Investors turn bearish on EU equities, BofA-ML survey shows

Investors' bullishness towards equities from the European Union finally buckled under the weight of Brexit, the results of Bank of America-Merrill Lynch’s European fund manager survey for July revealed.

Despite consistent underperformance over the past year, investors had continued to show a preference for European stocks, but all that changed after 23 June, with the world's fund managers moving towards a 4% 'underweight' on Eurozone equities, versus the 26% 'overweight' positioning they had sported in June.

That marked the largest single month drop in positioning ever, BofA ML said.

In parallel, UK stocks remained the least favoured globally, the broker's European quantitative strategy team said in a research report sent to clients on 19 July.

Tactical rallies possible, but nothing more

Such a big drop in sentiment towards EU stocks might unleash 'tactical' rallies, particularly given fund managers' increasing levels of cash on hand, BofA cautioned.

Nevertheless, the survey revealed that investors' expectations for growth and profits had fallen to a three-year low and valuations were nowhere near as compelling as three years ago - making for "an unpleasant combination".

BoA ML also found that 45% of investors were underweight banks, the lowest positioning in four years, and the only contrarian signal in the survey results, althoigh during the height of the eurozone crisis in 2008 60% were 'underweight'.

Sentiment towards Real Estate suffered the most month-on-month, but the bank said positioning was not yet extreme.

On the flip-side, technology saw the largest gain in positioning, although sentiment remained far from stretched levels.

Mutual fund and ETF flows data confirmed the bearishness seen in the fund manager survey, revealing that nearly half of last year’s inflows into European stocks had reversed over the past 23 weeks.

According to global investors, the European risk premium will be the most important driver of asset markets over the next six months.

More EU-exits expected, but very short-term contrarian signal possible

Indeed, recent events may only mark the beginning of the end, as over a third of investors expected another country to leave the EU over the next three years.

However, the collapse in European equity positioning may represent an opportunity - presenting so-called contrarian investors with an 'entry point'.

The last time there was a similar month-on-month collapse in sentiment towards emerging markets stocks was early 2011, during the Arab spring. Yet afterwards an eight-week rally ensued in emerging market stocks.

High global cash levels increase the probability of such a reversal, BofA ML said.

"However, the combination of poor macro conditions and valuations not being stretched suggests this collapse in sentiment will not represent a trough in European equity prices. This is best illustrated by Banks, the sector considered cheapest in Europe. However, valuation perception is far from extreme," strategists Manish Kabra, James Wel and James Barty wrote.

Among some of the survey's other main findings, around 15% of fund managers expected the European economy to weaken over the next 12 months, which waas up sharply from -43% in June.

The survey also found that 39% expected higher inflation over the next 12 months, down from 46% last month, and 33% said monetary policy was too stimulative, a fall from 54% last month.