Fund managers are displaying “extreme bearishness” as 2019 approaches, according to the Bank of America Merrill Lynch Global Fund Manager Survey, after one of the sharpest one-month rotation bonds in years was recorded.
BofA ML's final survey of 2018, which drew responses from 190 participants with $575bn in assets under management, revealed a more bearish turn in sentiment during the last month of the year.
Although just 9 per cent of respondents expect a global economic recession during 2019, more than half expect global growth to weaken over the coming 12 months, “the worst outlook on the global economy since October 2008”.
Indeed, December marked a significant shift in sentiment over one year.
A year ago, investors were more bullish with long positions in Bitcoin, global equities (the banking sector, in particular) and short positions in bonds and defensive stocks.
This December, however, saw the biggest-ever one-month rotation into the fixed income asset class with bond allocations rising by 23 percentage points
It comes after a challenging October and November for equity markets in which the MSCI World index lost 4.22 per cent in sterling terms, as the below chart shows.
Performance of index in October & November
Source: FE Analytics
While bonds are still a consensus underweight position – with a net 35 per cent underweight to fixed income among fund managers – it represents the highest allocation to the asset class since the Brexit vote in June 2016.
“Investors are close to extreme bearishness,” said Michael Hartnett, chief investment strategist at BofA ML. “All eyes are on the Fed this week and a dovish message could equal a bear market bounce.”
Given the heavy rotation into bonds during December, it was little surprise to see that equity allocation fell drastically also, with allocations to global equities down by 15 percentage points to a 16 per cent overweight.
The biggest fall was recorded in the UK, which dropped by 12 percentage points to a 39 per cent underweight position among global fund managers.
Indeed, the UK equity positioning is the second largest underweight on record and follows renewed uncertainty over the Brexit process.
Source: BofA ML Global Fund Manager Survey
Other big significant declines were seen in the US and eurozone equities, with both areas recording a fall of 8 percentage points.
For eurozone equities this meant that managers were underweight the region for the first time in two years.
Conversely, emerging markets saw a five percentage point increase in allocations, making it the most popular choice amongst allocators at an 18 per cent overweight, slightly ahead of Japanese equities.
Asset allocators are also at their most bullish about emerging market stocks over coming 12 months since July 2009, the suvey revealed.
Despite a rise in allocation to fixed income in December, asset allocators told BofA ML there is unlikely to be a full-scale rotation into bonds until the yield on the 10-year US Treasury reaches 3.6 per cent.
Fund manager’s expectations of inflation have also collapsed with just 37 per cent expecting prices to rise over the coming 12 months, compared with 82 per cent in April’s survey.
As such, fund managers preferred that companies use corporate cash glow to strengthen balance sheets rather than increase capital expenditure. Respondents to the survey were there most concerned about corporate leverage since October 2009, usually interpreted as a signal for a preference of bonds over cash.
Meanwhile, the biggest tail risk remains a trade war for the seventh straight month, as concerns over an escalation of hostilities between the US and China intensified after the G20 summit.
After 10 consecutive months, ‘long US dollar’ replaced ‘long FAANG + BAT’ (Facebook, Amazon, Apple, Netflix and Google-parent Alphabet + Baidu, Alibaba and Tencent) as the most crowded trade.
Indeed, investors claimed the US dollar was at its most overvalued level since the summer of 2006, most notably against emerging market currencies.
Given the increased bearishness, there has also been an increase in cash holdings among asset allocators – rising by four percentage points – to a 35 per cent overweight, well above the long-term historical average of 20 per cent.
Elsewhere, allocation to real estate remains at a neutral level – having already hit an eight-year low in October – the survey found, while commodities fell to a slightly bigger underweight of portfolios.
Looking ahead, managers expected large-caps to outperform small-caps over the next year, with a preference for higher quality companies over lower quality.
In terms of sectors, respondents to the monthly survey have sold out of technology – one of the most beat-up areas of the market in recent months – and energy in favour of more defensive industries such as consumer staples and utilities.
Allocations to tech stocks sank by eight percentage points to a 10 per cent overweight, the lowest level since January 2009, according to the bank.
In Europe, the region’s fund managers were also bearish about the prospects for UK and eurozone stocks and a more pessimistic view of markets more generally.
The regional survey revealed that 45 per cent of allocators expected the European economy to weaken over the next 12 months – the lowest figure for six years.
Source: BofA ML Global Fund Manager Survey
However, expectations of a recession have fallen as have expectations of higher inflation.
“European fund managers are the most pessimistic on economic and earnings per share growth since the eurozone crisis, amid a collapse in their inflation outlook and recession expectations rising meaningfully from zero,” the regional survey of 127 managers with assets of $291bn found.
On a corporate level, earnings expectations remain pessimistic with almost half expecting lower earnings per share growth over the coming 12 months, compared with 13 per cent in November.