Global fund managers are becoming yet more pessimistic about the prospects for economic recovery and a sustained equity market recovery, a new survey indicates.
Wariness over a perceived increase in the volatility of equity prices and jitters over the fortunes of the US dollar are adding further layers of uncertainty for institutional investors, according to the April Merrill Lynch fund manager survey.
According to Michael Hartnett, Merrill's director of European equity strategy, this toxic cocktail bodes ill for equity markets, despite a recent recovery. "This suggests the best part of the rally is behind us rather than ahead of us," he said. "We suspect that this is a classic traders' bear market rally that will run out of steam around May."
The April survey found that only a net 17 per cent of the 314 fund managers surveyed believed that global equities were oversold, compared to 71 per cent in March. Similarly the proportion of respondents expecting higher markets in 12 months time has fallen to a net 69 per cent, from 77 per cent in January.
This gloom is further illustrated in predictions for industrial commodity prices, with just a net 31 per cent of managers foreseeing higher prices in a year's time, versus 58 per cent in January, suggesting a further weakening in corporate pricing power.
"It is rare to get an improving growth and profits cycle underway at a time when investors are turning less positive on industrial price outlook," said David Bowers, Merrill's chief investment strategist. "Until this indicator starts to improve we would not rush to get more cyclical."
These gloomy sentiments are particularly telling as the fieldwork for the survey was conducted between April 3 and April 10, when US troops had already entered Baghdad and one layer of uncertainty had largely been removed from the global equation.
A new question in the survey further added to the pressure on equity prices. Some 55 per cent of respondents said the volatility of global corporate earnings was increasing, with only 12 per cent arguing that earnings stream were becoming less volatile.
The accepted wisdom is that the more volatile a corporate earnings stream is, the lower price/earnings multiple it can sustain. "If corporate earnings are still becoming less predictable, then equities may not be as cheap as they look," Mr Bowers added.
And even if fund managers decided equities were cheap, they have relatively little ammunition to push stocks higher. Average cash balances fell sharply in last month to 4.6 per cent from 5.4 per cent.
Away from the equity markets, the survey indicated that a large swathe of the fund management community was growing nervous about the fate of the US dollar. One-in-ten fund managers said they had hedged all or most of their dollar exposure, with 25 per cent hedging some.
With other managers either not allowed to hedge or not answering the question, the majority of institutional investors in a position to hedge appear to be doing so. Furthermore, 53 per cent of the respondents said they believed the dollar was overvalued, against just 38 per cent in March.
Mr Bowers believed this reflected growing concern over the US's twin deficits. Both the current account and budget deficits could be as much as 5 per cent of GDP this year and these deficits could present a risk to the dollar, hence the insurance policy of hedging.
"In the last 50 years we have never seen twin deficits of this magnitude, it is a theme we don't think is going to go away," he said.
"Although the US has been a net importer of capital for the last ten years, what the capital is financing has changed. Three years ago it was financing the private-sector technology-led investment boom, but now it is financing a public sector deficit, a significant difference.
"And if the world were to change the terms and conditions on which is supplies America with capital, there would be a variety of potentially adverse implications on the dollar, US interest rates, and maybe the US financials sector. It could also have major consequences for the eurozone, which is far more exposed to the US credit cycle than is generally appreciated."
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