Fund managers reduced cash holdings to their lowest levels for more than two years in October and have increased overweight positions to global equities, according to the monthly Bank of America Merrill Lynch fund manager survey.
Average cash balances sunk to 4.7 per cent, the lowest level in two and a half years and down from the October 2016 peak of 5.6 per cent, as the chart below shows.
However, the average cash balance remains above the 10-year average of 4.5 per cent and the survey’s cash rule has not triggered a sell signal, remaining firmly in buy territory.
Source: BofA Merrill Lynch Global Fund Manager Survey, Bloomberg
In the bank’s analysis, when cash balances rise above 4.5 per cent, a contrarian buy signal is generated for equities. When it falls below 3.5 per cent a contrarian sell signal is generated.
Michael Hartnett, chief investment strategist at BofA Merrill Lynch, said: “Cash balances dipped this month but remain somewhat elevated.
“A faster drop in cash leading into 2018 would indicate a sell signal from investors.”
The bank’s Bull & Bear indicator also remains in buy territory at 7.4 with cash too high to trigger a sell signal. The bank recommends staying long risk assets until sentiment reaches “euphoric territory of 8.0”.
Hartnett’s ‘Icarus Trade’ suggests that stocks and commodities will have one last 10 per cent “melt-up” before being followed by a meltdown. The current melt-up began in February 2016 and Hartnett said the trade remains intact.
The decrease in cash positions had been accompanies by a rise in global equity market cap of $18trn. Indeed, net overweight positions in global equities have now reached 45 per cent, the highest level for six months.
However, bearish contrarians note that a 40-45 per cent global equity overweight has historically coincided with equity underperformance versus bonds and cash over the following three months, according to the bank.
Fund managers were more bullish about the global economy in October, with a net 41 per cent expecting faster growth during the next 12 months. As such, the most surprising market event for respondents during next six months would be a recession.
Indeed, the survey further revealed that expectations for a macro ‘Goldilocks’ environment – characterised by above-trend growth and below-trend inflation – had hit a record high of a net 48 per cent.
For the first time since March 2011, this had exceeded fund manager expectations of a belief in below-trend growth and inflation ‘secular stagnation’ trend as a driver of financial markets, as the chart below shows.
Source: BofA Merrill Lynch Global Fund Manager Survey
Having emerged as the biggest tail risk in September, following increased rhetoric and a war of words with US president Donald Trump over its testing of intercontinental ballistic missiles and nuclear weapons testing, North Korea has slipped to second position in fund managers’ list of biggest tail risks.
A policy mistake by the Federal Reserve/European Central Bank once again returned to the top of biggest tail risk fears, as central banks begin to contemplate rising rates and the removal of stimulus.
Rounding out the top three biggest tail risk fears is a crash in global bond markets. Indeed, a record 85 per cent of fund managers believe that bond markets are overvalued.
Allocations to bonds also fell with the survey revealing a net 60 per cent underweight, the lowest allocation for seven months.
The survey also noted that only 3 per cent of global fund managers expected yields to go lower during the next 12 months.
Within the equity space, the allocation to the US rose from a 28 per cent underweight to a 21 per cent underweight in October.
The trend towards US equities come as fund managers expect US tax reform to emerge during the first quarter of next year. However, around two-thirds do not expect it have a big impact on risk assets.
In Europe, meanwhile, allocation to eurozone equities rose to its highest level in five months to a 58 per cent overweight position from 54 per cent, month-on-month.
Ronan Carr, European equity strategist at BofA Merrill Lynch, said: “Europe is in vogue according to global investors, with the overweight in eurozone equities back near record highs and earnings per share expectations accelerating.
“European investors remain positive on the macro outlook and are looking for a global reacceleration.”
Source: BofA Merrill Lynch Global Fund Manager Survey
Allocations to Japan also jumped during October, moving from a 12 per cent overweight in September to a 23 per cent overweight this month, with the trade benefiting from rising rates and inflation.
Shusuke Yamada, chief Japan FX/equity strategist, said: “More investors are saying they want to overweight Japan over the next 12 months but that still lags behind Europe and emerging markets.
“More ‘Japan catalysts’ may be needed to attract long-term investor interests.”
Allocations to emerging markets moved from 47 per cent overweight in September to a 41 per cent overweight in October.
Sentiment towards the UK improved as allocation rose from a 35 per cent underweight in September to a 31 per cent underweight in October. However, UK positioning remains the largest underweight relative to the history of the fund manager survey.
On a sector basis, banks were the most popular overweight position among respondents to the survey, with allocations rising from a 22 per cent overweight to 42 per cent in October. This is the highest weighting on record and the largest one-month increase in three years.
Other popular sectors included technology, pharmaceuticals, consumer discretionary, insurance and industrials.
The least popular sector was utilities with telecoms, consumer staples and energy stocks also disliked by managers.
Elsewhere, 28 per cent of fund managers expect value to outperform growth over the next 12 months although fewer expected large-caps to outperform small-caps compared with September.