Risk off is off, but risk on is not yet on, say fund managers

Investors have piled back into emerging market equities and out of cash amid improved liquidity conditions and rising global growth expectations, finds the BoA Merrill fund manager survey.

A net 44% of respondents report an overweight allocation to emerging market equities in the monthly survey carried out from February 3 to 9, up from 20% in January. This is the second biggest month-on-month jump in the poll’s history and the highest level since December 2010.

Overall, global allocations to equities made their largest one-month leap in a year, with a net 26% now overweight compared with 12% in January. Appetite for cyclical stocks, including industrials and materials, has picked up, while allocation towards defensive stocks has fallen. Technology remains by far the world’s favourite sector with a net 41% overweight.

At the same time, cash levels have fallen, with a net 13% of allocators now overweight cash, down from 27% in January.

In terms of the global economic outlook, a net 11% expect growth in the next 12 months, compared with a net 27% that predicted a worsening global economy just two months ago.

Investors say liquidity conditions and the ease of trading have bounced back. The success of Europe’s Long Term Refinancing Operation (LTRO) led to record monthly improvement in liquidity conditions.

A net 32% of the global panel assessed liquidity as “positive”, a big turnaround from a net 7% who said “negative” in January. It was the largest one-month improvement since the question was first asked in 2007.

“Improved liquidity has aided this rally, but it’s important to emphasise that it also reflects improving economic sentiment,” says Michael Hartnett, chief global equity strategist for BoA-Merrill research. “Hard economic data has to continue improving to sustain a recovery.”

While emerging markets were the principal beneficiaries of flows, sentiment towards the eurozone also improved sharply and it is has been replaced by Japan as least liked.

Only a net 5% of the global investor panel identifies the eurozone as the region they would most like to underweight, compared with 29% in January.

Looking ahead, a net 36% of the global panel says they would like to overweight emerging markets more than any other region. Not only is this an increase on January’s reading, but investors have expressed that they would like to underweight all other regions, including the US.

While there remains a big net underweight on banks globally (-25%), a net 12% of European investors are now underweight the sector, compared with a net 50% in January – a dramatic change of 38 percentage points.

Gary Baker, head of European equities strategy for BoA Merrill’s global research unit, says: “The strongest indication of risk appetite is investors’ definitive move into cyclical from defensive stocks and the closing of underweight positions in banks, especially in Europe.”

In terms of asset allocation, a net 54% of global respondents expect higher bond yields in 2012, while the commodity overweight is at an eight-month high.

Bond bulls should note the February survey reports the first big jump in inflation expectations since September 2010. A net 16% now expect inflation to be lower in the next 12 months, down sharply from a net 33% last month.

There was an increase in respondents who expect both long-term and short-term rates to rise; a net 36% expect the yield curve to steepen over the next year, versus 28% in January.

In terms of emerging markets and Asia, fund managers think the outlook for Chinese growth – arguably the most important barometer of EM sentiment – is the strongest it has been since November 2010. A growing 86% believe China is heading for a soft landing.

China (+53%) regained its seat as the most favoured EM market in February. Investors also increased their overweight position on Hong Kong from 4% in January to 18% this month.

But unlike emerging market investors, Asia-Pacific allocators reduced their exposure to Indonesia from +14% to -3% after the country massively underperformed the broader market year-to-date.

A total of 277 panellists with $783 billion in assets under management participated in the survey, which was conducted by BoA Merrill together with market research company TNS.