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Economic recovery on track despite bond market sell-off

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The upturn in global investor sentiment has withstood the recent large sell-off in bonds, according to a survey of fund managers by Merrill Lynch.

Investors have expressed confidence in global economic recovery and, broadly, in the equity markets, in spite of their fears the sell-off would damage sentiment. The yield on ten-year US treasuries rose to 3.85 per cent from 3.09 per cent between the May and June surveys.
 
A net 62 per cent of respondents believe that the world economy will improve in the next 12 months, an increase of five percentage points since May. For the first time since December 2007 the majority of asset allocators responding to the survey are overweight equities – a net nine per cent are overweight the asset class. Just seven per cent of the panel believes that the world will go through recession in the coming year, down sharply from 38 per cent in May and 70 per cent in April.
 
‘Investors are currently ruling out the prospect of the much-feared double-dip recession, and have shrugged off the weakness in bonds,’ says Michael Hartnett, Banc of America Securities-Merrill Lynch chief global equity strategist.
 
Investors are rewriting the rules for positioning their portfolios at the start of a new investment cycle. Rather than focus on moving from defensive to early cyclical stocks, such as consumer discretionary, they are basing their strategy around optimism over Chinese growth and emerging markets performance.
 
A net 62 per cent of respondents say that China’s economy will improve in the next 12 months – up one per cent and a new all-time high following the record reading of 61 per cent in May. Recognising the need to feed China’s appetite, investors are turning to commodities as their asset class of choice. A net 19 per cent of asset allocators are overweight commodities, up from seven per cent in May.
 
Reflecting this trend, energy is the sector attracting the biggest positive sectoral swing in allocations this month. A net 30 per cent of the panel is overweight energy stocks, up from a net 18 per cent in May and eight per cent in April. Global emerging markets (GEM) remains by far the most popular destination globally for equity allocations. A net 37 per cent of the panel picked out GEM as their preferred region to overweight, well ahead of the US, the second-favorite location.
 
However there are small signs that the euphoria surrounding emerging markets might have peaked. The figure of 37 per cent was down on May’s number of 40 per cent. Furthermore, a net ten per cent of the panel identified GEM as overvalued.
 
Global optimism has not spread everywhere, however. European respondents do not see an end to recession with 70 per cent of the regional panel predicting a further downturn in the next 12 months. Global investors view Europe as their least preferred destination, with a net 23 per cent picking the eurozone as the region they would most like to underweight.
 
The number of investors overweight cash has fallen to a net 12 per cent in June from a net 20 per cent in May. Belief in corporate profitability is growing. A net 49 per cent of respondents believe that the outlook for corporate profits will improve over the coming year. As recently as April, a net 12 per cent said the outlook would deteriorate.
 
The return of inflation, a possible cause of the bond market sell-off, is something the panel has recognised. A net 19 per cent of global investors believe that inflation will be higher in 12 months’ time, compared with only one per cent predicting lower inflation a month ago. A net 20 per cent of the panel believed that monetary policy across the globe is too stimulative.

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