We are very privileged to be able to share with you the latest findings from Merrill Lynch's fund managers survey, the release of which is one of the most sought after pieces of research in the square mile. The report is titled "cash says buy" as they continue to believe the equity market rally has further room to rise whilst investors remain underweight equities relative to history. Previous reports have highlighted, as an example of this, balanced funds in the US recommended holding of equities is now between 50 and 55 percent as opposed to the more usual 60 percent plus. Another piece of evidence they point to is the level of cash held within a fund managers portfolio.
The oft heard mantra by private and institutional investors over the past few years has been "I want to wait for the correction to buy". Last week's funds flow data, which we referred to over the weekend, showed the largest weekly outflows for some time from equities. This week, the fund manager survey reports that cash levels, which were already at the higher end, have risen again; at 5.1 percent, investors are holding close to the same level of cash they were at the lows in 2009. It appears that as they did earlier in the year, at the first sign of a correction retail and professional investors alike head for the exit sign. The survey may not be foolproof, but it clearly shows that fund managers may hold high levels of cash as the market bottoms, but ahead of a major market correction cash levels are low.
Some of the recent signals that appeared as lead indicators to a wider correction, for example were the weakness in high yield and the Russell 2000 of smaller companies which have modestly reversed themselves, adding stability to the broader market. On top of that, the geopolitical risks appear to have, at least in the short term, calmed down. We reiterate that despite these encouraging signs, our view remains that the correction has probably not run its course. It would be nice to see the Vix above 20 for example, which may well happen before the fund manager's sun tan fades completely.
When we published our view of the year ahead for 2014, we believed the fear was in bonds the greed in equities, and therefore we saw a risk that bonds did better than expected, despite the Federal Reserve tapering. So far in 2014 US treasuries have marginally outperformed the S&P 500 (6% against 5.7%). Although we still take the view fear exists in all asset classes, it would now appear that the signs indicate the balance between bonds and equities has shifted from the start of the year as some of the equity greed has faded, and along with the high cash levels that should bode well for equities into the year end. The one caveat for equities not to get a sharper jolt is we need a gentle falling out of love from bond investors, not a sharp break up à la 1994.