Global investors see equities as undervalued

Investors are waiting for the right conditions to return to equity markets amid the most pessimistic outlook yet recorded, according to Merrill Lynch's latest survey of fund managers.

The survey of 172 fund managers which was carried out between 3-9 October saw the number of respondents who believe equities are undervalued reached a 10-year high of 43%.

"Fund managers are waiting for the triggers that will give them the confidence to buy. What they are looking for is a loosening of monetary conditions and for 3rd quarter earnings to clarify where problems and opportunities lie across equity markets," said Gary Baker, head of EMEA equity strategy at Merrill Lynch.

Third quarter earnings season will be a vital input to investors' portfolio decision making and to gauging how the financial crisis has impacted the real economy.

Respondents appear to be placing little or no credibility in consensus earnings estimates for the year ahead. A net 92% of respondents regard estimates as "too high," and more than half say estimates are "far too high".

But despite the hope that undervalued equities could provide the foundation for a rally, about seven out of 10 respondents are of the view that the global economy has entered recessionary times, up sharply from 44% one month ago.

US fund managers are now much closer to fully accepting what they expect will be a deep and prolonged US recession. "In our view, however, it is too soon to say we have reached a bottom in equity markets given the current financial market turmoil," said Sheryl King, senior US economist at Merrill Lynch.

Growing risk aversion has led to a record 49% of respondents who are overweight in cash positions.

European gloom intensifies

At a time of global pessimism, the gloom is no more concentrated anywhere in the world than in Europe. A net 41% of global asset allocators are underweight in Euro zone stocks. Europe has now assumed the UK's mantel as the world's least popular destination for equity investment.

Within the Euro zone, a record nine out of 10 respondents expect economic conditions to worsen, while the net percentage those forecasting recession has doubled to 74% from 37% in September. The outlook for corporate earnings can hardly worsen, given that 97% believe EPS growth will be weaker in the 12 months ahead.

"Against this backdrop of fear over profits and recession, investors are selling expensive, highly cyclical industrials and opting instead for stable dividends and capital preservation," said Karen Olney, lead European equities strategist at Merrill Lynch.

Investors have stampeded out of Industrial Goods & Services over the past month, with 49% underweight the sector compared with 8% in September.

The biggest overweight positions are in telecom and healthcare, which traditionally provide safety and income. European sector allocation shifts over the past month suggest that investors have been moving towards remain pockets of potential growth that are less exposed to the credit crisis, such as media and technology. A net 39% are now overweighting the telecom sector, an increase of 2%.

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