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According to June’s Merrill Lynch Fund Manager Survey, overall stock market conditions are expected to improve this month from the lows of April and May. Merrill Lynch’s SMC (Stock Market Conditions Indicator), the summary measure of the survey, has already risen to 12.3 this month from 9.2 in May, the highest level since March 2002. The improvement, indicated the 282 fund managers surveyed, was due to a “more favorable perception of equity valuations, resilient earnings expectations, and benign monetary conditions.”

Sarah Franks, European equity strategist for Merrill Lynch, says she believes this month’s survey results are indeed a positive story. Fund managers reported that “investors think that stock market conditions have improved–even if it doesn’t necessarily feel like it,” she says. “The primary driver of this change in perception is a change in investors’ valuation assessment. Essentially, investors see value in equities again. Fund managers see that equities are trading at around 4% below fair value. And although this may not sound like much, the last times we recorded undervaluation points this extreme were in April and October of last year–two periods that were, in fact, good times to buy stocks.” Franks says there are some constraints on “unlocking this value.” The first, she says, “is that managers are already fully invested, meaning there’s not a great deal of cash on the sidelines to be put to work in the market. And the second is that, unlike April and October, interest rates are not declining further.”

The most compelling finding from the survey was of a more topical nature, says Franks. When asked what their (the fund managers’) investors would most like companies to do with any free cash flow generated, Franks reports “Forty-three percent said they want companies to clean up their balance sheets through the repayment of debt, and 33% want cash returned to shareholders–either through share buybacks or dividend payments. Only 15% want companies to increase capital expenditures.”