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Investors' high hopes dashed by economic realities

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2024-02-16

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The day before the US January consumer inflation figures forced investors to face up to the reality of higher rates from the Fed for longer, the February survey of global fund managers from Bank of America painted an upbeat outlook from investors.

In fact, they were the most upbeat for two years. It’s a pity a second survey can’t be taken after the slower than forecast fall in US consumer inflation and a rise in core inflation for January.

The data saw markets tank in some of the biggest falls seen for 11 months as investors were forced to reassess their overly optimistic belief the Fed will start cutting rates in May (it was a March start in January).

And even though there will no doubt be a recovery in confidence that the Fed will cut sooner than it thinks, don’t bank on it.

But the sell-off lasted a session and the boomlet recovered itself, and markets rebounded strongly on Thursday, especially Wall Street.

So the optimism about the outlook continues, even for the global economy (the survey was done before we learned that the UK and Japanese economies fell into a small recession in the closing six months of 2023).

The survey indicated that for the first time since April 2022, a recession is not the anticipated outcome for the global economy. Two-thirds of investors are expecting a "soft landing," while only one-tenth foresee a "hard landing."

Investors' optimism appears to be fueled by expectations of lower interest rates, with only 4% of respondents predicting higher short-term rates and just 7% expecting an increase in inflation.

85% of managers in the survey believe that the yield curve will steepen, and a record 46% claim to think current fiscal policies to be excessively stimulative (and yet they are running down cash holdings).

Fund managers' average cash level was 4.2% in the survey, down from 4.8% in January.

Bank of America noted that a greater than 50 basis point drop in cash allocations has typically been followed by an average 4% return for equities in the next three months.

The survey also highlighted prevailing market trends, noting that the "long Magnificent 7" trade has become the most crowded since the "long US dollar" trade in October 2022 (61% of respondents).

As well being "short China stocks" is the second most crowded trade (31%), with one-quarter of respondents advocating for a structural underweight position in Chinese shares.

Managers have their global equity allocation at a two-year high, with the allocation to US stocks reaching levels not seen since November 2021.

Investments in the technology sector have surged to the highest point since August 2020, thanks to the growth in AI related stocks and the huge surge in shares of Nvidia and fellow travelers.

And managers are now favoring growth stocks over value stocks at the highest level since the early days of the great Covid rebound in May 2020.

Naturally, with optimism high, fund managers have not only dropped their cash holdings but also investments in commodities, emerging markets, defensive stocks, and energy stocks, with the latter at its lowest allocation since December 2020.

When it comes to the US market, 41% of investors favor "large cap growth," followed by 18% for "small cap growth."

In fact, allocation to US equities rose 7 percentage points month-on-month to a net 21% overweight, the highest level since November 2021, according to BofA.

AI and chip companies have seen global fund managers raise their allocation to technology by 10 percentage points from January to a net 36% overweight, one of the highest levels since August 2020.

Tech has become the top overweight sector, a position it has not held since July 2021, replacing healthcare, which held the top spot between March 2022 and January 2024.

At the same time, allocation to bonds also increased, up 3 ppt from January to a net 6% overweight, with investors overweight bonds for 11 of the last 12 months.

And finally, for all the moves by investors, Nvidia’s December and 2023 figures next week will be the big influence on markets for at least a quarter, perhaps more if there are bullish signs from the figures.

Nvidia’s influence at the moment is potentially larger than the Fed and the prospect of a rate cut.

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