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Global investors have significantly cut US equity allocations as belief grows that the US Federal Reserve will raise rates in the second quarter, according to the BofA Merrill Lynch Fund Manager Survey for March. While so far in 2015 the main European stock index (Euro Stoxx 600) has risen more than 15% compared with a flat S&P 500, there is skepticism about the European recovery that is boosting the rise in European shares.
Stephanie Flanders, the chief market strategist for Europe at JPMorgan Asset Management, writes in the FT today that "there is some basis for [the] wave of European optimism. But that optimism can hardly be said to extend to the currency. Quite the opposite. Investors are assuming the ECB will continue to welcome a weaker currency and European leaders will continue to pin most of their recovery hopes on demand from abroad. Dig a little deeper into Europe’s 'outperformance' since the start of the year and this uncomfortable reality comes through clearly."
Flanders says that the "near 16% return on European equities since January 1 is measured in euros: in dollar terms, the rise is less than 2%. Similarly, it is only dollar-based investors who have seen a flat or negative return on the S&P 500 so far this year. If your base currency is euros, your return from US equities this year has been just shy of 13%."
On Wednesday Wall Street investors sent US stocks to new record highs, after the US Federal Reserve signalled that it would not raise record-low interest rates soon.
The Dow Jones gained 227.11 points, or 1.27%, to 18.076.19, while the broader S&P 500 added 25.14 points, or 1.21%, to close at 2,099.42 and the tech-heavy Nasdaq climbed 45.39 points, or 0.92%, to 4,982.83.
The Fed said it would wait for US labour market conditions to improve before raising rates. However, while it removed the word "patience" from its policy meeting statement, the cautious overall tone cheered investors, who see low interest rates as key to underpinning US share prices.
Stephanie Flanders says Europe is hoping that the weak euro will boost its existing trade surplus while US companies in the S&P 500 that rely on exports had the worst performances in the fourth quarter.
An overall total of 207 panelists with US$565bn of assets under management participated in the BofA survey from 6 to 12 March 2015 and it shows that allocations to Eurozone and Japanese equities have both increased, but investors have indicated that the shift to Europe has only just begun. A net 63% of respondents say that Europe is the region they would most like to overweight in the coming 12 months – a record since the question was first asked in 2001. The reading has spiked from a net 18% preferring Europe in January.
The move out of US equities is also set to continue. A net 35% says that the US is the region they would like to underweight the most, the most bearish reading in nearly 10 years. The spread between Europe and the US has soared to 98 net percentage points – also a record.
The March survey indicates that investors have started to bring forward the date of the Fed’s first rate hike, rather than continue to push it back. The proportion of investors expecting the Fed to raise rates in the second quarter has risen to 34%, from 28%. The number expecting a rate rise in the third quarter has fallen. Accordingly, a net 2% of the panel has taken the view that the US dollar is overvalued – the first overvalued reading since 2009.
“Investor consensus suggests that the strong dollar will act as positive rather than a negative for the global economy and markets,” said Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research. “Bullishness towards European stocks has reached uncharted territory. Demand for financials highlights confidence in domestic growth, while belief in European exporters is building on gains seen last month,” said Manish Kabra, European equity and quantitative strategist.
Inflation and rate expectations up sharply
Investors’ expectations of higher inflation and higher interest rates have risen sharply, according to the Global Fund Manger Survey. A net 52% of the panel expects high global consumer price inflation this month, up from a net 29% in February and a net 14% in January. Furthermore, increasing numbers take the view that global monetary policy could tighten. A net 34% say that policy is currently too stimulative, up from a net 26% a month ago.
More investors are forecasting increases in both long- and short-term interest rates. A net 66% of respondents believe short-term (three-month) rates will be higher in 12 months’ time, up from a net 53% in February. A net 63% expect long-term (10-year) rates in 12 months, up from a net 57%.
European bulls rush into banks
Investors inside Europe have echoed their global colleagues’ bullishness towards the region and made big allocations towards financial services. The proportion of European investors overweight banks has surged to a net 22%, from a net 26% underweight last month. The proportion of investors overweight insurance has risen to a net 31%, from a net 3% underweight in February
Belief in a rebound in profits is strong. A net 38% of respondents to the regional survey say that they expect double-digit earnings growth in Europe in the next 12 months, up from just a net 3% in February and negative net 43% in January. A net 88% of the regional panel says that Europe’s economy will be stronger in a year’s time, up from 81% a month ago.
Investors mindful of China default threat
With questions hanging over China’s debt levels, concern of default has moved to the forefront of more investors’ minds. China debt defaults is now seen the second-largest tail risk in world markets – 19% of investors rank it as their greatest risk, compared with 14% a month ago. “Geopolitical crisis” remains the most voted for tail risk.
Furthermore, the proportion of asset allocators underweight global emerging markets has risen to a net 11% from a net 1% in the past month. A net 57% of the global panel say that global emerging markets is the regional asset class they most want to underweight in the coming 12 months – down from a net 63% but remaining close to historic survey highs.
John Authers comments on a dramatic market reaction to the latest words from the Federal Reserve. It is data-dependent - so volatility lies ahead.