Mad Dash for Cash Hits Highest Level Since Crisis

With the threat of European debt contagion wafting through the air, investors are heading for cover, taking their most conservative positions since the depths of the financial crisis.

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Cash now makes up an average 5.3 percent of portfolios, the most since January 2009, according to the closely watched Bank of America Merrill Lynch Survey of Fund Managers for June.

Curiously, investors on some levels are more suspect not of prospects in Europe but in the U.S., where expectations for growth fell 25 percent, compared to 5 percent for the troubled euro zone, where debt problems in Greece, Spain, and elsewhere are stoking fears of a widespread recession .

As such, the clamor for central bank intervention is rising. A majority of respondents — by a 6 percent difference — believe that global monetary policyis "too restrictive" and in need of change.

"Hopes expressed last month of a policy response have now become expectations," Michael Hartnett, chief global equity strategist at BofAML, said in a statement. "Markets are keenly anticipating decisive action from key policy meetings in June."

Many economists, though, believe that the Federal Reserve likely is still a few months away from more quantitative easing .

The Fed's Operation Twist concludes this month, wrapping up a $400 billion program that entailed buying long-dated notes and selling an equal amount of shorter-dated securities in an effort to drive down borrowing rates.

More easing likely would face stiff political opposition, though Fed Chairman Ben Bernanke continues to say the Open Market Committee is watching the economy closely for signs that more stimulus is needed.

"If hopes of QE3 are to become a reality, either the economy would need to lose a lot more momentum, core inflation would need to fall well below the 2 percent target, or the downside risks to growth from the crisis in Europe and the looming fiscal cliff at home would need to rise significantly," Paul Dales, senior U.S. economist at Capital Economics in London, said in a research note.

Even while investors fear the stock market, they believe equities are cheap — with respondents saying global stocks are at their most undervalued levels since BofA began conducting its fund mangers survey.

But proper value remains an elusive measure in times dominated by uncertainty and global crises of unusual magnitude.

Nicholas Colas, chief market strategist at ConvergEx in New York, told clients Tuesday that even with stocks at a low price-to-earnings multiple by historic standards, "the path of least resistance to U.S. stocks appears to be lower" because of the "unusually long list of negative potential catalysts."

"There are several classic models for working out stock valuations by looking at various interest rates," Colas said. "You can pretty much toss them out, however, because of central bank intervention in the debt markets and investors' strong risk-averse appetites."

As such, Colas puts forth three downside scenarios for stocks, with the Standard & Poor's 500 bottoming at either 1,100 which would retest the lows of the past 12 months; 1,000, which figures in a recession in line with historic trends, or 900, which would be "another 2007-2008 meltdown."

He expects that the 1,100 test is the most likely of the three scenarios.

"If the market is in a deep recession, and you disagree with such a pessimistic viewpoint, then getting long makes sense," Colas said. "And if markets do not discount enough bad news — as currently seems to be the case — then a cautious view is in order."

That is the approach taken by survey respondents, who have gone underweight — a lower-than-normal allocation — to global equities, and have taken a less pessimistic position on bonds.

They increased allocations to pharmaceuticals, utilities, telecoms and consumer staples, while pulling back in materials, energy and industrials, with technology the most favored of the 10 S&P 500 sectors.

A net 36 percent of respondents believe the U.S. economywill weaken in the next 12 months, though allocations to U.S. stocks actually increased since May.

Gary Baker, head of European equities strategy for BofAML, noted the disparity, saying "Investors have taken extreme risk-off positions and equities are oversold, but we have yet to see full capitulation."

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