How professional investors reacted to market turbulence

Investors reduced risk in August, as fears about a US recession caused stock markets to wobble.

Professional fund managers, according to Bank of America’s monthly survey, rotated money out of the stock market and into defensive assets, such as bonds, cash and healthcare companies.

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Cash levels rose from 4.1% to 4.3% and the overweight positioning in shares dropped from 51% to 31%.

This came as the MSCI World index, in sterling, dropped about 5% from peak to trough in late July to early August, and the Nasdaq 100 dropped about 12%, before recovering.

The change in sentiment was triggered by a weak jobs report in America that showed that unemployment was rising, which could be an indicator that the economy is slowing and a recession is coming.

There were also concerns that technology companies were over-investing in artificial intelligence (AI) tools without being able to show any increase in profits, and Japanese share plunged due to rising interest rates.

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Recessions are bad news for company earnings, but good news for high-quality bonds, such as those issued by the UK or US government, as central banks will cut interest rates, and there may be a flight to safe-haven assets.

Bond prices are very sensitive to interest rates, with rising interest rates generally causing bonds to fall in value so that yields come in line with market rates. That is why bonds fell so much in 2022 – investors had to reprice existing bonds because new bonds were being issued with higher interest rates. On the other hand, falling interest rates have the opposite effect, with bonds increasing in value, reflecting lower yields.

Allocation to bonds increased at its largest monthly increase rate since November 2023, and investors are the most overweight bonds since December 2023.

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Nevertheless, investors are still optimistic. Bank of America found that hopes for a “soft landing”, where central banks bring down inflation without crashing the economy, are alive and kicking, but investors now think the Federal Reserve needs to cut interest rates harder now to guarantee no recession. Three-fifths of respondents said there would have to be four or more rate cuts in America in the next 12 months to achieve this.

Bank of America found that large-cap growth stocks are still viewed as the likely leaders of a new US equity bull market, but conviction is fading.

“Long Magnificent Seven” was the most-crowded trade for the 70th consecutive month, albeit a less crowded trade in August compared with July.

UK assets remained out of favour, with allocations to UK shares falling for the first time since January.