The Bank of America-Merrill Lynch (BoA-ML) November survey of fund managers has thrown up what may be another inflection point in the markets. According to the survey, more and more fund managers are now saying that companies should start spending on capital expenditure rather than use cash flow to repair balance sheets.
In response to the question: “What would you like to see companies doing with their cash flow?” says the survey, “‘Improve balance sheets’ remains top choice but fell to 36% (down from 50% in September) and is quickly approaching the level of those nominating ‘increased capital spending’ (32% up from 26% last month).” The last time this happened was in October 2003, which led to the long boom of 2003-07. Conversely, in January 2008, the number of respondents wanting companies to conserve cash outweighed those who wanted increased capital spending.
That switch in stance is very plausible, since companies have already been able to raise large amounts from the primary market in the last few months and have presumably already repaired their balance sheets. But with capacity utilization still low and a lot of uncertainty whether demand will continue to be strong even after the stimulus programmes have been withdrawn, expanding capital expenditure is likely to be still some way ahead, particularly in the developed world. Comparing the current downturn with the last one may not be the right thing to do, given the pricking of the consumer debt bubble in the West. Nevertheless, the point that while repairing balance sheets lowers risk for bondholders while adding capex leads to more gearing and hence transfers risk from equity to bond holders is important—signs of increasing capex should therefore be seen as buy signals for stocks.
The survey showed a continuation of recent trends, with the BoA-ML Risk Appetite index very high at 44 (this stood at 40 in September).
Cash positions are low. A net 53% of investors are overweight emerging markets—during the July survey, when a net 54% of investors were overweight on emerging markets, Merrill Lynch had warned that such a high reading posed a risk to emerging market equities. But emerging market stocks have marched on to new heights since then.
Moreover, the survey says investors favour the high-beta (more volatile) markets of Russia and China over the more sedate ones, again an indication of the strength of risk appetite.
What could derail the rally? A reversal of the weakness in the US dollar.
Investors now view the US dollar as the most undervalued currency. A net 36% of investors now view the US dollar as undervalued, compared with just 1% in September.
But that, says BoA-ML, “still remains some way above the -50 level which coincided with the last significant rally in the USD”. Which means the rally in non-dollar assets still has some way to run.
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