The volatility we’ve seen throughout the markets is being reflected in fund manager sentiment as we’re getting mixed messages involving cash and low conviction levels. It seems the fears of a global recession are starting to fade, however, according to the latest edition of Bank of America Merrill Lynch’s Fund Manager Survey.

Mixed signals on cash, sentiment

Chief Investment Strategist Michael Hartnett said in a report dated April 12 that cash levels climbed from 5.1% to 5.4% this month, according to their latest survey. He said this jump symbolizes the direction in sentiment among the world’s fund managers, although it runs counter to the conviction level, which he said tumbled to its lowest level in 18 months.

Fund managers are concerned about Quantitative Failure as this is the first time they turned Underweight on Japanese equities since December 2012. They’re also worried about a lack of follow-through to the massive short squeeze we saw last month in commodities, resources, and emerging markets.

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Hartnett also said that this is the first time in years that there’s a disconnect between fund manager equity valuation and allocation. He adds that the high cash levels protect against downside risk, although the valuation holds back upside risk. He predicts that risk assets will stay in the trading range.

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Cash levels are “superficially bullish”

The BAML strategist believes the current cash levels are “superficially bullish” right now, adding that cash almost never climbs so much during a risk rally. He said they’ve only recorded nine times this has happened since January 1998. They also saw the seventh highest bond and equity valuation reading in 13 years, which he explains is the best reason for this phenomenon.

Hartnett said they now have a contrarian buy signal for equities according to their FMS Cash Rule. The rule states that an average cash balance higher than 4.5%, triggers a contrarian Buy signal, while a cash balance below 3.5% triggers a contrarian Sell signal.

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Fund managers rotate into Staples, cash

BAML’s survey indicates a strong rotation into Consumer Staples and cash and away from Japan, Consumer Discretionary, Commodities and the Eurozone.

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Fund managers continue to see the most crowded trades as the long U.S. dollar, short emerging markets, and long high quality stocks.

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Global economy views stable

Hartnett said fund managers’ expectations for global growth remain low but are stable and that 82% say a recession is “unlikely” over the next 12 months. He said 10% of fund managers expect the economy to improve this month, which is down slightly from 11% last month.

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Also this month was the second month in a row in which global inflation expectations improved, climbing from 49% last month to 60% in April, which is a nine-month high.

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Most fund managers now believe the U.S. Federal Reserve will hike interest rates two times this year with 54% holding this view compared to last month’s 41%. The shift comes from the expectation of one hike, which fell from 37% last month to 27% this month. The percentage of fund managers expecting three hikes remained stable at 9%.

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