Fund managers’ inflation fears ease

Inflation fears among the fund managers fell to seven-year low as the oil prices began easing from record highs and major global economies inch towards recession, according to Merrill Lynch’s Survey of Fund Managers for August.

The survey captures an extraordinary reversal in investors’ attitude towards inflation. A net 18 per cent of the 193 respondents expect global core inflation to fall in the coming 12 months.

In June’s financial survey, a net 33 per cent thought inflation would rise. A falling oil price and growing evidence of recession have prompted this rethink.

More investors believe that the global economy has already entered recession – 24 per cent of the panel take that view this month compared with 20 per cent in July and 16 per cent in June.

During the credit boom, investors urged companies to borrow more, but, with the credit crunch biting, they are now concerned about leverage. The net percentage of investors who believe corporates are under leveraged has tumbled to nine per cent, down from nearly 40 per cent at the end of 2007.

“The message from investors to corporates is that if we are headed for a recession, they should clean up their balance sheets and prepare a financial buffer,” said Karen Olney, chief European equities strategist at Merrill Lynch. “As banks de-lever, non financial corporates will have to wake up to far less flexible world of credit.”

With the economic downturn spreading to the eurozone, investors are starting to view US assets as attractive. The net balance of asset allocators overweight US equities stands at 12 per cent, its highest level in more than six years. Supporting this view is the widely-held belief that the US dollar is undervalued.

A record net 58 per cent said the dollar is undervalued, while a net 71 per cent say the euro is overvalued. Investors believe that the United States has a better corporate profit outlook and higher quality earnings than the eurozone.

Inflation fears among the European panel have fallen to levels even lower than in the Global Survey. A net 45 per cent of European fund managers expect the region’s core inflation to fall over the next 12 months.

In June, 32 per cent of the European panel were predicting rising inflation.

“The market appears to have overreacted to a fall in the oil price, and investors have turned a blind eye to second round effects of inflation, such as rising ”

One consequence of the  fall in the oil price has been a rapid unwinding of what the survey has highlighted as a highly-crowded trade: Investors have reduced ‘long’ or overweight positions in energy and started closing underweight positions in financials.