Professional investors across the globe are yet to reach the level of peak bearishness, according to research by Bank of America Merrill Lynch (BofA ML), although they have been hiking cash and rotating into more defensive sectors over recent weeks.
The opening days of 2016 have been dominated by news of crashing stock markets, as global indices go through one of the worst starts to a new year on record. Since its intraday peak on 27 April 2015, the FTSE 100 has now shed more than 20 per cent – passing a common marker for being in a bear market.
Yesterday was a tough session for the blue-chip index as it tanked close to 3.5 per cent on the back of continued worry over the direction of the world economy and the protracted slump in the price of oil, with Brent crude currently trading at around $28 a barrel.
Other markets already in bear market territory include Japan’s Nikkei 225, China’s Shanghai Composite, the US’ Russell 2000, France’s Cac40, Germany’s Dax and the main Russian market. All have fallen 20 per cent below their peak recently.
Performance of indices since 1 Jan 2015
Source: FE Analytics
When it comes to private investors, sentiment is very depressed. The Lloyds Bank Private Banking Investor Sentiment Index has fallen to its second lowest level since its launch in July 2013; according to the research, the balance of investors who are more positive than negative stands at just 4.55 per cent.
There are some areas of the market where positive sentiment remains. Lloyds Bank’s index has positive readings for UK equities, UK property, UK government bonds and UK corporate bonds – which may not be surprising given the respondents are based in the UK – as well as gold, but sentiment has fallen towards all these apart from property and gold.
But there is negative sentiment towards eurozone and Japanese equities, two of the most popular areas with professional investors. They also have a negative view of emerging market stocks and commodities, which have been hit hard in recent months by fears over globe growth.
Markus Stadlmann, chief investment officer at Lloyds Bank Private Banking, said: “Investors are feeling particularly gloomy at the moment, with asset class performance dropping off as we start 2016.”
“Given declining market performance and falling levels of sentiment, it is surprising to see sentiment towards bonds also falling. But, by sticking to familiar investments like property and gold; some investors might be missing the potential opportunity offered by lower risk fixed income assets such as bonds.”
Turning to institutional investors and a similar picture emerges, according to the BofA ML Fund Manager Survey (FMS). This is a closely watched report on investor positioning, which polled a total of 211 global asset allocators with $610bn of AUM between 8 January and 14 January 2016.
Net percentage of asset allocators overweight cash
2 
Source: BofA Merrill Lynch Global Fund Manager Survey
The survey shows that average cash balances among fund managers are up to 5.4 per cent, which is the third-highest reading since 2009. It also means that a net 38 per cent of asset allocators are now overweight cash, highlighting their defensive positioning.
Meanwhile, net overweights to equities have fallen dramatically over the past month –a balance of just 21 per cent are overweight the asset class, down from 42 per cent in December’s FMS. Europe and Japan remain the most favoured stock markets, while sentiment towards emerging market is at its most bearish level on record.
Bond underweights have retreated over the month as investors sought perceived safe havens. Average allocations to bonds are now a net 47 per cent underweight, which is a three-month high and down from a 64 per cent underweight in December.
If it wasn’t clear from the heavy falls in stock markets recently, the above facts show the rotation away from risk taking place within portfolios. Over the past month, fund managers been selling stocks, resources, industrials, banks and emerging market assets to buy ‘safer’ investments like healthcare, consumer staples, cash and bonds.
Fund manager longs and shorts relative to FMS history
Source: BofA Merrill Lynch Global Fund Manager Survey
The move to safety suggests investors are no longer in denial about the risks of recession and/or a bear market, BofA ML says, but sentiment could have further to fall.
Highlighting fund managers’ bearishness, a balance of just 8 per cent expect the economy to strengthen over the coming 12 months – which is the survey’s lowest reading since 2012. Despite this, only 12 per cent think the global economy will fall into recession during the next year.
Of course, this could change now markets have gone through greater falls or if economic data continues to worsen. Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research, added: “Investors are not yet ‘max bearish’. They have yet to accept that we are already well into a normal, cyclical recession/bear market.”
Analysts at Capital Economics, however, argue that the market falls do not seem to reflect the economic reality.
Its comparison of the year-on-year change in the MSCI AC World index and the latest global composite PMI from Markit, which is a key indicator of economic conditions, suggests that the fall in global equities has been overdone.
Performance of index vs PMIs
Source: Capital Economics, Thomson Datastream, Markit
John Higgins, chief markets economist at Capital Economics, said: “Admittedly, we only have the global composite PMI reading for December. And there are myriad reasons why the performance of equities can decouple from that of the economy, such as changes in valuations and profit margins. But January’s global composite PMI reading would probably have to be less than 50 to alter this conclusion.”
“Of course, equities give their owners a claim on future earnings, so it is the prospects for, rather than the latest developments in, the economy that are relevant. Accordingly, the recent plunge in stock prices presumably reflects an expectation that the global economy is heading for a recession, even if it isn’t in one now.”
“We don’t share this view. Despite the prevailing gloom about the world economy, we think global growth is likely to pick up from 2.5 per cent last year to around 3 per cent in both 2016 and 2017, using our own estimates for China. The upshot is that, to the extent that global growth fears are partially behind the current sell-off, we would expect equities to stage something of a recovery over the remainder of the year.”