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Merrill Lynch’s reports Emerging Market Equities as 'still attractive'

While fund managers have turned more risk averse in light of global market instability they still believe equities offer value, says a report. According to Merrill Lynch’s Survey of Fund Managers for August emerging markets are more appealing to investors than the rest.

In the broadest snapshot of global institutional investor sentiment since the sharp rises in credit spreads and equity market volatility, a net 11 per cent still regard equities as undervalued. In contrast a net 41 per cent think bonds are overvalued.

Investors, polled at the height of recent volatility, have increased their cash levels one percentage point to 4.4 per cent of their portfolio. They have trimmed their expectations of corporate profits and expect global growth to slow. But what is striking this month is how few investors (7 per cent) think a recession is likely in the next 12 months. The survey suggests that investors have not rushed to reassess the prospects for equities.

“Investors seem to be viewing this turmoil as a potential buying opportunity for equities,” said David Bowers, independent consultant to Merrill Lynch.

"They appear unwilling to turn fundamentally bearish on equities so long as they believe the rest of the world can decouple from a vulnerable US economy”.

Respondents still appear to view wider credit spreads as a problem centred in the US housing market, and believe that emerging markets are relatively appealing.

August’s survey indicates a major shift in favour of global emerging market equities at the expense of US stocks. A net 29 per cent of respondents say that emerging markets offered the best corporate profit outlook of all regional sectors – overtaking the eurozone which has been the favoured region throughout 2007.

Secondly, investors believe quality of earnings in emerging markets, while a concern, is improving at a time that quality of earnings in the US are deteriorating. Thirdly valuations are seen as more attractive. Fewer respondents believe emerging market equities to be the most overvalued. Only a net 8 per cent hold that view while a net 19 per cent see the US as the most overvalued region.

At the global sector level investors still prefer stocks positioned to gain from cyclical trends, despite a more cautious outlook for growth. Globally, the number of surveyed funds overweight technology, for example, has risen by seven percentage points to 33 per cent, from 26 per cent in July. Other cyclical sectors gaining favour include materials, energy and industrials. Meanwhile credit turmoil has hit financials hard. A net 29 per cent of respondents are underweight banks compared with 18 per cent in July.

Europeans share the global sector view despite having reduced their positions in pro-cyclical stocks. “Investors in Europe maintain a pro-cyclical stance, though they have toned down their bet on the cycle,” said Karen Olney, chief European equity strategist at Merrill Lynch. “In the past month they have started to shuffle back into defensives, such as healthcare and food & beverages. This move was overdue, given how extreme the overweights in many of the industrials had become over the past few months.”

Rising counterparty and business-cycle risk

For the second month Merrill Lynch asked asset allocators to rate seven potential risks to financial market stability, scoring each risk in terms of the threat they thought it posed to financial market conditions.

Credit (default) risk was top of the list for the second month running. A net 78 per cent of the panel thought credit presented an “above normal” threat to economic stability up from 72 per cent last month.

However allocators now regard counterparty risk and business cycle risk as growing threats. More than half of respondents (51 per cent) say that counterparty risk is an “above normal” threat to financial stability – double the score in July of 24 per cent. A net 32 per cent of asset allocators see business-cycle risk as elevated, compared with 8 per cent in July. -(Trade Arabia News Service)

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