Investors begin to show a darker mood

By Jeremy Gaunt - Analysis

LONDON (Reuters) - Investors have been shifting their long-standing strategies in ways that suggest the current ructions on financial markets will not go away soon.

In short order, they have cut back on their exposure to stocks in general, begun to have second thoughts about once super-popular emerging market stocks, embraced the recently unloved yen and cosied up to government bonds.

Add to that various negative sentiment surveys -- from Merrill Lynch's fund managers' poll to UBS's risk appetite gauges -- and you have a picture of investors entering the final weeks of 2007 in a gloomy mood.

The primary reason, of course, is the credit crisis, which hit over summer and still haunts investors because of the fog of unknown consequences that comes with it.

"This credit turmoil is not just a storm in a tea cup," said Giorgio Radaelli, chief global strategist at Italian-owned wealth manager BSI. "It is something more significant."

But there are other factors too. The business and investment cycles are increasingly being viewed as having entered their late stages and the U.S. economy's downturn has many -- though by no means all -- investors concerned about a recession.

This has moved a number of investors to distance themselves from stocks, or at least to cut back on their exposure. Long-term investors tended not to do this during market declines earlier in the year.

Merrill Lynch's November poll showed an average portfolio now down to 51 percent stocks compared with 54 percent in October and 53 percent in September and August. Reuters' October asset allocation poll showed stocks holdings to be lower than their long-term average.

Most significantly, the Merrill survey showed a sharp decline in the share of fund managers who were overweight stocks, in other words those who thought stocks would bounce back soon.

ALL CHANGE?

While this kind of thing is not altogether unexpected or unusual given the concerns on markets there are other signs of investor retrenchment that have not been seen for some time.

Consider, for example, the sudden demand for Japanese yen, a currency that until recently has been mostly used to fund investments in other currencies -- that is, borrowed and sold as part of the carry trade.

Financial services firm State Street found during its latest scan of the $15.1 trillion in assets that it holds as a custodian bank that institutional investors are buying yen and have gone overweight for the first time since June 2006.

They have also sold the high-yielding currencies into which they had been swapping their yen.

"If risk aversion is going up the first trades to be closed are the carry trades," BSI's Radaelli said.