Managers have taken on more risk in July, having previously moved to their most bearish positioning last month, according to the latest edition of the highly regarded Bank of America Merrill Lynch Global Fund Manager Survey.
The study, which polled 162 participants with $489bn in assets under management, found there had been an about-turn by fund managers in July as they positioned for a more pro-risk environment.
The catalyst for many of the managers appears to be the Federal Reserve which, after pausing its rate-hiking programme earlier this year, now looks set to make cuts for the first time since December 2016.
However, there are signs that allocators are becoming cautious about the business cycle and corporate financial health.
According to the survey, 73 per cent of respondents rank the business cycle as the biggest threat to market stability, an eight-year high.
Fears over corporate debt remain strong, with 48 per cent of allocators believing corporate balance sheets are overleveraged.
Meanwhile, the outlook for earnings remains flat, with 41 per cent expecting a deterioration over the next 12 months. In addition, a record 38 per cent of respondents think that corporate payout ratios – which include share buybacks – are too high.
It is not just in the corporate space, either: fund managers are becoming more pessimistic on the outlook for the economy.
After an extremely bearish outlook on global growth in June – at levels not seen since the 2000-2001 and 2008-2009 recessions – sentiment rebounded somewhat, although a net 30 per cent of respondents still expect the economy to weaken over the coming 12 months. Expectations of higher inflation over the next 12 months are also bearish.
Source: BofA Merrill Lynch Global Fund Manager Survey
Nevertheless, allocators remain in buy-territory, according to a range of metrics used by the bank.
“The dovish Fed and trade truce have caused investors to reduce cash and add risk,” said Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch. “But their expectations of an earnings recession and debt deflation still dominate sentiment.”
While cash allocations remain elevated against a 10-year average of 4.6 per cent, exposure has fallen month-on-month from 5.6 per cent to 5.2 per cent, signalling more risk-on sentiment. According to the survey, a net 41 per cent of asset allocators are overweight cash.
After recording the lowest allocation to equities since March 2009 in June, there was a large swing to the asset class this month. Equity holdings increased by 31 percentage points, month-on-month to a 10 per cent overweight.
Source: BofA Merrill Lynch Global Fund Manager Survey
It was mirrored by a rotation out of bonds into equities, with the allocation to fixed income – the highest since September 2011 – falling by 12 percentage points to 34 per cent underweight.
Another significant change in asset allocation was a 12 percentage point slump in real estate investment trust exposure to a 2 per cent underweight.
Elsewhere, allocations to commodities rose 1 percentage point to a 2 per cent underweight allocation, on trade war concerns and fears about the deteriorating relationship with Iran.
The US-China trade war remains a big concern for international investors and has now topped the list of biggest tail risks in 15 of the past 17 monthly surveys.
Other significant tail-risk concerns include monetary policy competence, a China slowdown and a bond market bubble.
Meanwhile, the most crowded trades are dominated by US assets, including top-placed long US Treasuries, long US tech, long investment grade corporate bonds and long US dollar.
On the currency side, bearish sentiment towards the US dollar was down 11 percentage points on June, with a net 49 per cent of investors now saying that the greenback is overvalued. Meanwhile, just 29 per cent of respondents believe that the euro is cheap.
Emerging markets remains the most favoured geographical equity allocation, rising by a further 2 percentage points to a net 23 per cent overweight among survey respondents.
A more dovish Fed has been good news for US equities where allocations rose by 4 percentage points to a net 9 per cent overweight, making it the joint-second most preferred region among respondents.
It ties for second with eurozone equities, where allocations jumped by 17 percentage points to a 9 per cent overweight and the highest weighting to the region’s stocks since September 2018.
Source: BofA Merrill Lynch Global Fund Manager Survey
At the start of July, allocations to the UK had risen by 1 percentage point to a net 23 per cent underweight, the highest allocation since October 2018. However, it remains the least favoured region among respondents, with Brexit still unresolved.
Having sat at a three-year low in June, allocations to Japan rose by 2 percentage points although it remains a net 4 per cent underweight.
On a sector basis, allocators remain overweight growth and defensive stocks over cyclical and value names. Just 2 per cent of respondents expect value to outperform growth over the next 12 months.
Global technology allocations rose by 4 percentage points to a net 25 per cent overweight, making it the top sector among respondents, closely followed by global healthcare (net 24 per cent overweight).
The biggest increase in allocation, month-on-month, was in industrials, which rose by 11 percentage points to a 10 per cent overweight despite a drop-off in manufacturing activity to seven-year lows.
The largest fall in allocations, month-on-month, was in the utilities sector, which fell by 6 percentage points to a 20 per cent underweight, although this was from a relatively high allocation in June.
With cyclicals out of favour, allocations to global materials stocks hit a three-year low after dropping by 6 percentage points to a net 14 per cent underweight.