Classic Contrarian Signal

Investor optimism about the global economy has soared to its highest level in nearly six years, with portfolio managers putting their cash back into equity markets, according to the Merrill Lynch Survey of Fund Managers for August.

A net 75 per cent of survey respondents believe the world economy will strengthen in the coming 12 months, the highest reading since November 2003 and up from 63 per cent in July. Confidence about corporate health is at its highest since January 2004. A net 70 per cent of the panel respondents expect global corporate profits to rise in the coming year, up from 51 per cent last month.

August's survey shows that investors are matching their sentiment with action, by putting cash to work. Average cash balances have fallen to 3.5 per cent from 4.7 per cent in July, their lowest level since July 2007. Equity allocations have risen sharply month-over-month with a net 34 per cent of respondents overweight the asset class, up from a net seven per cent in July. Merrill Lynch's risk and liquidity indicator, a measure of risk appetite, has risen to 41, the highest in two years.

'Strong optimism in August represents a big turnaround from the apocalyptic bearishness of March. And yet with four out of five investors predicting below trend growth for the year ahead, a nagging lack of conviction about the durability of the recovery remains,' says Michael Hartnett, chief global equities strategist at Banc of America Securities-Merrill Lynch Research. 'The equity rally has been narrowly led by China and tech stocks. We have yet to see investors fully embrace cyclical regions such as Japan or Europe, or Western bank stocks.'

Global emerging markets, led by China, and technology stocks are the strongest engines behind the early recovery. Investors would rather be overweight emerging markets than any other region, and by some distance. A net 33 per cent of the panel prefers to overweight emerging markets while investor consensus is to remain underweight the US, the eurozone, the U.K. and Japan.

Technology remains the number one sector, with 28 per cent of the global panel overweight the industry. Industrials and materials lag with global fund managers holding 11 per cent and 12 per cent overweight positions respectively.

Further behind are banks. Global fund managers remain concerned about the sector, holding a ten per cent underweight position. In contrast, investors within emerging markets are positive about banks with a net 17 per cent of fund managers in the regional survey overweight bank stocks.

Some of these sectoral and regional imbalances are starting to erode, however. Global fund managers have scaled back their underweight positions in bank stocks from 20 per cent in July. Industrials and materials have recovered from underweight positions one month ago. Emerging markets are less popular than in July when 48 per cent of the panel most wanted to overweight the region. And Europe is a lot less unpopular. In July, a net 30 per cent of respondents wanted to underweight the eurozone. That figure has dropped to just two per cent in August.

Within Europe, fund managers appear as excited about the outlook as their global colleagues. A net 66 per cent of respondents to the regional survey expect the European economy to improve in the coming year, up from a net 34 per cent in July.

The net percentage expecting earnings per share to rise nearly trebled, reaching 62 compared with a net 23 per cent a month ago. Investors in the region took an overweight position in basic resources, a cyclical sector, and radically scaled back their overweight position in pharmaceuticals, a defensive sector.

In contrast to global respondents, those in Europe have failed to inject new money.

'European growth optimism has finally caught up with other regions, but fund managers have yet to fully act on this and cash levels have actually increased and overall sector conviction is near record lows,' says Patrik Schöwitz, European equity strategist at Banc of America Securities-Merrill Lynch Research.