Fund managers are becoming pessimistic about the outlook for risk assets, with 46 percent claiming equity markets are overvalued, according to a new survey.
Fund managers are hedging risk exposures and stockpiling cash as asset management firms grow increasingly downbeat about the prospects for global equities in the year ahead.
The latest Bank of America Merrill Lynch Fund Manager Survey of 200 fund managers, conducted each month, found that 46 per cent of respondents think equity markets are now overvalued a record high for the survey. Only a third are expecting corporate profitability to improve over the coming year.
In a note accompanying the report, Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, said stock market investors expectations of corporate profits have taken an ominous turn this year. He said this was a warning sign for those who had embraced equities over bonds, high yield over investment grade, and cyclical sectors over defensive ones. Hartnett added that any further deterioration would likely trigger risk-off trades.
The report follows similar warnings from fund managers and other market observers about the outlook for riskier assets, with managers repeatedly noting that investors are locking in gains and reducing risk.
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At least one famous fund manager disagrees. In a telephone interview with CNBC on Tuesday, Appaloosa Management founder David Tepper said that while he doesnt think stocks are screaming cheap, he does think past comparisons to overvalued stock markets --such as the equity market of 1999, before the dotcom bubble burst -- are ridiculous and that the U.S. stock market is nowhere near overheated. To that end, Tepper ramped up his exposure to technology stocks to nearly a quarter of his stock portfolio at the end of the second quarter, according to CNBC.
The BofA Merrill survey found that managers perceive the two biggest potential risks to the market to be a policy mistake by the U.S. Federal Reserve and a crash in global bond markets. Twenty two percent of investors cited the former as the biggest risk, while 19 percent cited the latter.
In a note to clients, Christian Preussner, chief client portfolio manager for U.S. equities at J.P. Morgan Asset Management, said stocks have been climbing a wall of worry since 2009 and acknowledged that there is fear that a correction is overdue. He added that for investors concerned about the possibility of a correction, defensive stocks and strategies that are less correlated to the equity markets are sensible investments.
The BofA Merrill survey found that European fund managers are increasing their cash stockpiles as a result of concerns that stocks may be on the expensive side, with cash representing 5.3 percent of portfolios, the highest level since March 2003. Globally, the average cash balance was 4.9 percent.
The survey also found that 31 percent of fund managers think the most crowded trade is that of investors positioned for a rising Nasdaq. This is the fourth month they have made this conclusion, the survey noted.
Fund managers and investment advisers have been sounding concerns that some portfolios may be carrying more risk than anticipated, with investors having allocated more to high-yield credit in recent years to achieve a better yield.
John Burke, head of institutional business at Royal London Asset Management, tells Institutional Investor that savvy investors realize that going further out on the risk spectrum carries risk. What worries me is that [some] people dont understand the risks that they are taking, he says.