BofA-ML fund manager July survey: Trade war biggest tail risk since EU debt crisis

World currencies

A trade war is now seen as the biggest tail risk for markets since the 2012 European debt crisis and that could offer opportunities for contrarian plays, the Bank of America-Merrill Lynch fund manager survey for July found.

An around net 60 percent of the fund managers surveyed considered a trade war the biggest tail risk, the highest conviction rate for a market fear since the European debt crisis in July of 2012, it said in a report on Tuesday.

But the report noted that the magnitude of the fear opened up the possibility of contrarian trades on the outcome.

“We tactically advise contrarian bulls to position for overblown trade war concerns via yield curve steepening, emerging market and EU stock upside, weaker U.S. dollar,” the BofA-ML note said.

It pointed to the extreme tail risk fear surrounding the EU debt crisis in June of 2012, which was followed by a 45 percent rally in shares of EU banks in three months.

Fund manager sentiment also turned more bearish, the report said.

Profit outlook

A net 9 percent of fund mangers surveyed said they thought global profits wouldn’t improve in the next 12 months, down 53 percentage points from January, it said, the lowest level since February of 2016, which the report said signalled that cyclical sectors may underperform defensive sectors.

Indeed, fund managers’ July rotation showed they were selling banks, emerging market and eurozone equities to buy defensive and growth sectors/regions, it said. Allocations to tech, healthcare, staples and U.S. stocks rose, while those to Japan, eurozone, banks and emerging markets fell, it said.

The survey found expectations for faster global growth slumped 12 percentage points to negative  11 percent in July, below the bust threshold and the lowest since February of 2016, when the S&P 500 hit an intraday low of 1810, it said.

A net 33 percent of fund managers surveyed didn’t expect yield curves would steepen over the next year, the lowest level since March 2011, when the U.S. Treasury curve was at its steepest of the post Global Financial Crisis era, it said.

Fund managers said that a U.S. 10-year Treasury yield of 3.60 percent, as the average weighted mid-point of responses, was the “magic number” to push investors to rotate from equities back into bonds, the survey found.

Allocation changes

Fund managers’ cash balances slipped 0.1 percentage point to 4.7 percent, compared with the average of 4.5 percent over the past 10 years, it said, noting that the fund manager survey’s contrarian cash rule is for levels above 4.5 percent to trigger a buy call.

In July, fund mangers increased their U.S. equities allocation by 8 percentage points to 9 percent overweight, the highest since February 2017, it said, noting mangers were net 28 percent underweight in September of last year, it said.

Allocations to eurozone equities dropped 8 percentage points to a net 12 percent overweight, the lowest since December of 2016, it said.

The trade war fears spurred an outflow from emerging market allocations, which fell 23 percentage points to a net 1 percent underweight, down from a net 43 percent overweight in April, it said.