Bullish sentiment, but no one’s buying

The signs of economic apocalypse are everywhere: job cuts measured in the tens of thousands; residential foreclosure rates rising; and stock markets bouncing along at multi-year lows. But now there are signs of renewed investor optimism.

In fact, investors appear to be in the best mood since December 2005, according to the latest Merrill Lynch Survey of Fund Managers.

The March survey found that investors are no longer predicting lower global economic growth for the coming year. Bear in mind, throughout the bull market of 2006 to mid-2008, they were predicting lower global growth; they were wrong about 2007, about half-right for 2008, and bang-on the money about 2009.

In the January survey, a net 70% of respondents (or 85% overall) were predicting China’s economy would decline over the coming 12 months. That figure has now dropped to a net 1% (or 50.5% overall) in March.

So far, survey respondents are reluctant to deploy their capital, however, with concerns over the U.S. banking system ranking as the number one impediment to investing in stocks.

“March’s survey shows signs that investors want to believe in an economic recovery,” said Gary Baker, co-head of international investment strategy for Banc of America Securities-Merrill Lynch. “However, caution on banks is firmly capping risk appetite.”

A net 48% of asset allocators said they were underweight bank stocks in March. In February that figure stood at a net 39%. Japanese and eurozone stocks remain under suspicion.

With little appetite for risk, survey respondents say they have increased their holdings of cash and bonds. A net 41% (70.5% overall) are underweight in stock, compared to a net 34% (67% overall) in February.

A net 26% are overweight in fixed income, compared to just net 7% in February.

“How investors resolve this anomaly between growth optimism and risk reluctance will determine the fate of equity markets this spring,” said Michael Hartnett, co-head of international investment strategy, Banc of America Securities-Merrill Lynch.

There is a powerful enticement to get back into the stock market, however, as a net 42% (71% of respondents) believe that stocks are undervalued, up from a net 24% (or 62% in total) in February.

Respondents showed strongest interest in defensive stocks, such as in pharmaceuticals, as well as their more cyclical counterparts in the technology sector.

Investors are pinning their hopes on a recovery in emerging markets, especially China, where the command economy is expected to force growth. Survey respondents have taken a net overweight position in emerging markets for the first time since August 2008, a slim net 4% being overweight, compared to a net 4% being underweight in February.

“Optimism on growth has been expressed with higher weightings in emerging markets equities and commodities,” said Hartnett.

He points out that a net 40% of respondents (70% of total) were underweight eurozone stocks, with a net 39% (69.5% of total) underweighting Japanese stocks.

“Investors might look to review their extreme underweight positions in eurozone and Japanese equities if economic data follow growth expectations higher.”

(03/18/09)