Coronavirus has dominated investor sentiment for the past year but the prospect of higher inflation has overtaken the pandemic as the market’s biggest tail risk, according to a closely followed survey. 
The March edition of the Bank of America Global Fund Manager Survey found that 37 per cent of asset allocators now consider higher than expected inflation to be the largest potential problem facing markets, up from around 25 per cent last month.
Some 35 per cent cited a ‘tantrum’ in fixed income markets as the biggest tail risk. Signs of this have already been seen, after concerns of higher inflation prompted a sell-off in bonds and forced yields higher.
Fund managers’ biggest tail risks
Source: Bank of America Global Fund Manager Survey – Mar 2021
As can be seen in the chart above, this has pushed coronavirus down into third place with only 13 per cent of managers saying this is the biggest worry.
This is the first time since February 2020 that the Covid-19 pandemic has not been viewed as the biggest tail risk by asset allocators.
Inflation expectations among the fund managers surveyed are now at an all-time high. A net 93 per cent of asset allocator think inflation will be higher in one year’s time, up from a balance of 84 per cent from last month.
Inflation expectations at an all-time high
Source: Bank of America Global Fund Manager Survey – Mar 2021
Bank of America chief investment strategist Michael Hartnett, recently argued that 2020 likely marked “a secular low point for inflation and interest rates”.
He said this is down to a reversal of deflationary secular factors, fiscal excess and “an explosive cyclical reopening of the global economy” creating excess demand for goods, services and labour, thereby pushing up prices.
Hartnett also said investors need to prepare their portfolios for the return of inflation: “We believe the long-term asset allocation implications of 2020s inflation are bullish real assets, commodities, volatility, small-cap, value and Europe, Australasia, Far East/emerging market stocks, and bearish bonds, US dollar and large-cap growth.”
A net 91 per cent of managers expect that the global economy will be stronger in 12 months time, the best economic outlook in the Bank of America Global Fund Manager Survey’s history.
The Bank of America also found that higher growth and higher inflation is now the consensus expectation among fund managers, with 53 per cent anticipating this. This outlook is now more common than the expectation of higher growth combined with lower inflation.
Fund managers’ expected path of global economic recovery
Source: Bank of America Global Fund Manager Survey – Mar 2021
This has led most investors to say the recovery from the coronavirus crisis will be V-shaped. Some 48 per cent think we’re in a V-shaped recovery, up from just 10 per cent in May 2020.
These growth and inflation expectations, combined with continued progress in the coronavirus vaccine rollout, saw investors buy banks in March.
Cyclical areas such as banks tend to outperform in times of higher inflation and interest rates, while growth areas like tech tend to fall behind.
Bank of America’s analysis of changes in portfolio positioning suggests banks are benefitting from ‘rising optimism’ while tech stocks are subject to ‘rising pessimism’.
Change in fund managers’ sector positioning
Source: Bank of America Global Fund Manager Survey – Mar 2021
This move away from tech has seen asset allocators lower their tech overweight to a net 8 per cent, which is its lowest since January 2009. The last time they underweighted tech was November 2008.
However, the move towards cyclicality did not just involve adding to banks or selling tech. Indeed, a record 52 per cent of managers think the value style will outperform growth over the coming 12 months.
Fund managers’ sector positioning versus history
Source: Bank of America Global Fund Manager Survey – Mar 2021
As the above chart shows, there has been a complete reversal in fund managers’ positioning versus history when compared with the situation one year ago – with March witnessing an almost wholesale rotation toward cyclicals (with the exception of energy) and a move away from defensives.
When it comes to worries over a ‘tantrum’ in fixed income markets, asset allocators are running a new 66 per cent underweight to bonds – the lowest since February 2018.
The Bank of America Global Fund Manager Survey found 43 per cent of investors believe a 2 per cent yield on the 10-year Treasury is the ‘level of reckoning’ that would cause a 10 per cent fall in equities.
What level on the 10-year Treasury yield will cause a +10% correction in stocks?
Source: Bank of America Global Fund Manager Survey – Mar 2021
In addition, the average respondent to the survey thinks that bonds become attractive relative to stocks when the 10-year Treasury yield reaches 2.5 per cent.
The Bank of America Global Fund Manager Survey was carried out between 5 and 11 March, polling 197 asset allocators with total assets under management of $597bn.