Eurozone Turbulence Prompts Uptick in US, Emerging Market Equities

(November 17, 2011) — Eurozone turbulence is prompting money managers to seek US and emerging market equities, according to a study by Bank of America Merrill Lynch. 

According to the firm’s November survey of fund managers, a net 27% of investors are overweight in emerging markets during the month, up from a net 9% in October. Meanwhile, a net 20% of investors are overweight in US equities, up from a net 6% in October.

A total of 72% of European managers who responded to the survey believe that Europe will sink into a recession in the next 12 months, up from a net 37% in October. Yet, fears about a global recession have waned slightly, with a net 31% of global investors expecting the world economy to avoid a recession, up from a net 25% the previous month.

“Strong macro headwinds and uncertainty about global growth kept investors stubbornly bearish in November,” the report stated. “Unsurprisingly, cash levels remained elevated at 5.0%. Despite broad risk aversion, however, investors became more constructive on EM as the relative growth potential, policy options, and equity underperformance gained investor attention…Sentiment also improved on China, where growth expectations became less grim (-25% this month from -47% last month) and the vast majority of investors now expect a ‘soft’ landing.”

In August, the firm issued another report showing that global emerging markets have increased in popularity, as concerns about a weakening of the Chinese economy have subsided. The findings showed 19% expected the Chinese economy to weaken over the next year, down 20 percentage points from July. This improved outlook was supported by a shift toward commodities, Merrill said.

The firm’s evidence showcasing a greater attraction to US and emerging market equities follows a September report by the International Monetary Fund (IMF) that revealed that pension and insurance funds may up their allocation to equities and other riskier assets in emerging and developing countries. According to the group’s Global Financial Stability Report, historically low interest rates in industrialized markets are threatening pension plans in Canada, Germany, Japan, Switzerland, Britain and the United States. Due to the low interest rate environment of those markets, pension and insurance vehicles are being left underfunded as a result of their reliance on traditionally safe investments, which are yielding little or nothing.

Consequently, the IMF noted opportunity in more aggressive, relatively riskier assets.

The report stated: “Investing in emerging markets is seen as potentially increasing portfolio returns without taking on excessive risk. A number of factors contribute to this view, including (i) underweighting of emerging markets in most portfolios (although exposure was already increasing before the crisis), so that emerging market assets can help diversify portfolios; (ii) low returns and increasing risk in advanced economies; (iii) a favorable view of the liquidity available in most large emerging markets; and (iv) an improvement in economic outcomes and a decline in policy risk in emerging markets.”

In addition, the report concluded that new regulations designed to help lower exposure to high risk investments may actually be undermining global financial stability. “With many first-time investors taking advantage of the relatively better economic performance of these countries, the risk of a reversal cannot be discounted if fundamentals — such as growth prospects or country or global risk — change,” according to the report. “For larger shocks, the impact of such reversals could be of the same magnitude as the pullback in flows experienced during the financial crisis.”