Fund managers find cracks in bull case, Merrill survey reveals
• Most panellists believe protectionism will lead to inflation with limited growth or to stagflation
Fund manager surveys are often contraindicators, reflecting exuberance just before the global financial crisis or piling into platinum shares just before they turned down. But at times their views become self-fulfilling as they move in packs into certain sectors and regions.
The Bank of America Merrill Lynch survey shouldn’t read as a tip sheet but it is a good reflection of the way the big fund managers are thinking. Merrill Lynch itself was known as the thundering herd, as it had thousands of salesmen around the US, mostly extroverts of Irish descent. It titles its global fund manager survey, with apologies to the late Hunter S Thompson, Fear But No Loathing. There were 176 participants in the survey. In effect Merrill has corralled a new herd.
The panellists believe there are cracks in the bull case: the prospect of US President Donald Trump setting off a trade war, stagnation combined with inflation (known as stagflation) and the amount of leverage in the financial system after years of quantitative easing. These are the lowest global growth expectations since July 2016 and the highest inflation expectations since June 2004. About 87% of the panellists believe protectionism will lead to either inflation with limited growth or full-on stagflation.
There are three main plays for contrarians who can see that one asset class has attracted investors at the expense of another: one is to favour bonds against equities, another to favour UK equities over emerging markets and the third to favour pharmaceuticals over technology. Yet investors are still long on technology as well as bank shares and are keeping cash balances at 4.6%. But there is limited demand for government bonds: the US 10-year Treasury yields 2.9%; it has yielded even less in the recent past. But most fund managers will not come back to Treasuries until they yield at least 3.6%.
Meanwhile they are having fun through long and short positions. One is to go long in Fang and BAT. Fang is the collective name for high-flying US tech businesses Facebook, Alphabet, Amazon and Netflix. Sometimes Microsoft is considered an honorary member. And BAT is three Chinese internet giants: Baidu, Alibaba and Tencent. Some fund managers are long in all these shares and short the US dollar.
There is the highest allocation yet to banks relative to history. Emerging market, eurozone and Japanese shares also have weighty allocations.
However, allocations to UK shares are at a record low while bonds and healthcare are also largely overlooked.
Investors should be careful about preference for the eurozone over the UK. In the survey of European fund managers it was found that eurozone shares are likely to underperform because of their poor earnings trends. But the European food and beverage sector is 41% under its benchmark weighting, which Merrill Lynch calls a tactical contrarian buy signal. The 31% underweight in retail is getting close to another buy signal.
A net 66% of investors expect European inflation to increase over the next 12 months, and 81% believe the European Central Bank’s monetary policy is too stimulatory, bringing inflation in its wake. A large cohort in the global survey is afraid of a policy mistake at the European Central Bank or the Federal Reserve. European investors hope a weaker euro will stimulate their appetite for risk, along with companies with business models that can produce real returns of at least 10% a year.
Apart from the 41% underweight to the UK, Switzerland and Italy are also out-of-favour countries. Managers have sought out the safe haven status of the two core eurozone countries, Germany and France.
In the South African fund manager survey, the exuberance of early in the Cyril Spring is now more muted. In February 73% of fund managers believed the JSE would go up over the following six months. By March this had fallen to 30%.
The panellists said rate-sensitive sectors such as banks were fairly priced but a net 40% believed earnings estimates for resources companies were too low. The biggest domestic risks to equity performance are “policy shifts to the left”, including the land issue, and a further derating of sovereign debt.
Weak earnings were much less often cited. And most fund managers (60%) will buy SA 10year bonds at a yield of 8.75%9% versus prevailing yields at 8%. Only 10% of managers were overweight in bonds, while 40% were overweight in equities and 60% in cash. And 20% of the sample plan to increase their cash holdings even further.
The herd just keeps falling more in love, with 50% of the panel describing themselves as bullish on equities, up from 27% in February. None of the managers in the survey expects negative returns, and they expect a 9% return for the year. And 10% of fund managers expect more than a 15% return. Yet 40% of the panellists believe the South African equity market is overvalued and none believes it is undervalued. It reminds me of the classic saying of Chuck Prince of Citigroup, that as long as the music was playing he would get up and dance. So long as everyone is investing in the JSE, fund managers can’t afford to reduce their positions, even in a pricey market.
While globally there is a huge appetite for financials, in SA a net 20% of the panel is underweight in the sector. In life insurers a net 6% is underweight. In industrials there is zero change overall, but two camps of 30% each have divergent views, much of it around Naspers, which will need to remedy its discount to net asset value. The beverages and tobacco sector is an exception as it is an overweight position with a net 17% of managers holding overweight positions.
The panellists’ sector picks are worth noting. Chemicals and tobacco are the most favoured sectors, followed by food and drug retailers. The laggards, they claim, will be industrial metals, general retailers and gold.
In SA, 80% of the group believe the economy will get a little stronger; 10% expect it to get a lot stronger. But no one is expecting a recession. And there is still some fear that inflation locally will get slightly higher.
It might be time to take some money off the table or at least to rotate between sectors, relooking at the high p:e shares.
THE BIGGEST DOMESTIC RISKS TO EQUITY PERFORMANCE IN SA ARE ‘POLICY SHIFTS TO THE LEFT’