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US Fiscal Cliff Trumps EU Crisis as Top Worry: Survey

A looming fiscal problem in the U.S. is now identified as the top tail risk for investors, marking the first time in 17 months that Europe’s debt crisis was not seen as the biggest concern for fund managers, a monthly survey by Bank of America/Merrill Lynch shows.

Fiscal Cliff
Steve McAlister | Photodisc | Getty Images
Fiscal Cliff

The U.S. “fiscal cliff,” a combination of tax hikes and spending cuts set to come into force in January 2013, was identified by 35 percent of respondents as the largest risk going forward, up from 26 percent in August.

In contrast, 33 percent of the respondents rated the euro zone debt crisis as their biggest concern, down from 48 percent in August. The survey of 186 fund managers, who oversee a combined $524 billion, was conducted from Sept. 7 to 13.

“Investors now view the U.S. ‘fiscal cliff’ as a greater threat than the euro zone — and the upcoming election is putting these fears into sharper focus,” Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research, said in a report, referring to the U.S. presidential election that takes place in November.

Unless U.S. lawmakers reach a compromise to avoid the impact of the so-called fiscal cliff, the U.S. economy could face a sharp slowdown in growth, the Congressional Budget Office has warned. (Read More: Leaders Remain Far Apart on ‘Fiscal Cliff’ Fix.)

Concerns over the fiscal health of the U.S. government are reflected in the asset-allocation decisions of the fund managers surveyed by Bank of America/Merrill Lynch.

For the third straight month, investors reduced their holdings in U.S. equities, with 11 percent overweight in September, compared to 13 percent in the previous month.

In addition to worries over the outlook for the economy, 58 percent of investors feel that U.S. stocks are overvalued — the highest level since 2004. The S&P 500 stock index, which has risen 16 percent this year, is trading at around 14 times forward earnings. This is much higher than its peers in Europe, with the U.K.'s FTSE 100 , for example, trading at 11.5 times forward earnings.

European equities have been the primary beneficiary of the rotation out of the U.S. market, with asset allocators turning overweight the region’s stocks for the first time since April 2011.

“We have seen a 25 percent rally in European stocks from the June low, but sentiment on Europe has only just turned positive. Any extension of the rally is likely to be led by sector rotation and buying of unloved, domestically exposed stocks,” said John Bilton, European Investment Strategist at BofA Merrill Lynch Global Research.

The European Central Bank’s latest efforts to contain the currency bloc’s prolonged debt crisis — through a plan for unlimited bond-buying — have helped comfort investors.

Downbeat on Japan

According to the survey results, 24 percent of investors say Japan is the country they most want to reduce their exposure to — double the level in August.

A large factor behind this is strength in the yen , which 68 percent of the respondents in the survey perceive to be overvalued.

A strong yen, which has gained more than 5 percent against the U.S. dollar over the past six months, is a threat to the economy and its exporters. A stronger currency erodes the repatriated profits of exporters and makes their goods less competitive.

Worries over the outlook for the Japanese economy prompted the country’s central bank to announce aggressive monetary easing measures on Wednesday. That action pushed the yen broadly lower. (Read More: Why the Bank of Japan Is Fighting a Losing Battle.)

The Bank of Japan expanded its asset buying and loan program, currently its key monetary easing tool, by 10 trillion yen ($127 billion) to 80 trillion yen, targeted at purchases of government bonds and treasury discount bills.

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