Rotation Into Equities Picks Up As Europe Recovers - BoA Merrill Lynch

Sandra Kilhof

14 August 2013

There has been a sharp upwards surge in investor sentiment over the past month as Europe leads the way on global growth and the industry rotates towards equities and away from bonds, according to the for August.

The survey revealed that 72 per cent of investors expect the world’s economy to pick up within the next year, as they become significantly more positive on key developed markets.

The survey asked 229 panellists with a total of $671 billion assets under management between 2 and 8 of August, about their views on current industry developments, market risks and asset allocations.

The rise in positive sentiment on the global economy is the strongest reading in nearly four years, and according to the firm, this largely comes down to eurozone optimism reaching a nine-year high. As such, sector patterns are also playing out in line with the growth sentiment on Europe, as consumer oriented sectors like banks, telco’s, media and travel strengthened.

“In relative positioning to the US and United Kingdom, Europe still has a way to go”, European investment strategist, John Bilton, told journalists at a media briefing yesterday.

As investors are becoming more bullish on Europe, Bilton maintains that there is potential for a lot more growth in the eurozone, especially as the conviction on the European recovery seems to be somewhat lacking, with 55 per cent not seeing double digit earnings growth for Europe in the coming year.

“Eurozone equity is at a high allocation with 17 per cent overweight in eurozone stocks and we are seeing sector tendencies that confirm the pick-up. However the growth optimism is still fragile, and investors might be a touch too optimistic on the pull-back of European austerity, especially when it is unlikely that Berlin will be willing to see a turn-around on structural reforms,” Bilton added.

Investors cool off on Japanese equities

On a global basis, the positive outlook on growth in Europe is lowering asset allocations to former big value player, Japan. Japanese equities decreased to net 19 per cent overweight in August, compared to 27 per cent in July.

“Optimism on Japan has generally toned down over the last three months. But Japan is still the second most preferred region to invest in for the long-term. We see inflation expectations in Japan as the real game-changer. Monetary policies can really bring in the issue of inflation and investors seem to be believing that, as 95 per cent in the Japanese survey say they expect inflation to go higher,” said Manish Kabra, equity analyst at BoA Merrill Lynch.

Japan was the big value play during the eurozone crisis and equities have in recent years been an investor favourite. However, as Europe stabilises more investors are looking to diversify and add European value trade rather than Japan exclusively.

Similar to Europe, the US is beginning to look very good for investors that are willing to avoid the somewhat negative US energy commodities. To this end, it is largely the US consumer, that is helping pick up the economy, along with 72 per cent of investors favouring the US dollar on a 12-year horizon.

According to the survey, this pick-up in terms of developed markets, stands in stark contrast to emerging market sentiment. US and eurozone allocations to equities are very high, but by comparison, allocations to emerging markets equities are at the lowest (19 per cent underweight) since November 2001, after sentiments have worsened for six months straight. Whether this bearishness on EM equities will continue, very much depends on coming US developments, said Bilton.

“A lot hinges on where the US dollar goes. The next Federal Open Market Committee meeting is pretty important, as it will tell us whether we get a tapering in September or not. If the dollar weakens the usual quid pro quo is that we get a little more support for emerging markets and a little more support for commodities. That is the catalyst I would watch,” Bilton added.

Great rotation continues

Meanwhile, the great rotation in asset allocation is well underway. According to the survey, investors are bullish on stocks, developed markets and on the dollar; and increasingly bearish on emerging markets, bonds and commodities. As few as three per cent of investors expect yields to fall in the next year, surmounting the bearish industry attitudes towards bonds.

In August, ERFP data showed that equities had $48 billion in inflows, that month alone. This is in comparison to bonds which had a yearly inflow of $45 billion, and is at a 28-month low for asset allocator exposure.

“The rotation is happening and in a much more constructive way than expected, as the marginal shift in preference is moving toward equities, while we’re not seeing great outflows from bonds, which would be de-stabilising,” Bilton concluded.

Last month, the same survey showed that a record number of investors are betting on the US dollar, as fund managers around the world have growing confidence in the global economy. This stood in stark comparison to growing doubts about China’s economic growth and concerns of associated risk. Read more on that subject, here.