Investors are offering the clearest signal yet that the global economic slowdown is forcing them to overhaul their asset allocation, according to Merrill Lynch's Survey of Fund Managers for July. The credit crunch is leading to polarized investment allocations and is taking survey readings into uncharted territory, setting four records: q Net 53 percent of asset allocators are overweight cash. q 40 percent are underweight equities. q 32 percent are underweight eurozone equities. q 40 percent are underweight UK equities. Risk appetite is close to record lows last seen in March. However, despite the sell off in equities, only a net 16 percent of respondents find equities cheap. Furthermore, the survey demonstrates that investors have an increasingly skeptical view of earnings forecasts. A net 83 percent of managers polled believe consensus corporate earnings are “too high.” Of that figure, a net 29 percent believe they are “far too high.” European fund managers are beginning to reassess inflation risks in light of increasing awareness that slower economic growth will put the brakes on inflation. Responses in the regional survey suggest that inflation may be less of a threat than previously feared. A net 24 percent of respondents are forecasting inflation to fall over the coming 12 months. That sits in contrast with results one month ago when a net 32 percent of respondents predicted Europe's Consumer Price Indices would rise. This trend is consistent with global consensus. The regional survey picks up a significant uptick in fund managers who believe that Europe's economic growth will deteriorate, with 96 percent who believe Europe's economy will weaken over the next 12 months, a 10 percentage point rise from June. Fears over the economic outlook coupled with disillusionment with emerging markets have catapulted investors into healthcare stocks - a traditional safe harbor from wider economic trends. 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. “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 markets caught in stagflation find July's survey also captures an abruptly more negative view of emerging market equities. Back in May, a net 31 percent of fund managers were overweight emerging markets. This month, only a net 4 percent have a positive stance towards the asset class. Investors are increasingly concerned that rising inflation in emerging markets makes them more vulnerable to monetary tightening and slowing domestic demand. Asked whether emerging market risk is either “above normal” or “normal,” a net 23 percent opted for “above normal” in July, representing a large swing from June. “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. 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,” said Michael Hartnett, Chief Global Emerging Markets Equity Strategist at Merrill Lynch. Shareholders' priorities shift towards balance sheet repair Global investors indicate that they would rather corporates use cash to improve balance sheets, than return money to shareholders. In a break with recent convention, 39 percent of respondents to the global survey said they would like companies to prioritize measures such as repaying debt and topping up pension plans. Only 32 percent want companies to focus on share buy backs 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?” __
