we expect spending to edge up just 0.6%. It remains difficult to make a case for a robust consumer recovery.”

Canada may be more fortunate in this area than the U.S., according to CIBC economist Benjamin Tal, who authored a report suggesting that the employment slide in Canada is not as severe as it appears.

Read: Jobless stints shorter this time around

(08/19/09)