By The Editors of Wealth Management Exchange

The leading investment managers across all major asset classes believe the economy and markets are improving and that there is, generally speaking, more optimism and reason take on more risk.

"Managers are back on the offensive, as equities are in favor and defensive classes and sectors are seen as less promising. But context is key. While the majority of managers see short-term gains as likely, the longer term picture remains much more uncertain. And even if most managers expect recovery, they also expect plenty of bumps along the way," according to Russell Investments Quarterly Investment Manager Outlook (IMO).

What's important to take into consideration is much of the data is comparative and should be seen in the context of how managers reacted to the March IMO. Then, investment managers were much more cautious and generally did not believe that the markets had hit bottom.

In this June survey, investment managers were bullish on almost every asset class. Six of 13 asset classes and eight of 12 sectors ranked first or second all-time IMO highs. Only cash and Treasuries were less bullish.

"Between these last two IMOs, the risk switch seems to have gone from full off to full on, with no in-between. With few exceptions, managers seem to have made a strong rotation from defense to offense since then. Cash, U.S. Treasuries and the healthcare sector—traditionally defensive strategies—all were seen as significantly less bullish by surveyed managers than three months ago. In their place, managers turned to high yield and corporate bonds and equities of nearly every style and sector. They indicated that they liked it all," says Mark Eibel, Director, Investment Management and Research— Client Investment Strategies, and author of the report.

The following asset classes and sectors recorded IMO all-time high or second-highest all-time levels for bullishness.

ALL TIME HIGHS

  • High yield bonds
  • Emerging market equities
  • Small cap growth
  • Other energy
  • Integrated oils
  • Materials & processing
  • Autos and transportation

SECOND HIGHEST ALL TIME STATUS

  • Corporate bonds
  • Small cap value
  • Large cap value
  • Technology
  • Financial services
  • Consumer discretionary & services
  • Producer durables

(Source: Russell Investments, Investment Manager Outlook, June 2009)

High Yield Bonds Soar

Russell respondents clearly point to improvements in the credit market over the last 11 months. From the second quarter of 2008 to the first quarter of 2009, the bullish score of high yield bonds nearly doubled, from 32% to 61%. There was bullishness this quarter as well but only to the tune of 5 percentage points, to 66%. "Managers were bullish on corporate bonds and high yield and have been rewarded for that stance so far this quarter. They still like high yield and corporate bonds in a big way. But their "six months to a year" response and the leveling off of the bullishness trend shows that almost no one believes the credit markets are fully out of the woods," notes the IMO.

Equity Markets and Sectors

Russell asked investments managers: Which of these general valuation conditions best describes the current U.S. equity market?

  • Thirty-eight percent of managers believe U.S. equity markets to be undervalued. That represents a significant decline from last quarter's 57%, which declined from the previous quarter's all-time high of 72%.
  • There was an increase in those who believe the U.S. equity markets are fairly valued (from 33% to 44%). Also, those believing markets are overvalued increased from 11% to 18%.

Russell believes these drops of the undervalued statistic happened for two reasons: The first drop, from December 2008 to March 2009, was because managers assumed the market could still go down. The most recent drop, from the March 2009 IMO to its current state, is because the market has gone up, which validates how undervalued it probably was.

"We expect the markets to bounce around all summer. We believe there is still room for the market to continue moving in a positive direction. The so-called optimistic managers who responded to the survey are not convinced the recovery is real." They're expecting months of volatility as investors test out the market to find out if we've reached the real bottom or not.

Investment managers were generally bullish on equities, with the exception of midcap and large cap growth, where bullishness trended slightly downward, but still remained above 50%. "In a long-term trend reversal, small cap growth moved up seven percentage points and passed large cap growth. And small cap value increased by one of the largest margins of all asset classes—15 percentage points. Midcap and large cap value followed this lead, as they increased by 10 and eight percentage points, respectively," noted the IMO.

Here are some highlights on sector trends:

  • Bullishness for the materials and processing sector nearly doubled, from 33% to 60%. According to Russell analysts, the reason is that managers see the economy as improving to a sustainable level. Simply put, in an expanding economy, people need materials.
  • The energy sectors also rose in manager bullishness. "While this may be partially due to a weakening dollar, it also reflects an overall sentiment that our economy is likely to get better and create a higher and longer term demand for energy."
  • The financial sector is making a comeback. Bullishness on financial services increased from the last IMO's 30% to this quarter's 52%, moving it from 8th place to 5th place. Russell analysts believe managers are confident banks are no longer at risk of going bankrupt.
  • Emerging markets. 74% bullish. Russell believes this high ranking is partially due to a resurgence in commodities prices, a weaker dollar and partially because China's fiscal recovery efforts are working.
  • Healthcare. 44% bullish, a drop of more than seven percentage points. Russell believes bearishness increased because healthcare is traditionally a defensive play. Many managers have moved toward an "offensive direction."
  • Technology. According to the IMO, the bullishness—75% in this IMO—is because tech is one of the major sectors where the U.S. is seen as having a competitive global advantage.

Conclusion

The Russell Report quoted Richard Rosen, senior portfolio manager, MacKay Shields, to sum up general investment manager sentiment for the coming months: "I think the doomsday scenario that plagued the market over the past year or so is well behind us and stocks will now begin to reflect improving economic conditions worldwide. The rally over the past three months seems only to reflect the removal of that doomsday scenario and is therefore totally warranted. Further market gains will occur as the economy bounces back in response to the unprecedented stimulus being applied by governments worldwide. The surprise in this market may be the strength in the rebound, as most anticipate only a lackluster recovery."