The fear of freefalling

Is this capitulation territory – the time when investors give up believing that things are going to get better and accept whatever vagaries stockmarkets throw at them, take any losses on the chin and learn to love a bear?

Or is there a bit more pain to endure before the nadir of the present sell-off is reached?

Those questions arise from the results of the very pessimistic monthly survey for July of big global investors by Bank of America.

In June, big global investors were at their gloomiest for years as markets slid, inflation surged and central banks started accelerating their rate increases according to that month’s results from Bank of America survey of big investors.

A month later and the latest Bank of America survey shows those investors are even gloomier – they have boosted their cash holdings to 6.1% of funds under management a 21 year record and equal to the level in May in the immediate aftermath of the Russian invasion of Ukraine in late February.

The most ostensible reasons are the now usual suspects, fears of higher inflation, higher interest rates and recession, but big investors are becoming very, very gloomy about corporate earnings – in fact they sound positive miserable.

As a result they have slashed their exposure to equities to multi-year lows as well. Given that selling it’s no wonder sharemarkets have been weak.

Allocation to equities were cut to their lowest level since the collapse of Lehman Brothers at the height of the global financial crisis in late 2008, as mounting fears of a recession fuel concerns about corporate earnings.

The Bank of America survey of 259 investment managers with combined assets of $US722 billion (conducted from July 8 to 15) said the move to cash up came as exposure to equities was cut to its lowest share of funds under management since October, 2008, the month after Lehman Brothers collapsed.

The survey was in fact done after Wall Street posted its worst first-half decline since 1970. It’s now down almost 20% in the year so far.

Michael Hartnett, chief investment strategist at BofA, said investors had reached a “tight level” of pessimism as they worry that a global monetary policy tightening could lead to a broad slowdown in growth.

He added that a higher proportion of fund managers — 79% net — now expected corporate earnings to worsen than at any point during the pandemic or when Lehman Brothers collapsed in September 2008.

And big investors are reducing risk when they do invest in equities.

The survey showed that a net 58% of BofA respondents said they took lower-than-normal risk in their portfolios with allocations to US defensive sectors, such as healthcare, utilities and consumer staples, which are considered less vulnerable in a recession and hit their highest levels.

Over the past four weeks, fund managers have also alternated euro-zone stocks, banks, energy stocks, materials and commodities with defensive sectors and bonds.

A third of investors said high inflation was their biggest concern, while just under a quarter cited a recession as the biggest risk.

Bank of America said the survey showed big global investors remained at “maximum bearishness”.

While three-quarters of fund managers surveyed expect inflation to fall in the next 12 months, the backdrop remains “stagflationary” with high inflation and slowing growth underpinning sentiment.

Long the US dollar was the No. 1 crowded trade in July followed by long oil/commodities and long ESG Assets.

The prospect of inflation staying high was the top tail risk for followed by a global recession. The Russia-Ukraine invasion and war, the trigger for much of the gloom, has dropped to No. 5.

Half the investors surveyed want companies to shore up their balance sheets while less than a third would like to see more capital spending.

With an eye on slowing economic growth, funds cut allocation to bank shares by 16 percentage points from June levels, going underweight in the sector for the first time since October 2020.

But there was a sliver of light for the optimists in the detailks of the survey.

The BofA said the survey indicated its Bull/Bear indicator was now at “Max bearish”, suggesting a turnaround might be on the cards. “sentiment says stocks/credit rally in coming weeks.”

But BoA’s Michael Hartnett Hartnett said “Any rally is likely to be temporary. The catalyst for a sustained recovery will be a change in monetary policy from the Fed when it sees that Main Street is suffering along with Wall Street.”

“We are still some distance from the kinds of levels on the [US S&P 500 stock index] that would cause policymakers to panic and change course,” he added.