Most Investors Believe Fiscal Cliff Is Not Yet Priced In To Equities

Nearly three quarters (72 percent) of global investors believe that the fiscal cliff is not substantially priced into global equities and macroeconomic data. The fiscal cliff is identified as the number one tail risk by 42 percent of respondents – up from 35 percent in September and 26 percent in August. EU sovereign debt funding risk is seen as less of a threat. A net 27 percent of the panel see it as their number one risk, down from a net 33 percent a month ago and far lower than the reading of 65 percent in June.

Investors have otherwise become more positive, building on growing sentiment since the summer. A net 20 percent of investors now believe the global economy will strengthen in the coming 12 months – a rise of three percentage points month on month. Concerns about the outlook for corporate profits have eased noticeably. A net 11 percent of investors say corporate profits will fall in the coming year, down from a net 28 percent in September. However, expectations of a sharp bounce in earnings fell back with a net 58 percent saying double digit earnings gains are unlikely in the next year, up from 55 percent in September.

Equity allocations rose significantly month-on-month. A net 24 percent of asset allocators are overweight equities, up from a net 15 percent in September. Fund managers increased allocations to seven of the 11 global sectors, including banks and industrials. Allocations to the eurozone and global emerging markets increased, but allocations to Japan fell to a three-year low.

“While the U.S. fiscal cliff is a hurdle, growing belief in the global economy could spur a more ‘risk on’ stance from investors,” said Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research.

“The outlook for European equities is improving, eurozone fears are receding and appear largely priced into equity risk premia; core government bonds offer negative real yields so the impetus to rotate into stocks in Europe, as the outlook stabilizes, is profound,” said John Bilton, European investment strategist at BofA Merrill Lynch Global Research.

Gap in popularity between U.S. and Europe disappears

Two months ago the gap in popularity between U.S. and European equities was substantial – but now the two regions viewed equally in the eyes of allocators. October’s Fund Manager Survey shows a net 10 percent of the panel is overweight in both regions. A market change from August when a net 13 percent of asset allocators were underweight Eurozone equities vs. a net 13 percent overweight for the U.S.

Furthermore, the outlook for the two regions is also identical. The U.S. and the eurozone both receive a net 3 percent of investor votes for the region they would most like to overweight over the coming year.

Japanese risk rising

Investors have become more bearish on Japan as concerns grow over a dispute with China over the Senaku Islands and its impact on trade. A net 38 percent of global asset allocators are underweight Japanese equities, the lowest reading since March 2009 and up from a net 23 percent a month ago. The outlook suggests no improvement. For the second consecutive month a net 24 percent of investors say Japan is the region they most want to underweight.

Pessimism within Japan has risen acutely in the past month. A net 30 percent of the regional panel believe the Japanese economy will weaken in the coming year, up 26 percentage points since September. A net 22 percent expect Japanese earnings per share to decline, up from a net 9 percent a month ago.

Sovereign bonds tipped to make way for ‘risk on ‘investments

As well as increasing equity allocations, investors are shifting towards higher risk sectors. A net 7 percent of investors are overweight industrials, a highly cyclical sector, this month compared with a net 8 percent underweight in September.

Riskier sectors such as Banks, Insurance and Materials also saw positive shifts. Within the banking sector in particular, valuations have fallen sharply despite improving sentiment. A net 18 percent of the panel believe Banks is the most undervalued sector, up from a net 11 percent in September and double the reading of the second most undervalued sector, materials, at a net 9 percent.

This month, we asked investors for the first time what they would sell to fund the purchase of high Beta equities. The number one pick (37 percent) was to sell government bonds. One third of the panel believes investors will use cash and 19 percent opted for defensive equities. Significantly, only 4 percent opted for corporate bonds as the asset class they expect to be sold.