Managers turn bullish on global growth despite China fear

Investors are turning bullish on global growth prospects except for China and Asia, although a jump in inflation expectations has led them to price out fresh central bank liquidity injections.

A net 28% of global asset allocators expect the world economy to strengthen in the next year, from 11% in February, finds the latest Bank of America-Merrill Lynch fund manager survey.

It is the highest reading in this category since March last year and a sharp rise from January, when the majority of respondents predicted the global economy would weaken.

For the first time since last July fund managers expect global profits to improve (+6%) rather than deteriorate – implying that global earnings have room to revise up further.

In particular, economic and profit growth expectations increased most for the eurozone (+16%), compared with +6% for the US and +5% for Japan.

But while global growth expectations are accelerating, the percentage of investors who expect to see a stronger Chinese economy declined month-on-month to -9%, from -2% in February.

And sentiment in Asia-Pacific ex-Japan also dampened, with a net 41% of respondents to the regional survey expecting Asia’s economy to weaken in the year ahead, a rise from a net 35% last month.

Investors now expect global core inflation to be higher in 12 months’ time. A net +13% expect inflation to rise – the highest reading since last July and a jump from a net 16% who expected inflation to fall last month.

As a result investors are starting to price out fresh central bank liquidity injections: 47% now expect no QE3 from the US Federal Reserve (versus 36% for February), while 43% now see no new QE from the European Central Bank (versus 23%).

While the percentage of investors overweight cash dipped to 10% (from 13%), the average cash balance remained unchanged at 4.2% in March.

“The prospect of higher inflation reflects a victory of central banks in the war against deflation,” says Michael Hartnett, global chief equity strategist at BoA Merrill global research. “Risk appetite is rising with hedge funds more active, but cash is still on the sidelines to put to work.”

Perceived liquidity conditions continued to improve, while tail risk fear associated with the EU sovereign debt crisis fell to its lowest level since May last year.

On the contrary, fears of an oil price spike and China real estate bust are on the rise.

Meanwhile, equity and bond allocations remain close to historical norms. Equity allocations rose to 33% overweight in March, from 26% the month before, while for bonds it went from 44% underweight to 37% underweight.

The net percentage of global asset allocators overweight global emerging markets remains high at 40% (44% last month), and GEM continues to be the most favoured market.

It appears the relative underperformance of emerging markets over the past month has not persuaded fund managers to reduce holdings, which may in part be due to the improving macroeconomic outlook.

EM fund managers became more cautious on the energy sector despite a $7/bbl jump in Brent crude oil prices over the last four weeks – swinging from a +33% overweight to a -6% underweight. Similarly materials fell back to an underweight (-12%) in March, while managers remain bullish on the consumer, adding to consumer discretionary.

China held onto its favourite market status in March (+41%) among EM allocators. But while Asia-Pacific investors are still overweight China, allocations fell to a five-month low of 26%.

The strong rally in Indian equities since the start of the year has encouraged EM managers to reduce their underweight to -6%, while they continued to scale back their exposure to Indonesia to +12%.

The Philippines saw the biggest month-on-month jump in weighting among Asia-Pacific investors to +9% from -10%. Tech and energy were the consensus sector overweights for the fourth straight month, with the high price of oil not scaring Asia-Pacific investors.

A total of 212 fund managers with $639 billion under management participated in BoA-Merrill’s global survey, while 145 with a total of $354 billion took part in the regional surveys. The bank was helped in its research by TNS.