Economic Slowdown Puts Asset Allocation Out of Whack

Merrill Lynch’s Survey of Fund Managers for July found dramatic polarization in investment allocations and increased skepticism for earnings forecasts.

Investors are offering “the clearest signal yet’ that the global economic slowdown is forcing them to overhaul their asset allocation, Merrill Lynch said. The credit crunch has polarized investment allocations, setting records in the Merrill survey, according to a press release on the results.

More specifically, those record results are:

  • net 53% of asset allocators are overweight in cash;
  • 40% are underweight in equities;
  • 32% are underweight in Eurozone equities;
  • 40% are underweight in U.K. equities.

Merrill said risk appetite is close to record lows last seen in March. Despite the sell-off in equities, only a net 16% of respondents find equities cheap.

Fund managers again said consensus corporate earnings are too high, with a net 83% of managers surveyed viewing consensus corporate earnings as “too high.’ Of that figure, a net 29% believe they are “far too high,’ the release said. In May, when Merrill introduced the survey question, 77% of surveyed managers said the earnings were too high (see Inflation Fears Mount Among Fund Managers).

Repairing Balance Sheets

Merrill said in “a break with recent convention,’ 39% of respondents said companies should prioritize repaying debt and replenishing pensions. That number was slightly more than the 32% who want companies to focus on share buybacks and dividends.

“Financial companies have taken steps to repair their balance sheets with an abundance of capital raising initiatives this year,’ said Barnaby Martin, credit strategist at Merrill Lynch. “Two questions arise for the second half of the year: Will they be able to complete their recapitalizations within the timeframe investors expect and will non-financials have to take similar measures?’

European Outlook

In its regional survey, Merrill found a significant uptick in fund managers who believe Europe’s economic growth will deteriorate; with almost all (96%) saying Europe’s economy will weaken in the next year.

Investors have turned to the traditional safe harbor of healthcare stocks, Merrill said. One-third of investors in Europe have a net overweight position in healthcare and pharmaceuticals, compared with zero in June.

“What investors are looking for right now is immunity from the ills of the market place and the healthcare sector provides that,’ said Karen Olney, chief European equities strategist at Merrill Lynch, in the release. “Healthcare companies might have their own industry risks, but they do offer immunity from the three horrors that are bugging investors: a rising oil price, the slowing economic cycle, and the credit crisis.’

Emerging Negativity

Fund managers displayed a much less positive stance toward emerging markets in July’s survey. According the release, only a net 4% were positive toward the asset class, compared with a net 31% who were overweight in emerging markets in May.

Merrill attributes this to concern over rising inflation in emerging markets. A net 23% said market risk in emerging markets is “above normal.’

“The best combination for emerging market equities is rising commodity prices and falling EM interest rates; the worst is falling commodity prices and rising EM interest rates,’ said Michael Hartnett, chief global emerging markets equity strategist at Merrill Lynch. “Weaker global growth and higher inflation in emerging markets is raising the risk of the latter, which is why asset allocators have become much more cautious on emerging markets.’

Conducted with help from market research company Taylor Nelson Sofres, Merrill Lynch polled 191 fund managers for the global survey and a 169 managers for the regional surveys.