Merrill’s latest fund manager survey is flashing a warning on these crowded trades
Global investors are expecting an awful lot from both the Fed and the European Central Bank which have already spooked markets on more than one occasion
Investors are ignoring their own warnings
The monthly Global Fund Manager Survey by Bank of America Merrill Lynch (BAML) is one of the most authoritative surveys in financial markets. In canvassing the views of 200 or so institutional, mutual and hedge fund managers around the world with some US$600 billion of assets under management, the report provides an overview of investor sentiment and sheds light on the key factors influencing the asset allocation decisions of money managers.
Its findings, therefore, deserve close scrutiny.
The results that receive the most attention are those that pertain to the vulnerabilities in markets, particularly the sectors or asset classes which the survey’s respondents deem to be the most crowded, or riskiest, trades.
In the latest survey, carried out between July 7 and 13 and published last week, a crash in global bond markets supplanted a tightening in Chinese credit conditions as the biggest “tail risk”. In a further sign of the extent to which fund managers are increasingly concerned about the conduct of monetary policy, a policy mistake by the Federal Reserve or the European Central Bank was cited as the second biggest tail risk.
Over half of money managers surveyed by BAML now believe the biggest risks facing markets stem from the actions of the world’s leading central banks, with nearly half of those surveyed deeming global monetary policy to be “too stimulative”, the highest proportion since April 2011.
Yet if international investors are fretting about missteps in monetary policy, they have a funny way of showing it.
According to the survey, two of the three most crowded trades in markets right now are “long” (or an overweight position in) European equities and corporate debt, the very sectors which stand to lose the most if the European Central Bank triggers a sharp sell-off by withdrawing monetary stimulus prematurely or by miscommunicating its policy intentions - a risk that was thrown into sharp relief by last week’s decidedly dovish comments from the central bank’s president, Mario Draghi, stressing that he is no rush to scale back, or “taper”, quantitative easing (QE), and is even ready to provide more stimulus if warranted.
The other crowded trade, which has topped the list for the past three months, is exposure to the Nasdaq Composite, the technology-heavy US equity index which surpassed its March 2000 dotcom bubble peak in late April.
The US tech sector as a whole has been a on a tear for some time now, with shares in the blue-chip firms in the S&P 500 tech index - which include the much-talked-about FANGs (Facebook, Amazon, Netflix and Google) - up a staggering 23 per cent since the start of this year, powering the gains in US stocks.
Yet the survey also revealed that 80 per cent of investors believe US equities have become overvalued. More worryingly, most respondents believe that the outlook for growth and corporate earnings is deteriorating. The percentage of investors anticipating stronger global growth fell to just over a third in July (down from 62 per cent in January), while the share of money managers expecting earnings to improve in the next 12 months dropped to 41 per cent, down from 58 per cent in January.
Why are global investors ignoring their own warnings?
To be sure, fears about the consequences of a withdrawal of monetary stimulus are nothing new. Investors and traders have been acutely sensitive to any hint of policy tightening ever since the Fed provoked the “taper tantrum” in 2013 by unexpectedly announcing its plans to wind down QE. The latest bout of anxiety was caused by the perception that the European Central Bank was about to begin tapering. Yet as Draghi made clear last week, the ECB is fearful of unsettling markets. Deep down, investors know this and are therefore willing to take risks.
As for the booming US tech sector, valuations are on a much firmer footing than during the 2000 dotcom bubble, with the sector’s price-to-earnings ratio just over 21 compared with a mind-boggling 65 in 1999, according to data from Bloomberg. The tech sector is also benefiting from strong earnings growth.
Still, global investors are expecting an awful lot from both the Fed and the European Central Bank which have already spooked markets on more than one occasion. They are doing so, moreover, while becoming less optimistic about growth and earnings.
At some point, something will have to give.
Either there will be a major misstep in monetary policy or the corporate fundamentals underpinning the bull market in equities will start to be questioned more severely by investors.
Global fund managers can only ignore their own warnings for so long.
Nicholas Spiro is a partner at Lauressa Advisory