Global Fund Managers Dash For Cash

Topics Covered

• Sharp decline in global growth expectations
• Consensus outlook remains for Chinese soft landing
• Fund managers see further QE by both Fed & ECB
• Cash balances jump to third highest level on record
• Managers commodity exposure very under-owned

Overview

Today's post specifically focuses on BofA Merrill Lynch Fund Managers Survey. It is one of the best contrarian indicators I know within the market space, as Merrill Lynch surveys about two to three hundred funds every month to get a consensus outlook. This month, the survey period was from 31st May to 7th June 2012, with an overall total of 260 panellists with $689bn AUM. Out of the overall total, 82 are Institutional Funds, 24 are Hedge Funds, 56 are Retail Funds and 26 were other. More than 66% of all funds manage over 1 billion dollars. Fund managers are asked to focus on global growth, inflation, profits expectations, asset class and sector weighting positions, plus variety of other questions regarding risk and exposure. Enjoy.

Economic Data

The survey reported that "global growth expectations fell sharply from +15% to -11% this month, the largest MoM drop since Aug’11. This suggests new orders to inventories ratio will roll over." The chart above, which I've edited, shows that majority of the time economic slowdowns or recessions intensify with below net 40% of managers expecting weak growth ahead. Currently we aren't close to those readings yet, but since this is not an normal economic cycle based on strong fundamental growth (like 03 - 07), an external surprise shock out of Eurozone could easily derail growth in an instant.

The survey also reported that net percentage of managers thinking that the Chinese growth will improve fell towards neutral levels this month, but without a sharp decline. Merrill Lynch writes that "despite weakness in global growth expectations, fund managers have not yet discounted a materially weaker Chinese economy, as investors are still overweight China." Major Chinese growth recoveries occur when we see close to net 40% of managers expecting the growth to improve and unfortunately we aren't close yet.

Chinese economic outlook by fund managers remains quite bullish or even complacent by some standards. A net percentage of managers who think China will experience a “hard landing” edged higher to a net 16% from 9% last month. But, the overwhelming consensus is that 81% of investors still think “soft landing", engineered by the government, will be the main outcome. I am not so sure I can agree with 81% of fund managers on this one...

Interestingly the sharp drop in growth expectations also showed a sharp drop in inflation expectations too. The report went onto say that "a net 14% expect inflation to fall in the next 12 months, a deflationary signal. But the good news is that this paves the way for policy easing." Usually, when major expect deflation as the main outcome, it tends to put a intimidate top in bond prices and a bottom in commodity prices.

Such a dire outlook on global growth has managers tilting towards further central bank stimulus measures. The survey went onto to report that "expectations for additional quantitative easing rose sharply in June, particularly in Europe. A net 73% expect more ECB QE within next 4 months (up from 46%). 44% expect Fed QE3 within next 4 months (up from 31%)." Finally, Merrill Lynch went onto to summarise the overall global growth outlook by stating the following:

"Sharp decline in global growth expectations (+15% to -11%); global profits outlook also deteriorated,; only 5% of investors see 'above-trend' growth next 12 months; big rise in QE expectations; in next 4 months 73% expect ECB QE & 44% now expect Fed QE3"

Equity Markets

Fund managers continued to raise cash in June. Managers weightings towards cash allocations jumped sharply higher this month towards a net 39% overweight, which is up from a net 28% overweight last month. We are now much higher than the typical one standard deviation of extremes in fear. Furthermore, average cash balances remained jumped towards 5.3%, from 4.7% last month. From a  contrarian point of view, reading above 5.0% should be considered as a major buy signal. In 2008 the cash balance reading peaked at 5.5% in December. In 2011 the cash balance reading peaked at 5.2% in August. Both proved to be close to a major bottom in all risk assets, including equities.

The survey went onto show that managers equity weightings have been modestly reduced towards an slight underweight position in the month of June. Merrill Lynch stated that "equity allocations turned negative for the first time in 7 months, consistent with only 5% of investors believing there will be above-trend global growth over the next 12 months." So in other words, while equity managers are not yet in full panic mode, they are edging pretty close at this point, with very high cash positions and very low equity exposure. Finally, Merrill Lynch went onto to summarise the overall risk outlook by stating the following:

"Cash balances jump to 5.3%, third highest level on record after 3/2003 & 12/2008; 5.3% equals a buy signal ML Survey trading rule; First Equity underweight in 7 months; Risk Index plunges to 30, lowest since 9/2011; key to note investor perceptions of liquidity conditions turn negative for first time since ECB’s LTRO, so expect more policy catalysts."

Bond Markets

While the Merrill Lynch survey showed that managers are dashing for cash, that was not the only is not popular safe haven investment right now. Bond allocations once again rose in June, just like it rose in May as well. A net 23% are now underweight bonds, up from a net 33% underweight last month and a net 48% of fund managers two months ago. Despite a powerful and historical rally in the Bond market, majority of fund managers still seem to be only modestly exposed to this asset class, even with ongoing Eurozone worries.

Currency Markets

Nothing new to report. Refer to the side menu for previous articles.

Commodity Markets

The survey also showed that fund managers reduced their allocation to commodities for the fourth month in the row. A net 8% of fund managers are now underweight commodities sector, as opposed to net 2% underweight in May. This is now the lowest exposure level since February 2009.

Commodity sectors are extremely oversold due to a cyclical huge bear market in commodity prices. Fund managers survey showed that global materials sector weighting is currently 2 standard deviations underowned relative to the ten year history.

Similarly, global energy sector weighting is currently 1.5 standard deviations underowned relative to the ten year history. If the commodity sectors are under-owned and oversold, one might ask is popular investments with fund managers? The answer is all the overbought sectors like consumer discretionary and technology. Think vertical prices rises from Apple to Starbucks (chart below).

Finally, Merrill Lynch went onto to summarise the overall commodity outlook by stating the following:

"Death of Commodities; allocation to Commodities plunges to lowest since Feb'09; investors running massive UW of Materials & Energy; commodity investor hold large cash positions."

Credit Markets

Nothing new to report. Refer to the side menu for previous articles.

Trading Dairy Updates

• I have closed all shorter term trades (including options) from SPY to SLV to RJA. However, I am also still holding onto that core Silver position from late December 2011 bottom at $26.
• Another Monday another gap up, followed by a sell off. Risk assets still remain on my watch list for some shorter term bullish rebound trades. These include Brent Crude (BNO), Commodity Indices (GCC / RJI), Precious Metals (GLD, SLV, CEF, PSLV, etc) and Agriculture (RJA). I believe commodities are very oversold right now and should bounce soon.
• I am waiting for an equity & currency market rebound first, before engaging into some shorts, as I believe a global bear market is here. I do not want to short commodities, as they are in a secular bull market and relatively cheap to equities.