Global fund managers edged closer to "extreme bearishness" this month, according to Bank of America Merrill Lynch's benchmark survey, and are looking for companies to focus on balance sheet improvements over shareholder returns for the first time in a decade as markets turn lower into 2019.
Fund managers are piling cash into both government bonds and the U.S. dollar, the December BAML survey of 243 investors controlling around $700 billion in assets revealed, and are the most bearish on the global economy since the global financial crisis, with a net 53% expecting a 2019 slowdown. However, even with market poised for a "big bottom" in 2019, a Federal Reserve rate decision that signals a pause in tightening could trigger a near-term bounce heading into the final trading days of the year.
"Investors are close to extreme bearishness," said BAML chief investment strategist Michael Hartnett. "All eyes are on the Fed this week, and a dovish message could equal a bear market bounce."
Bond allocation, the survey noted, hit the highest levels since the 2016 Brexit vote, at a net 35% underweight, with the fastest month-on-month rotation (+23 percentage points) on record. Investors were also adding to cash balances, suggesting further equity market caution, with overall levels rising to 4.8% from 4.7% in the previous month.
Investors also favored U.S. dollar allocations over pretty much everything else, the survey suggested, with "long USD" overtaking "long FAANG+BAT" as the market's most crowded trade for the first time in nearly a year.
Global equity allocation fell 15 percentage points this month to a net overweight of 16%, the lowest in two years, with investors taking U.S. equity holdings to a net overweight of 6% (down 8 percentage points) and clipping exposure to European stocks to net underweight for the first time in two years.
The change of heart -- from equities to fixed income and cash -- reflects broader concerns over corporate balance sheets, the survey suggested, with a record high 46% deeming them to be overleveraged and a net 57% thinking profit margins will deteriorate in 2019.
"The most preferred use of corporate cash flow amongst [Fund manager survey] investors is improving balance sheets (46%, highest since 2009), followed by increasing capex (34%, lowest since 2012) and returning cash to shareholders (13%)," the survey noted.
That concern echoes a warning earlier this week from the Bank for International Settlements, an umbrella group for global central banks, which cautioned that the "bulge of BBB corporate debt, just above junk status, hovers like a dark cloud over investors."
"Should this debt be downgraded if and when the economy weakened, it is bound to put substantial pressure on a market that is already quite illiquid and, in the process, to generate broader waves," the BIS's head of monetary and economic development, Claudio Borio, warned Sunday.
Trade war risks topped the survey's key concern for a seventh straight month, BAML said, followed by worries of a faster reduction of either the Fed's $4 trillion balance sheet or the €2.6 trillion in bonds held by the European Central Bank (18%) and slowing economic growth in China (16%).