US investors show signs of capitulation

Citigroup and Merrill Lynch report investors are throwing in the towel on US equities, marking a psychological turning point.

The buzzword from big American fund houses these days is "capitulation", as in US investors are giving up faith in equities. More capitulation is good news, because it means that the bear market is closer to the end than the beginning, say Citigroup Asset Management and Merrill Lynch executives.

Last week, Merrill Lynch examined the results of its monthly poll of 298 fund managers and analysts responsible for $702 billion of assets under management. David Bowers, chief global investment strategist, says, "The optimism overhang has been eliminated."

He notes fund managers' profit expectations, instead of continuing in freefall, have stabilized, with 48% now expecting some sort of economic rebound in the next 12 months. Moreover, the US has gone from having the worst corporate outlook to having one better than Europe or Japan (which has hit the skids), although Asia remains more attractive by far.

This is the first survey taken since August 14 when American CEOs had to personally affirm the quality of their SEC filings, and the stable outlook indicates fund managers believe the quality of statements has been verified. Nonetheless, more than half the respondents agree the US market is the most expensive - but asset allocaters are already underweight, and may move to neutral in the coming months.

As far as capitulation goes, it is a mixed field. Asset allocaters remained too bullish in the spring but have gone underweight. But individual fund managers still think equities will go higher and a quarter expect double-digit returns. "This is worrying," Bowers says, because it means a lot of managers have yet to face reality.

In short, Bowers says the US is exiting the bear market but will remain a short-term trading market for some time.

This view is echoed by top US portfolio managers at Citigroup, who see active capitulation among clients. "It doesn't guarantee a rally but it means we're much further along the bear market," says Richard Freeman, managing director and manager for multi-cap growth portfolios in New York.

His colleague Hersh Cohen, managing director and manager for large-cap growth portfolios, says low interest rates, low inflation and the fallout from Nasdaq's bubble and accounting scandals are hallmarks of a closing bear market, not the start of one.

Citi managers add investors are now shorting the market only because they see it going down, the mirror image of those who bought it in the late 1990s simply because it was going up.

Peter Bourbeau, investment strategist for Citi in Hong Kong, says the firm believes the US market is in for a time of slow growth, as occurred from 1974 to 1982, when the market posted modest gains. He says Citigroup expects active managers should achieve 10%-12% returns over the next decade.

Bowers at Merrill Lynch says cash levels are beginning to strengthen, a positive sign because that indicates redemptions are slowing down, but they are rising from a dangerously low base.

Citi seems to agree. Bourbeau says while Citi portfolio managers tend to keep cash levels of 4%-6% right now, the overall US fund management scene still has too-low cash levels to take advantage of any upside, due to continuing redemptions. He says most retail mutual fund managers have only 2% cash, and discretionary portfolios only 3%-4%. "That's the dark cloud," he says.

Share our publication on social media
Share our publication on social media