Six out of 10 fund managers sees onset of recession

Expectations of a global economic recession have risen sharply with risk aversion reaching a new high, according to a Merrill Lynch's global survey of 186 fund managers carried out between 5 September and 11 September.

Fear about the prospects of global economies is evident with 61% of respondents of the view that a global recession is likely in the next 12 months.

The survey findings were tabulated after the US Federal Reserve's takeover of Fannie Mae and Freddie Mac, but before the failure of Lehman Brothers.

Highlighting the flight to safety, the survey also found asset allocators have overweighted bonds in their portfolios for the first time in over a decade. Many have adopted more defensive strategies and shortened their investment time horizons. A net 39% of respondents rate liquidity conditions as negative compared with 19% in August.

"Investors care little about inflation with recession on their doorstep and the banking system under pressure. They have made it clear that monetary policy is too restrictive and rates need to be cut," said Karen Olney, lead European equities strategist at Merrill Lynch.

A net 48% of global fund managers however expect inflation to be lower next year.

Views towards Eurozone darkens

Investors globally rank the Eurozone as their least favourite destination, with 50% of them underweight in Europe – the most negative reading since the survey began. The outlook for corporate profits is less favourable in the Eurozone than anywhere else, according to the survey.

European investors have become much more bearish over the past three months with more than two-thirds expecting a recession in Europe within 12 months, up from 13% in June.

However, European investors have radically changed their view on inflation with 69% expecting to fall, compared to 32% in June. Nearly two-thirds of the respondents are also of the view that Europe's monetary policy is too restrictive, up from 36% who held that view in August.

"European fund managers are migrating towards lower-risk industries – feasting on food and beverages while purging their positions in commodities," noted Olney.

Food & beverages, a sector most negatively correlated to risk appetite over the past two decades is now viewed as a safe haven and saw the biggest upswing. A net 2% of investors are underweight the sector now compared with a net 26% who were underweight in August.

The biggest sector swings from August to September were out of basic resources and chemicals stocks – both recognised as high-risk sectors during a downturn. A net 37% of respondents to the European survey are underweight in basic resources, reflecting a collapse of 47% from an overweight of 11% just a month ago.

Reflecting the reduced risk appetite in equities, about one in four hedge funds surveyed said that they have a net short equities position, compared with 6% who held net short equities positions in August.

Record underweight for emerging markets

Most of the fund managers have also moved to their largest underweight positions in emerging market equities since 2001 as a result of falling commodity prices, global growth concerns as well as residual inflation fears in emerging market economies.

Michael Hartnett, chief global emerging markets strategist at Merrill Lynch said: 'An improvement in sentiment toward the asset class will arrive once commodity prices stabilise and central banks in emerging markets ease monetary policy."

Benoit Anne, local markets strategist at Merrill Lynch added: "High profile problems for US financial firms are negative for emerging market currencies. These latest events will likely lead to greater risk aversion and a sharp correction in emerging market currencies."

Most emerging market investors have shifted their sector allocation toward defensive stocks overweighting telecom and staples while taking an underweight stance towards energy, materials and industrials. Overall, a net 13% said they would underweight emerging market equities over the next 12 months.

About 3 out of 5 respondents expect the Chinese economy to weaken over the next year – one of the most pessimistic readings on record. "The next big move in emerging market equities will be dependent on how quickly the Chinese government eases economic policy," says Hartnett.

A net 45% of global fund managers were overweight in US equities, which is a record level, though it must be noted that it was before the onset of the Lehman collapse and rescue of AIG by the US Fed.

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