Global fund managers are more fearful and risk averse than at any time since the September 11th bombings of 2001. That's the main finding from the latest Merrill Lynch monthly survey of fund managers.
Instead of using the recent stock market plunges to bargain hunt, managers are hoarding money. Forty-one per cent say they are overweight on cash, a dramatic increase from the December reading of 26 per cent and the highest level in seven years.
Thirty per cent have hedged against further falls over the next three months. Just 43 per cent now believe that a global recession is unlikely, down from 73 per cent in December.
The number of managers who believe that a global recession has already begun, while still a minority (16 per cent), has quadrupled in the last two months alone.
Over two-thirds expect corporate profits to deteriorate in 2008.
Institutional investors are particularly wary of European equities, with just 7 per cent of asset allocators overweight on euro-zone shares. Europe has been an institutional favourite over the last four years. Optimism peaked last May, when an astonishing 56 per cent of managers said they were overweight on European equities, a mood Merrill described at the time as "EU-phoria". The outlook today is different and managers are utterly unconvinced by the integrity of current earnings estimates.
"Investors are sending a clear signal that they expect a raft of downgrades to consensus earnings forecasts - 96 per cent of respondents say these forecasts are too high", according to Karen Olney, chief European equities strategist at Merrill Lynch.
Although the ECB has not followed the aggressive rate-cutting example of the US Federal Reserve, stressing instead the need to keep inflation in check, "investors are asking for rate cuts, worried not by inflation, but by a potential collapse in growth," Olney said.
The pessimism is far from confined to Europe. US corporate profits are likely to fall over the following 12 months, growth in China is expected to slow and emerging markets are seen as particularly overvalued. Japan was regarded as very undervalued.
Unlike polls of retail investors, the Merrill survey is not regarded as a "dumb money" indicator. After all, this group of 190 managers controls $587 billion in assets, so their views cannot be dismissed.
Nevertheless, contrarian investors might take some comfort from past surveys that recorded extreme levels of optimism or pessimism.
Certainly, last May's "EU-phoria" among fund managers ("enthusiasm towards euro-zone equities has reached a new level", Merrill said then) was misplaced, almost perfectly capturing the top for European markets.
Furthermore, the most recent data was accompanied by a statement that "investors have a shorter-term focus than at any time since March 2003". Uncertainty regarding the invasion of Iraq was gripping investors at that time but equities went on to race ahead for the remainder of the year, triggering a bull market that lasted until recently.
Whether the current pessimism turns out to be another successful contrarian signal remains to be seen. There's no doubt what issue is uppermost in the minds of fund managers - the ongoing turmoil in the credit markets. The February data reveals most respondents believe equities are, in fact, undervalued at the moment. Holding them back, however, is a concern regarding the impact the credit crunch will have on corporate activity.
"Risk aversion is so extreme and cash levels are so high, that the challenge is now to identify the catalyst that prompts money to return to the stock market," said David Bowers, a consultant to Merrill Lynch.
