Where the Herd's Headed

My favorite monthly publication has just come in. No, not The Atlantic, Forbes, or GQ.

The Merrill Lynch Global Fund Manager survey.

OK, I admit it. I'm a stock market nerd. I love this stuff. The survey offers probably the best insights into what the big institutional money managers think about the market. Where they are placing their bets. And, sometimes, what they might do next.

It's a contrarian's bible. These are the people who move markets. So the assets they already own too much of are going to have a hard time outperforming, because who is left to buy more? Meanwhile, the reverse can be true for those investment classes they are currently neglecting.

The latest issue is a fascinating read. The big money crowd, the world's best financial minds, have looked at the wreckage of the worst financial crisis in 80 years. They considered the parade of humiliating fiascoes on Wall Street. And the bumbling and eye-watering extravagance in Washington. And yet the two asset classes they still seem to like are IOUs issued by the federal government, and stocks on Wall Street.

Go figure.

If you are thinking about investing in equities, you should know that institutional investors are already overexposed to U.S. stocks at the expense of the rest of the world. A thumping 55% of the fund managers surveyed now have more money in U.S. equities than their benchmark would require: Just 19% say they are under-invested in Wall Street.

Meanwhile, the picture for British and European equities is almost exactly reversed. Nearly half the fund managers say they are underinvested there.

Of course there is a lot of economic misery to come in Europe – especially in Britain, whose real estate bubble has only just begun to deflate.

Yet it's unclear whether this bad news is already factored into share prices there. British and European share indices have more than halved since last year's peaks and are now trading on multiples last seen in the mid 1980s. Several shrewd value managers are arguing that Europe – and Japan – now offer the best long-term buys.

As for bonds: I've been trying for weeks to understand fully why anyone would lend money to the federal government for thirty years, let alone at today's anemic interest rates.

The bailout parade slowly making its way through Washington, each package dazzling the crowd with its size and extravagance, is surely going to lead to slow-motion default in years to come through devaluation and inflation. That's a disaster scenario for bonds.

Nor could I understand why the only Treasurys that were unloved were TIPS – the ones that actually have inflation protection.

Now I know. These fund managers, the people who move the market, have suddenly written off inflation as a near impossibility. A startling 87% think core inflation will be lower a year from now than it is today. Just 5% think inflation might be higher.

Complacency? You make the call. Note that just a few months ago more than four-fifths of these guys thought inflation was going to be higher than normal. So it's fair to say they're capable of changing their minds, dramatically, in a short period.

Heaven help anyone in the way when the herd suddenly changes direction.

At the moment, 84% of the fund managers think the global economy is already in recession.

One startling fact: Hardly any professional fund managers believe Wall Street analysts anymore. A whopping 90% told the Merrill Lynch survey they thought the consensus earnings estimates on the Street for the next year were too high. Amazingly, 59% called the estimates "far" too high.

That's a pretty damning indictment.

Doomsayers claim that stock markets must fall further because earnings forecasts have to come down.

Sure, Wall Street analysts remain laughably bullish. But it turns out no one with any money believes them anyway.

Write to Brett Arends at brett.arends@wsj.com