Quick Take | Global fund manager survey finds extreme bearish sentiment, but allocation to emerging markets improves

The December survey of global fund managers by Bank of America-Merrill Lynch finds that sentiment is close to being extremely bearish, which suggests that a dovish statement from the US Fed today could lead to what the survey calls ‘a bear market bounce’. In all 243 global fund managers with assets under management of USD 694 billion participated in the survey.

Does the extreme bearishness trigger a ‘buy’ signal, given that the Fund Manager Survey is usually taken as a contrarian indicator? The survey says it doesn’t, for two reasons. One, cash levels are not low enough for a buy signal for risk assets. And two, it expects the ‘Big Low’ for stocks to come in 2019.

Be that as it may, there’s some good news for emerging markets. Global fund managers now say the region they would most like to overweight in the next 12 months is the emerging market (EM) universe. A net 18 percent  of global investors are now overweight emerging markets, a sea change from the 10 percent underweight three months ago. What’s more, the current allocation is 0.1 standard deviations below its long-term average, so there’s plenty of scope for it to go higher. The percentage of fund managers overweight EM was much higher towards the end of last year and the first few months of 2018.

The key to what happens to emerging markets lies in the strength of the US dollar. The survey says that ‘Long US dollar’ is now the most crowded trade and its price action needs to be monitored closely. The net percentage of fund managers who say the USD is overvalued, especially against EM currencies, is at its highest since 2006. If that contrarian indicator works, the USD will soon weaken, helping emerging markets. A dovish Fed will of course hasten the process.

Investor sentiment has soured on Eurozone assets and UK stocks and the net overweight on US equities too has fallen. If emerging markets can get their act together, there could be a good chance of a rotation into EM stocks. Much will depend, though, on how China fares — a trade war remains the biggest tail risk cited by fund managers.

That said, investors are very worried about global growth. Consider these results from the survey: the proportion of fund managers who expect global growth to weaken over the next twelve months is the most since October 2008, when Lehman Brothers went down; the percentage of investors who think corporate balance sheets are overleveraged is the highest on record; and the profit outlook is the worst since December 2008.

Small wonder then that net allocation to equities by fund managers have crashed to a two-year low.