Equity markets once again crawl higher giving more pain to the bears, the S&P 500 making new highs as markets continue to climb the wall of worry. The bricks that compose the wall are well documented, from Greece, to rising yields, along with continued concerns as to the strength of the global economy.
Merrill Lynch on Tuesday released its latest sentiment survey from the fund manager community. Despite the S&P 500 continuing to make new highs fund managers are the most underweight US equities relative to the rest of the world than they have been for the past 8 years. According to Merrill fund managers remain in" risk on" mood, but have over the past months kept higher levels of cash than historically is associated with an overly bullish stance. In the past month they have increased cash positions, reduced equity holdings but continue with a higher equity allocation than historically normal. Fund managers remain optimistic on economic growth, the majority still believe the first US interest rise will be September, but more are now starting to feel it could be later in 2015 or possibly 2016. The survey covers managers holding assets of more than $600bn.
The UK economy fell into deflation on Tuesday as the year one year rate in April fell to -0.1%. 10-year UK gilt yields fell on the news, as one would expect. The core inflation rate fell to 0.8% despite the recent recovery in the oil price. Another indication of inflationary pressures is the producer price input index, this index has fallen over 11% year on year for the month of April. The output side of the index falling less than 2%, this may be some indication how companies are continuing to maintain margins.
Central bankers have made much of the fear of deflation, at its core it can encourage hoarding of cash and lack of investment. Why buy something today when you believe you can buy it cheaper tomorrow? Prices fall further to encourage spending as savers continue saving, so the spiral continues. In reality a little deflation may not be such a bad thing, we have seen signs of wage growth and that growth increases in real terms in an economy running on modest deflation. Real yields on risk assets such as property and equities rises, encouraging further investment into those asset classes. A mild deflationary environment should lower bond yields and assuming equities can maintain earnings, the gap between earnings yield and bond yields widens again adding to the attractiveness of equities.