Stagflation fears are gripping investors, but inflation concerns are
fast overtaking worries about economic growth, according to Merrill
Lynch’s Survey of Fund Managers for May.
Fund managers were slightly less negative in their expectations for
economic growth and corporate earnings. Particularly striking was that
fewer panellists believe the world has already entered recession –
18 percent took that view in May, down from 24 percent in April. The
number expecting recession within a year fell to 29 percent from 40
percent. Instead, investors are focusing on inflation. A quarter of
respondents expect global core inflation to rise in the coming 12
months, compared with just 7 percent in April. This is prompting
predictions of higher bonds yields, with 80 percent of investors
expecting long-term rates to be higher a year from now. In contrast,
fewer respondents are predicting higher short-term rates.
“Evidence is pointing to a possible sell off
in bonds as inflation worries mount,” said David
Bowers, independent consultant to Merrill Lynch. “A
sharp rise in bond yields could help convert this financial crisis into
an economic crisis.”
Investors unconvinced by earnings forecasts
Despite expressing a lower risk of recession, the panel still worries
that earnings estimates are detached from reality. More than three
quarters of investors (77 percent) said, in response to a new question,
that consensus estimates for global corporate earnings are too high.
Moreover, fewer investors see value in equities. The number of investors
who believe that equities are undervalued fell to a net 15 percent in
May, which is down from a net 26 percent in April. Fears of
overvaluation are also apparent in commodities. In response to new
questions, a net 52 percent of asset allocators said that they thought
oil is overvalued, and a net 29 percent of asset allocators thought gold
to be trading above fundamentals.
Scarcity of earnings re-ignites the commodities trade
Fuelled by growing inflation fears, Eurozone investors have rediscovered
their enthusiasm for the commodity trade. Oil & Gas, seen as
inflation-proof, has extended its position as Europe’s
favourite sector with 41 percent of investors overweight, compared with
29 percent in April. A net 11 percent of investors expect inflation to
rise in the coming year (2 percent in April). Oil & Gas and Basic
Resources benefit from one of the few clear growth stories.
“In a slowdown, earnings momentum drives
out-performance - not value. The relentless need for food and
infrastructure in developing markets means that commodities, and not
labour, are the scarce resources in this cycle, and this scarcity means
pricing power,” said Karen Olney,
chief European equities strategist at Merrill Lynch. “Banks,
on the contrary, are being penalised for earnings decay. While still
unloved, this month they are no longer seen as cheap as they move from
value-trap, implying upside, to trap status.”
One month ago nearly a quarter of Eurozone and U.K. investors said banks
were undervalued, and that number has now fallen to zero.
The threat of stagflation is also bad news for company pension plans.
Indexation means a rising cash-call at a time when profits are
moderating for many. Developments in the U.K. are being watched closely.
“Investors might not appreciate that the U.K.
Pensions Regulator has the power to ensure pension contributions rank
ahead of dividends. As of 14 April, these powers have been strengthened,”
said Karen Olney.
Liability Driven Investment (LDI) can hedge pension plans
Investors should be paying close attention to the unfolding story of the
extent to which higher inflation translates to higher pension fund
payments for corporates. They should monitor the investment strategy
that plan sponsors are using. The gap in performance between those
corporate pension plan sponsors using and not using LDI could increase
markedly as stagflation takes hold.
“Plan sponsors using LDI have the advantage
of a hedge against higher inflation and sharp changes in interest rates,”
said Gordon Latter, Pensions and Endowments Strategist at Merrill
Lynch. “Those pension plans that remain
unhedged leave themselves at the whim of the market.”
NOTES TO EDITORS
A total of 191 fund managers participated in the global survey from 2
May to 8 May, managing a total of U.S.$615 billion. A total of 179
managers participated in the regional surveys, managing U.S.$413
billion. The survey was conducted with the help of market research
company Taylor Nelson Sofres (TNS). Through its international network in
more than 50 countries, Taylor Nelson Sofres provides market information
services in over 80 countries to national and multi-national
organizations. It is ranked as the fourth-largest market information
group in the world. Survey results were analysed by David Bowers, who is
joint managing director of Absolute Strategy Research Ltd, a financial
services consultancy.
Merrill Lynch Global Research has consistently achieved high rankings
for its equity and fixed income research in numerous regional and global
investor surveys, such as Institutional Investor, The Wall Street
Journal, LatinFinance, Asiamoney, Euromoney, Extel and Reuters.
Merrill Lynch is one of the world's leading wealth management, capital
markets and advisory companies, with offices in 40 countries and
territories and total client assets of approximately $1.6 trillion. As
an investment bank, it is a leading global trader and underwriter of
securities and derivatives across a broad range of asset classes and
serves as a strategic advisor to corporations, governments, institutions
and individuals worldwide. Merrill Lynch owns approximately half of
BlackRock, one of the world's largest publicly traded investment
management companies, with more than $1 trillion in assets under
management. For more information on Merrill Lynch, please visit www.ml.com.
