Inflation no longer investors' bogeyman

Global institutional investors' view of inflation is undergoing a sea change. Two months ago, almost three in five managers thought inflation would rise over the next 12 months. Now, fewer than one in three feel that way, according to the latest monthly survey by Merrill Lynch & Co. Inc.

Now, more believe inflation will decline over the next year than think it will increase, and the overall level of concern about inflation is the lowest it has been since the downturn of late 2001.

While fewer and fewer global fund managers are fretting about inflation or stagflation, thanks in part to a falling oil price and a weakening global economy, the survey shows that more are concerned about recession. Forty-eight per cent of the respondents now believe a global recession is either likely or very likely over the next 12 months, up from 41 per cent in July and 34 per cent in June. Moreover, almost one in four think the recession is already here.

Investors have also been reading interest rates differently, with less than half of respondents expecting long-term interest rates to be higher within the next year, down from 80 per cent two months ago. The majority also believe short-term rates will be steady or lower in a year, the reverse of two months ago.

Despite the change in their views of inflation and interest rates, investors still tend to regard global stocks as undervalued, the survey found, though they have become more favourably inclined towards fixed income. The bulk of the respondents still regard bonds as either overvalued or fairly valued.

There have been other big changes as well. "With the economic slowdown now spreading to regions that had been assumed to be immune - such as the euro zone - U.S. assets are starting to look relatively attractive to institutional investors," said Karen Olney, chief European equities strategist at Merrill.

"The net balance of asset allocators overweight U.S. equities now stands at its highest level in more than six years, supported by a widely held belief that the U.S. dollar is undervalued," she added.

What is seen as a better outlook for corporate profits and an improving quality of earnings in the U.S. compared to the euro zone also factors into that view. The United States is listed as the area the global fund managers most want to overweight over the next 12 months and the euro zone as the region they would most like to underweight, while the emerging markets are becoming considerably less popular.

A total of 193 institutional investors managing $611-billion (U.S.) in assets participated in the survey, conducted between Aug. 1 and 7. Another 161 handling $432-billion in assets responded to regional surveys.

The fund managers are also less likely to be overweight energy than they were previously, given that the price of crude has tumbled from more than $147 a barrel to $116. But Merrill wonders if the managers have lost sight of the fundamentals in beginning to unwind those long energy positions as it sees crude averaging $119 a barrel in the fourth quarter.*****

What they say

How likely do you think it is that the global economy will experience recession (two quarters of negative real

GDP growth) over the next 12 months?

In 12 months' time, will global core inflation be...

On a 12-month view, which region would you most like to overweight/underweight?

Most like to overweight

Most like to underweight

Net

SOURCE: MERRILL LYNCH