Today is the monthly Bank of American Merrill Lynch fund manager survey day. I always enjoy this report on the basis that you need to know what other market participants are doing and thinking as an important input for your own analysis and conclusions. John Maynard Keynes got it absolutely correct in 1936 when he wrote in his book "General Theory of Employment Interest and Money" comparing the stock market to a beauty parade in the following manner:
It is not a case of choosing those [faces] that, to the best of one's judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.
Before we even try to think "what average opinion expects the average opinion to be" let's take a look at where average opinion is standing on two important asset classes: emerging market equities and bonds.
A lot has happened since 2001, but we have to go back over twelve years to find a time when survey respondents were this negative about emerging markets as shown in the bottom part of the chart below.
We all know that growth expectations in the emerging markets are coming down but using data published in the Monday 12th August 2013 edition of the Financial Times relating to the major stock markets in each country, there is not only over pessimistic sentiment but also relative value in emerging markets:
- BRIC 4 (Brazil, Russia, India, China) - current year average P/E x10.2, yield 3.6%
- Developed 4 (S&P500 for the U.S., U.K., Germany, Japan) - current year average P/E x15.5, yield 2.6%
I am comfortable being contrarian and building up my emerging markets focused exposure today. It will be volatile and numbers will move around but that is the nature of emerging market investment. Over any reasonable period of time, the rise of the emerging market middle classes (consumption boom) helps drive the relative importance of the emerging markets to global growth. Numbers in the Prudential corporate results yesterday suggested that Asia alone would account for 44% of global growth in the period 2010-30. For the emerging markets overall this figure will be even higher.
I also note in the chart above the strong performance of the emerging markets relative to the rest of the world in 2002-2004 following the aforementioned 2001 sentiment lows.
If we turn to fixed income, we have another asset class that is out-of-favour. As per the blue lines in the chart below, fixed income allocations are at a 28 month low.
I note that bond investors have been more cautious than this at points during 2003, 2004, 2005, 2006, 2007 and 2011 over the last ten years. Investors are negative towards bonds ... but not that negative on a historical basis.
The other difference with the emerging markets is relative value. A 2.7% yield for 10 year U.S. Treasuries, 2.6% for 10 year U.K. gilts and - the still astonishing - 0.73% yield for 10 year Japanese government bonds. We await the views of Mr. Bernanke on tapering and the like (if he does anything it cannot be good for bonds), meanwhile the new Bank of England governor Mark Carney will not tighten policy until inflation breaches 2.5% and, in Japan, Abeconomics is all about trying to drive inflation to 2%. Now these policy aims may not be achieved but the views are there. Bonds do not seem good value.
So ... two big contrarian macro ideas but there is only one I am interested in. Look for opportunities to raise your emerging market exposure but bonds remain unattractive big picture.