Bearish outlook prompts investor caution

February 12, 2019

If you're finding stock markets hard to call, or are nervous about how to invest right now, then don't worry.

It appears that the market professionals feel exactly the same.

The monthly survey of fund managers, conducted by the banking and broking giant Bank of America Merrill Lynch, points to a good deal of bearishness.

That is despite a rally since the beginning of 2019 that, to date, has sent the S&P 500 up by 9%, the Dow Jones Industrial Average up by nearly 8.5% and the FTSE 100 and Nikkei 225 up by around 2.5% apiece.

The survey, conducted among investors with assets of more than $515bn under management, found that, globally, the share of portfolios allocated to stock markets fell this month to its lowest level since September 2016.

Nor was the anxiety confined to equity markets. Allocations to commodity markets also fell.

Meanwhile, in another sign of the caution being displayed, the proportion of professionals who are 'overweight' in cash (where a fund manager believes a particular security or asset class will perform better than others) is at its highest level since January 2009 - a period in which the financial crisis was raging and global markets were gripped by fear.

Keeping your money in cash, in a low interest rate environment like the current one, usually indicates that investment professionals fear falling markets and are merely looking to preserve capital rather than seek capital growth.

The survey also points to a sharp increase in the number of fund managers who are gloomy about both the growth and the inflation outlook for the global economy during the next 12 months.

BoAML highlights growing concern about 'secular stagnation' - a period of very low or no growth over the long term - which, it notes, is a return to how fund managers felt in the period immediately after the financial crisis.

Michael Hartnett, chief investment strategist at BoAML, said: "Despite the recent rally, investor sentiment remains bearish."

So what's behind all this?

At the macroeconomic level, there are a number of factors, the most obvious of which is an expectation that the global economy will grow more slowly this year than it did in 2018.

The biggest contributor to that is concerns over a trade war between the United States and China which, for the ninth consecutive month, topped the list of investor worries.

A possible slowdown in the Chinese economy is also a contributor to the unease while there are also concerns over a corporate credit crunch.

Strikingly, when asked what the companies in which they invest should do with their cash, the most popular answer among fund managers was that companies should be strengthening their balance sheets and reducing their borrowing.

The proportion of investment professionals plumping for this option was the highest since July 2009 and a significant number of fund managers worry that companies have taken on too much debt.

The next most popular answer was to use corporate cash flows to increase capital expenditure while the least popular was for companies to return cash to their shareholders.

The net balance of investors backing this option was at its lowest ever.

Another key driver of this sentiment is a sense among investors that the market has gone as high as it can go for now.

One of the key drivers of the sell-off last autumn was the fact that equity markets had been rising for nearly ten years in a row and were due some sort of correction.

Even though the S&P 500 suffered its first annual decline last year since 2008, that view appears to be persisting, with BoAML noting that the last month had seen a large jump in the number of investors who think that the index hit its peak last year.

That number has actually risen from a net 11% in September, when the S&P500 actually peaked, to 34% today.

In Europe, while more money has been allocated to stocks during the last month, the mood remains cautious.

BoAML detected that, looking ahead over the next 12 months, the number of fund managers intending to own European stocks has dropped to its lowest level for six years due to the outlook for company profits in Europe being weaker than elsewhere.

Investors expect that, while Europe will avoid a recession during the next year, Europe's economy will slow down.

Nowhere is sentiment more depressed than in the attitude towards investing in the UK stock market: a net 25% of fund managers were 'underweight' UK equities which, remarkably, was the best showing for four months.

The outlook for corporate profits is regarded as weaker than in any of the US, the Eurozone, Japan or emerging markets and the UK is the market of which investors said they would most like to be 'underweight'.

If that all sounds unremittingly gloomy, fear not.

BoAML notes that, when the proportion of cash in an investor's portfolio rises above 4.5%, it is usually a 'buy' signal for shares.

The current cash balance is currently 4.8% compared with the average of 4.6% for the last decade.

The bad news is that this particular signal has been flashing 'buy' for the last 11 months.

As Mr Hartnett observes, there is currently a "buyer's strike" among investors, which looks likely to persist until such time as the world gets greater clarity on the trade dispute between the US and China and can be convinced that the latter's economy is not going to slow too dramatically.

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