But fears over sovereign debt have fueled the highest level of European economic pessimism since depths of the credit crisis. Nearly two-thirds of the panel identified EU sovereign debt funding as the number one tail risk (64 percent compared with 43 percent in June). A net 22 percent of respondents to the Regional Survey expect Europe’s economy to weaken in the coming 12 months – the most negative reading since April 2009.
European investors have sharply reduced positions across many sectors, but the most eye-catching position is in banks. A net 57 percent of the European panel is now underweight banks (versus 33 percent in June), leaving the sector at its lowest ebb since February 2009.
While respondents to the global survey have scaled back positions in eurozone equities, they have increased them in every other region, including the U.S. As sentiment improves, desire for a third round of quantitative easing (QE3) remains low – 40 percent of respondents said in July that they are not expecting QE3. But 48 percent of the panel says that QE3 will be necessary if the S&P 500 falls by 20 percent.
“Our question about QE3 this month shows that investors don’t want policy makers to panic now – but many expect the Fed to apply QE3 if the S&P 500 falls below 1,100,” said Michael Hartnett, chief Global Equity strategist at BofA Merrill Lynch Global Research. “Investors have acted decisively in response to recent developments in EU sovereign funding. The question is whether eurozone equities have been oversold,” said Gary Baker, head of European Equities strategy at BofA Merrill Lynch Global Research.
Sentiment towards GEM and Japan improves
As the eurozone suffers, Japan and Global Emerging Markets are the regions with the greatest positive sentiment momentum.
A net 33 percent of asset allocators were overweight Global Emerging Markets equities this month, a rise of 10 percentage points since June. Looking ahead, Global Emerging Markets is the region investors would most like to overweight.
Among Asian and emerging market portfolio managers, concerns over China’s growth prospects have eased. A net 24 percent of respondents are now predicting slower growth over the next 12 months down from a net 40 percent in June.
Allocations to Japanese equities received a large positive swing over the past month. A net 22 percent had been underweight in June, but that transformed to net 2 percent overweight in July. Expectations within Japan are also strong, especially regarding corporate performance. A net 76 percent of respondents to the Japanese Regional Survey expect corporate earnings to improve in the next 12 months, up from a net 54 percent in June. A net 56 percent believe that Japanese equities are undervalued.
Poor trading conditions dampen risk appetite
While July’s survey shows that appetite for global equities rose, it also suggests that the desire to invest has been constrained by poor trading conditions. The BofA Merrill Lynch Risk and Liquidity Composite indicator remained stable at 38 – a little below the average risk benchmark of 40. Cash holdings ticked downwards and the overall level of risk increased, although it remained below average. A net 21 percent of the panel is taking below average portfolio risk relative to their benchmark, compared with a net 26 percent in June.
Asset allocators increased equity allocations and reduced bond holdings. A net 35 percent of asset allocators were overweight equities in July, up from a net 27 percent in June. A net 45 percent of the panel was underweight bonds, up from a net 35 percent in June.
But investors have indicated that liquidity conditions worsened over the past month. A net 20 percent of the panel described liquidity conditions as positive, down from a net 35 percent in July. Visibility has also deteriorated. A net 35 percent of investors describe their current investment time horizon as shorter than normal – up from a net 26 percent in June and the weakest reading since May 2010.
Europeans betting on export-led stocks
Changes in European investors’ sector allocations reflect growth fears about the eurozone economy and the need to hunt for growth elsewhere. European investors are upping allocations to pro-cyclical exporters such as Autos and Parts, Basic Resources and Technology. In contrast, global sector allocations show a balance between defensive and cyclical stocks.