Goldilocks, chased out by the bears two years ago, is back in town. The global boom of 2004-07 was frequently described as a Goldilocks economy, neither too hot nor too cold, thereby allowing a loose monetary policy that was good for the markets. Bank of America Merrill Lynch’s September survey of fund managers shows that investors believe Goldilocks is back, with 72% of investors saying we’re headed for below-trend growth and inflation. That will allow central banks and governments to postpone exits from their stimulus packages, keeping liquidity abundant and asset prices high. The performance of the markets echoes that belief, with the Sensex up 8.2% in the past month.
Merrill Lynch’s Risk and Liquidity indicator stood at 40 during the September survey, a notch below last month’s level. That accounted for the rise in cash balances with fund managers from 3.5% to 4.1%. But the survey was held between 4 and 10 September and the rise in the markets since then indicates some of that cash is being put to work. Consolidation was also seen from the overweight on equities falling back to a net 27% of investors from a high 34% in August. Investors’ overweight position on global emerging markets fell to 40% from 52% a month ago.
What do the survey results tell us about the future? Recall that Merrill Lynch had warned during the July survey, when a net 54% of investors were overweight emerging markets (EM), that such a high reading posed a risk to emerging market equities. Well, the markets didn’t do much in August. But now that the EM overweight is down to a net 40%, that should be cause for comfort since it leaves room for an upside. That also holds true for the reduced overweight on equities as well as the higher cash levels.
True, the survey points out that one of the reasons for the reduced overweight on emerging markets may be the increased weight to Europe, and it says the outperformance of EM equities has been considerably reduced. But cash inflows into risky assets are being fed by outflows out of US money market funds, into which money had retreated during the panic. Fund tracker EPFR Global points out that during the week ending 9 September, money market funds surrendered another $14.9 billion (Rs72,116 crore). The Merrill survey’s finding that fund managers have taken a new liking for Europe is also seen from the EPFR numbers, which show that flows to Europe equity funds hit a five-week high.
The August survey had warned that, because optimism about a global recovery is so high, any weakness in news flow and data could lead to sell-offs in the market. But Merrill Lynch’s advice was to buy on these dips as it would help investors position themselves for the eventual recovery. That advice has worked very well.
How long will Goldilocks stay this time? Most policymakers, as well as the International Monetary Fund, have been at pains to emphasize that the current recovery is a weak one. The scare of Chinese lending coming to a sudden stop seems to have been overblown. Pimco boss and bond market guru Bill Gross is warning of several years of subdued growth, because of the weakness in US consumption.
Even Reserve Bank of India governor D. Subbarao has said he will start tightening only when he is sure that the “recovery is secure.” According to Morgan Stanley’s Joachim Fels, “Policymakers are likely to keep accommodation in place until they can be reasonably sure that the recovery can stand on its own feet. We think that the latter will only become apparent from about the middle of next year, and in many cases only in 2011.”
Tepid real growth and loose monetary policy is a heady brew for asset markets.
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