Monday, December 22, 2008

Signs point to a lighter mood among financial players

A funny thing happened to some of the world's most powerful investors as they stared into the market abyss. They stepped back. And maybe that's a sign that the rest of us can soon step up.

Recently, Merrill Lynch released its monthly survey of global money managers, strategists and economists, and found that their mood about the world's markets and economy remains sour. However - and this shouldn't be understated - it has improved. The implication is that some key individuals, whose opinions drive the investment decisions of the institutional investors that collectively own about three-quarters of global equities, may be about to stop pulling money off the table and start putting some back on.

On almost every front, the survey improved. Views on the global economy, risk aversion, corporate profits and equity valuations all brightened.

Granted, the improvements are from very depressed levels, but hey, you've got to start somewhere - and this is how turnarounds start.

"After the extreme pessimism of the past two months, there is evidence of investors pulling back from the brink," Merrill's global equity strategy team said.

"We have been struck by tentative signs that the
pace of deterioration may be slowing."

Notably, the net percentage of respondents expecting further deterioration in the global economy over the next 12 months sank to 36 per cent, from 45 per cent in November and a miserable 60 per cent in October. And only a net 29 per cent of survey respondents still think central bank interest rates are too high, down from 65 per cent in November. (And this was before the U.S. Federal Reserve's stunning cut to a near-zero federal funds rate this week.)

Taken together, the message is exactly what central bankers have been wanting to hear: Key players in the financial markets believe the aggressive monetary easing is starting to work. And that may finally be putting a bottom under equities.

This isn't the only recent evidence to suggest that the downward spiral may be ending, particularly in the U.S. economy. This week, the Empire State manufacturing index and National Association of Home Builders' Housing Market Index both held essentially steady after months of sliding, a sign that two key components of the U.S. slump - housing and manufacturing - may be starting to stabilize.

If, indeed, institutional money managers are starting to see light at the end of the tunnel, they have in their hands vital fuel for a turnaround in equities. The Merrill survey shows that fund managers are still massively overweight cash and bonds - and they consider bonds grossly overvalued, much more so than a month ago - while they are deeply underweight equities, which they consider severely undervalued.

With their risk views easing and outlook improving, the arguments against returning some of that money to the market are less convincing.

Still, risk assessment remains historically high, and Merrill said fund managers remain fearful that the low valuations of equities may be a "value trap." But at least their views are no longer deteriorating, and that's a critical prerequisite for the market to stabilize before reversing course.

Yes, it's a long walk back out of the wilderness. But the money is there, and, perhaps, the baby steps have begun.

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