Merrill's Fund Bulls Vs Citi's Japanese Candlestick Masters

Bank of America Merrill Lynch published its monthly Fund Manager Survey Global on Wednesday. The summary of key findings is as follows:

Investors optimistic for 2010 despite giving up on banks
Walls of worry seemingly litter the landscape but investors exit 2009 hopeful that the New Year brings economic recovery, strong EPS growth, moderately rising interest rates and positive returns for equities. This comes despite a global collapse in optimism on banks during December (a month where two of the largest ever bank capital raisings were successfully completed).

7.7% expected total return for global equities
Investors forecast a +7.7% total return for global equities in 2010 led by APR (+9.1%) and GEM (+9.0%) closely followed by Europe (+8.9%) and UK (+8.3%). The laggards are forecast to be US (+5.5%) and Japan (+7.0%).

Growth, but where is the rate cycle?
A net 80% of investors think the global economy will get stronger over the next 12 months (a current cycle high) but a majority (63%) see growth as likely to be below trend together with below trend inflation. This may explain an easing in expectations of rate rises, with 51% of fund managers seeing no Fed rate hike before Q4 next year at the earliest, compared to just 41% last month. Optimism on corporate profitability, meanwhile, is at the highest level since December 2003.

Risk appetite constrained
Near record macro optimism is held in check by moderate risk appetite. In December, cash balances rose to 4.0% from 3.7% and our Risk & Liquidity composite indicator was static at 44, marginally above its long term average. Hedge fund exposure did, however, tick up to 35% the highest level since May.

Equities, EM & Europe in; Bonds, UK and Japan out
Investors have high conviction in the attraction of equities over bonds (the latter falling to the lowest level of valuation support since April 2006). Optimism on China also remains rock solid leaving Emerging markets as by far the most overweight region followed by Europe. Meanwhile pessimism on the UK and Japan continues to increase.

US$ bulls, Yen bears, gold overvalued
A net 37% of panellists see US$ strengthening over the next 12 months (the third highest ever reading and compares to -5% a mere 4 months ago). Conversely a net 35% of investors see the Yen depreciating. The 72 point difference in $/¥ view is the highest level since Feb 2002. Meanwhile the recent surge in gold sees a net 39% of investors viewing the metal as overvalued; consistent with $ views.

Near record macro optimism? Click on chart to enlarge, courtesy of BofA Merrill Lynch.

Interestingly, the Japanese candlestick masters at Citi, who usually do not bother with macroeconomics, have a different view:

Global equities — We think global equities will be vulnerable to a shakeout in
2010, as the intermediate rally off the spring 2009 lows plays out. The global
correction could be drawn out through to mid-year or autumn, especially for US
equities, which have been playing the anchor role.
...

Interest rates — US and Japanese long-term yields may take different paths through spring. The US 10-year T-note yield could rise to 4.25% or 4.69% through June or October. Conversely, we think the JGB yield will continue on its downtrend through March but then turn toward an uptrend.

Forex — While dollar weakness is an ongoing longer-term trend, 2010 will be a year in which the dollar could easily stage an intermediate rebound. We think the dollar could rebound to $1.38-$1.35 against the euro. Against the yen too, we see a possible rebound of ¥15 or ¥22 in the second half of the year following weakening to ¥82.30 or ¥80 in February–March.

Commodities — In commodities, 2010 could be a year of bottom firming. WTI crude futures could be pushed down close to the December 2008 low of $33.87. Gold, too, could be subject to a shakedown of $200–$300 in the second half of the year after rallying on to $1,300 or $1,410 in the first half.

For the US equities, the reasoning behind the expected headwinds:

After a rise uninterrupted by a meaningful correction, the DJIA stalled as it approached major resistance at 10,500. The brakes came on in November and the index immediately appeared to have peaked. We think further upside is unlikely for the reasons outlined below.

1. The time from the 2007 high of 14,164 (2007/10/9) to the 2009 low of 6,547 (3/9) was only 18 months, not long enough to constitute a reliable wave pattern from a time perspective (a declining wave normally lasts just under three years or longer before reversing).
2. In the first stage of the two-stage rebound, from March to June 2009, trading volume was relatively high. But the pattern during the second stage, from July onward, was unsustainable, with share prices continuing to rise amid declining trading volume. This is not characteristic of a strong rising wave.
3. It appears increasingly likely that US long-term bond yields have bottomed out, and there are signs that the downturn in the dollar depreciation, which has supported share prices since March, is reversing.

Considering the aforementioned factors, we believe the intermediate rally from 6,547 (3/9) will peak at 10,500 or 10,600 and give way to a correction early in 2010.

Click on chart to enlarge, courtesy of Citigroup Global Markets.

They see two possible scenarios for a correction in 2010:

Scenario 1): A relatively mild near-term correction of 1,480pts ending in February-March, followed by the formation of a second ceiling around June. This gives way to a larger second-stage correction of 2,480pts, ending with a bottom in September-October.

1,482pts: The magnitude of the rise from 7,552 (2008/11/20) to 9,034 (1/2)
2,487pts: The magnitude of the decline from 9,034 (1/2) to 6,547 (3/9)

Scenario 2): A large drop of 1830-2,840pts from March through June, bringing an end to a correction from a price perspective. Bottoming firming until September-October gives way to a rebound.

1,828pts: The magnitude of the decline from 8,375 (1/28) to 6,547 (3/9)

In either case, we expect the correction to last until September-October, and if a second bottom to 6,547 (3/9) is formed this could set the stage for another intermediate rebound in 2001 H1.

An alternate (risk) scenario is that of a 1,480pts correction through February- March followed by an intermediate rebound to new highs that lasts to August or October. In this case we see potential upside to 10,980 in 2010. If the DJIA does not break above this level it would complete a major head-and-shoulders pattern starting from the 2000 high. This would be a warning signal for a potentially massive fall from autumn 2010.

10,983: Derived by adding to 6,547 (3/9) the magnitude of the decline from 11,722 (2000/1/14) to 7,286 (2002/10/9)

Key dates from a perspective of time cycle analysis are June, September- October, December, and February-March 2011. Important dates in 2010 H1 are January 4, 13, and 26; February 2 and 23; March 4 and 30; April 20; May 5 and 17; and June 18.

Click on chart to enlarge, courtesy of Citigroup Global Markets.

Near record macro optimism, but where is the rate cycle? Bond markets ready to go on strike?