A SURVEY of fund managers reported new records in pessimism in terms of the extent of cash overweights and equity underweights, raising the question of whether capitulation is complete.
Merrill Lynch said that its October fund manager survey is one of the most pessimistic.
Institutional fund managers believe that the world is in recession; that monetary policy is too restrictive; and that companies should use what cash flow they have to rebuild balance sheets.
Fund managers have lost faith in global growth, commodities, China's economy and emerging markets.
'By historical standards, a lot of bad news is now in the price, although the fragility of the financial system means that history may be a less reliable guide than usual,' Merrill said.
Merrill said that three factors that tend to be associated with market rallies are coming together:
risk appetite is extremely pessimistic;
cash levels are extremely high; and
for the first time, there is a sharp increase in the number of managers - a net 43 per cent - who believe that equities are undervalued.
The latter is the highest reading in more than a decade.
'All that is missing is a catalyst to put this cash back to work,' said Merrill.
It added that the catalyst may come with a shift in monetary conditions.
A net 59 per cent of managers believe that policy is 'too restrictive', in the light of an 'unprecedented' reassessment of inflation expectations.
The net balance expecting higher global core inflation is currently the lowest in over a decade, a dramatic turnaround from three months ago.
The collapse in inflation expectations reflects the correction in commodity prices as well as a growing assessment of the imminent economic downturn and a major squeeze on operating margins.
'(Managers) are bracing themselves for a period of below-trend growth and below-trend inflation, and they want to see short rates cut,' said Merrill.
Among asset allocators, the net balance that is overweight cash, underweight equities and overweight bonds hit new records.
They remain overweight US equities and underweight all other major regions.
They still regard the US dollar as undervalued, and are convinced that the euro and British pound would fall further.
This article was first published in The Business Times on October 17, 2008.
