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Emerging markets poised for further rally: BofA-ML

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Emerging market equities are poised to extend gains into year-end, according to contrarian indicators, said Bank of America-Merrill Lynch's fund manager survey for October.

"Allocations towards emerging market stocks remain stubbornly low despite elevated Chinese growth expectations," the survey found, adding funds' high cash levels offer a contrarian signal.

It noted the current average cash balance slipped to 4.4 percent from September's 4.6 percent . But while this is its lowest in four months and below the 4.5 percent level BofA-ML generally uses as its contrarian buy signal, the bank still views cash levels as high and expects emerging markets to continue a "quiet contrarian rally."

(Read more: What's important in Asia this week)

"We continue to think EM is best placed for further upside into year-end," it said, although it noted the survey response this month was lower than usual.

One in five global fund managers are still concerned over whether China may face a "hard landing" and whether commodities may collapse, helping to explain the emerging-market skepticism, it said. But it did note that the survey's underweight allocation toward emerging market equities fell to a net 10 percent underweight, from September's 18 percent.

(Watch now: Emerging markets, best returns: Pro)

Fund managers' country positioning in emerging markets isn't much changed from September, with Russia still a "market darling," with a net 67 percent overweight, while China positioning remained high, with a net 56 percent overweight, the survey found.

Investors were the most underweight Turkey in the survey's history.

(Read more: With debt deal done,are emerging markets set to soar?)

Asia-Pacific fund managers remained skewed toward North Asian countries, such as Korea, Taiwan and China, preferring them to Southeast Asia, while India stayed out of favor.

By contrast, the survey said a technical contrarian sell signal has been triggered in Europe, the first "potentially overbought" regional signal since emerging markets triggered one in December 2010.

It noted 77 percent of portfolio managers are expecting the continent's economy to grow next year and a net 46 percent are overweight European stocks, up from a net 36 percent in September.

(Read more: Flashing Red! Europe bullishness triggers 'sell' signal)

But it added valuations in the region remained low, with a net 28 percent of respondents viewing the EU as cheap and a net 6 percent of portfolio managers now expecting double-digit earnings-per-share growth next year, the most since July 2011.

"If earnings do recover, Europe could stay overbought for some time; if not, the challenge for portfolio managers will be to find a compelling alternative," it said.

"With a net 68 percent seeing U.S. stocks as rich, a net 30 percent already overweight Japan, and a net 38 percent seeing an unfavorable emerging market profit outlook, if portfolio managers do sell EU, it's not clear where they'll go."

By CNBC's Leslie Shaffer. Follow her on Twitter: @LeslieShaffer1

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