This week's pounding of the euro by worried investors decamping for the strengthening US dollar (and abandoning gold and other commodities) shouldn't come as much of a surprise as we look into 2012.

Europe, the eurozone and the euro will be the big themes next year, just as they were for the last half of 2011 and the middle months of 2010.

And the issues were have seen in recent weeks, fiscal stability, the search for a "Big Bazooka" to defend the likes of Italy and Spain, and that running sore, Greece, won't go away over the break.

This justifiable pre-occupation with the eurozone and the currency showed up in the December survey of big global and regional fund managers by Merrill Lynch/Bank of America Securities.

In it, nearly half of all institutional money managers now fear a partial break-up of the eurozone, and nearly 75% predict that America's credit rating will be downgraded still further by ratings agencies.

The survey polled 190 major institutional investors with about $US600 billion under management and a further 137 managers managing US$332 billion, participated in the regional surveys.

It was conducted from December 2 to 8, so it ended just before the latest questionable deal from the latest EU summit in Brussels last Friday which now seems to be slowly falling apart.

Some 44% of fund managers say they expect at least one country to leave the 17-member eurozone and a third believe that will happen by the end of next year.

But offsetting that, nearly half of the panel (48%) believes that no member state will exit the euro in 2012 or the foreseeable future.

But in total, 45% expect a member to depart in the foreseeable future, with 7% undecided.

On the further downgrading of US sovereign debt, 48% of mangers predict it will happen as early as next year.

Rating agency Standard & Poor's downgraded US debt for the first time in August.

The gloom in the survey wasn't just about Western government finances either.

Big fund managers say the big picture (macroeconomic) economic outlook remained bearish.

Fewer than one third of respondents to the survey predicted stronger global growth in 2012, while liquidity conditions were rated as the worst since April 2009.

Inflationary expectations also fell to their lowest levels since March 2009, suggesting that the prospect of deflation may be weighing on investors' minds.

BofA warned in commentary that, "key indicators of market sentiment... show parallels with the credit crunch months of early 2009".

A large balance of money managers expect the global economy to weaken and for earnings to fall over the next year, and nearly all of them expect the Chinese economy to continue to slow.

Right now money managers are holding a lot of cash - an average balance of 4.9% of their assets.

Cash balances are typically high before a rally: they were also high in 2008-9 and in 2002-3.

But that could be wishful thinking by some commentators who see this as a bull point and ignore the real reason for many managers being overweight cash: they remain fearful about the eurozone and the great unknown of what happens if the euro collapses.

As a result, investors say they are heavily underweight bank stocks and European equities.

And Japanese and British stocks are also out of favour.

Low-yielding bonds are also unpopular, even though inflation fears have eased.

Investors are gearing for below-trend growth and inflation in 2012 by moving into US equities, even though there are those fears about a credit rating downgrade and concerns about the strength of the economy

A net 50% say the outlook for US profits is most favorable (up from 47% last month), while 72% say the euro region has the least favourable outlook.

(This is as more and more companies warn or downgrade their sales and profit outlooks for either the 4th quarter or early 2012.)

They also see the dollar firming and euro weakening in 2012 (which is happening now in a rather big way).

Within sectors, investors are pushing into pharmaceuticals and staples (food and retailing) and reducing exposure to technology, industrials and discretionary.

The survey reveals that some managers dipped into cash reserves to make an end-of-year move into equities with the US their preferred destination.

A net 8% of asset allocators are overweight equities this month, compared with a net 5% underweight in November, but that was due to one region, the US.

"With improving growth prospects, U.S. equities are seen as a popular destination and a refuge from turmoil," said Michael Hartnett, chief Global Equity strategist at BofA Merrill Lynch Global Research.

"Investors are slightly more optimistic about equities but retain a defensive approach, so that means reduced European exposure and a preference for counter-cyclical stocks," said Gary Baker, head of European Equities strategy at BofA Merrill Lynch Global Research.

On liquidity the survey's results were very interesting as we head into 2012.

They help to explain why the move by the European Central Bank to lend money up to three years to the eurozone's banks was such a welcome move.

That's also why the move by the six major central banks to boost US dollar liquidity in the eurozone was also very welcome.

"Key indicators of market sentiment in the Survey of Fund Managers show parallels with the credit crunch months of early 2009," the survey report said.

"Investors say that liquidity conditions have deteriorated significantly in the past month to reach their worst level since April 2009.

"A net 13 percent of the panel rates conditions (such as depth of market and breadth of bid-offer spreads) as negative.

"In October, a net 4 percent described conditions as positive, and at the beginning of 2011, more than a net 50 percent of respondents were describing market conditions as positive.

"Liquidity still has some way to deteriorate before reaching the nadir of the credit crunch when more than a net 60 percent described conditions as negative," it concluded.

And concerns about inflation have fallen to levels not seen since 2009, which is a natural outcome if you think of it, regarding the growing fears about liquidity and slowing growth or recession in 2012.

"The proportion of the panel predicting a fall in inflation fell to a net 34 percent in December, down 2 percentage points since November and the lowest reading since March 2009.

"For the first time since March 2009, a majority (a net 6 percent) believes that global monetary policy should be more stimulative. At the depth of the crisis more than a net 60 percent called for monetary stimulus," the survey report said.

And to check on what the survey said a year ago, as we headed into 2011, here are some excerpts from the December report:

"U.S. equities are the primary beneficiary of the continuing upswing in global investor sentiment, according to the BofA Merrill Lynch Survey of Fund Managers for December (2010).

"A net 44 percent of the respondents predict the world's economy to strengthen in 2011, compared to 35 percent a month earlier. A net 51 percent anticipate corporate profits improving next year, up from 36 percent in November.

"At the same time, more investors believe that inflation is likely to rise with a net 61 percent of the panel forecasting higher core inflation in 2011.

"With Europe's sovereign debt crisis continuing, investors are turning to U.S. equities. A net 16 percent of asset allocators are overweight U.S. stocks up from a net 1 percent in November.

"A net 4 percent are underweight eurozone equities, compared with a net 15 percent overweight in November. Bullishness towards the U.S. dollar is evident with a sharp increase in the number of investors forecasting dollar appreciation.

"A net 36 percent expect the dollar to make gains in 2011, up from a net 14 percent in November. In the U.S. regional survey, the net percentage of U.S. investors expecting double-digit profit growth has doubled month-on-month to 40 percent.

"Despite rising confidence in global growth, the survey shows that Europe is losing investor support as political procrastination and banking concerns overshadow a strong corporate outlook," said Gary Baker, head of European Equities strategy at BofA Merrill Lynch Global Research.

"The pending new tax deal in the U.S., combined with QE2, has restored confidence in the prospects of U.S. companies, at a time that Europe is out of favor and investors are questioning Chinese growth prospects," said Michael Hartnett, chief Global Equity strategist at BofA Merrill Lynch Global Research."

The upshot is there was a guarded belief in Europe among big fund managers that was undermined as the year went on.

They also were too confident about US markets, despite improved profits from most sectors.

Wall Street is now less than it was when the year started.

US interest rates are lower as investor have climbed into bonds as a form of protection (and Australian bond yields are lower, by the way).

And the big investors were also spot on with their doubts about China's slowing, but it is not the huge problem many fund managers believed it to be.

Copyright Australasian Investment Review.
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