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Fund Managers Cut Cash, Buy Commodities and Emerging Markets

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Global fund managers have become more optimistic about financial markets, especially those that have been out of favor such as commodities, including energy, emerging markets and high-yield debt.

According to the Bank of America Merrill Lynch Fund Manager Survey for March, managers have cut cash levels to 5.1% from 5.6% in February — their highest level in more than 14 years — while increasing allocations to industrials, commodities, energy, materials, emerging markets and high yield. The survey records changes in allocations between mid-February and mid-March.

The high February cash level was an “unambiguous buy signal,” according to the survey, which was released Tuesday. According to the survey’s cash rule, when average cash balance rise above 4.5% a contrarian buy signal is generated for equities. When the cash balance falls below 3.5%, a contrarian sell signal is generated.

Fund managers apparently abided by the rule. Since Feb. 11, when the S&P 500 closed at its lowest level in 10 months, the index is up more than 10% as of the close on Monday. But the rally may not last.

Cash weightings among fund managers remain somewhat high, slightly above the three-year average of 4.8%, while equity weightings are still low – near multiyear lows compared with cash, bonds, commodities and real estate investment trusts, according to the survey. Investors have been underweight U.S. equities for 13 straight months, according to the survey.

“With cash levels now slightly above their three-year average, investors no longer are sending the unambiguous buy signal we saw last month,” said Michael Hartnett, chief investment strategist.

That seems to be the case in the U.S. stock market where trading has been volatile. The survey notes that “risk assets look toppy as buy signals fade.”

Also weighing on stock is “investor fatigue with financial engineering” — buybacks and dividends. In the latest survey, 16% of managers thought the payout ratios were too high — the highest percentage in almost seven years.

REITs recorded their second highest allocation ever among fund managers, and managers are more overweight real estate than in February.

But one of the biggest changes in allocation was in commodities, which experienced a record jump, and prices followed. The broad Reuters/Jefferies CRB Commodities Index rose almost 11% in value, and U.S. West Texas Intermediate crude oil, which hit a 13-year low on Feb. 11, gained 42% since then.

Managers reports that short oil positions, along with short emerging markets and long U.S. dollar, were the most crowded trades.

The iShares Emerging Markets Index (EEM) hit its second lowest low on Feb. 11 and has risen slightly over 2% since then.

Looking more globally, Europe remained the most preferred destination for investments, maybe because the euro is trading at its cheapest level in 13 years; while Japan continued to fall out of favor. Managers’ allocation to Japanese equities fell to a 22-month low.

In the U.S., fund managers expect no more than two rate hikes this year from the Federal Reserve, whose policymakers began a two-day  meeting Tuesday.

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