By Claire Milhench
LONDON (Reuters) - Global investors increased their U.S. equity holdings to the highest in more than three years in July, but trade conflict between the United States and China encouraged them to trim their exposure to emerging-markets stocks.
Reuters' monthly asset allocation poll of 50 wealth managers and chief investment officers in Europe, the United States, Britain and Japan was carried out July 16-31.
During this period the U.S. economy reported second-quarter growth of 4.1 percent, the fastest pace in nearly four years,, while U.S. President Donald Trump threatened fresh tariffs against China, raising the stakes in their bitter trade dispute.
But investors remained bullish despite the growing protectionism, raising their U.S. stocks allocation by 2.3 percentage points to 41.9 percent, the highest since June 2015.
The S&P 500 <.SPX> looks set to end July up around 3 percent despite a late-month wobble in technology, with industrials providing support.
"We prefer U.S. to Europe due to a more solid economic environment, historically strong buyback activity and a stronger corporate earnings momentum, even without taking into account the fiscal package positive effect," said Cedric Baron, head of multi-asset strategies at Generali Investments, referring to corporate tax cuts.
Investors also raised their global equity exposure to 47.5 percent, the highest since April, from 46.8 percent in June.
TRADE WAR CROSSHAIRS
But they trimmed their emerging-market stocks allocation to 12.2 percent from 12.4 percent in June, with many poll participants saying these export-oriented markets were likely to suffer most in the event of a full-blown trade war.
Investors are doubly focused on China and its integrated supply chains following a U.S. deal with the European Union to refrain from imposing car tariffs while the two negotiate
"Assuming that the dispute, at least in the short term, will mainly involve the U.S. and China, the countries most exposed to these two countries (Vietnam, Taiwan, Colombia, South Korea, Malaysia) could be more vulnerable," said Pascal Blanque, group chief investment officer at Amundi.
Trevor Greetham, head of multi-asset at Royal London Asset Management, was one of those adding to more defensive U.S. equities while cutting emerging markets, citing weaker global growth and a strong dollar, which have led to underperformance.
MSCI's benchmark emerging stocks index <.MSCIEF> is down 6 percent year-to-date, although it is on track to end July in the black after five losing months.
Investors also reduced Japanese equities by almost 2 percentage points to 17 percent, the lowest since January. Several poll participants identified Japan as another potential loser in a full-blown trade war.
In fixed income, investors cut their U.S. bonds exposure by 1.5 percentage points to 37.7 percent, a three-month low. Some 82 percent of poll participants who answered a question on the U.S. 2 to 10-year Treasury yield curve do not expect it to invert by year-end.
An inversion of the yield curve - the spread between short-term and long-term debt securities - is considered a signal of a possible recession.
Andrew Milligan, head of global strategy at Aberdeen Standard Investments, expects a flat yield curve for some time as the market prices in "further improvements in U.S. growth, some underlying inflation, considerable pressure from public sector debt issuance as the U.S. deficit expands, and strong demand from pension funds and households for higher yielding assets".
Investors were also asked their view of British Prime Minister Theresa May's ability to deliver Brexit following a turbulent month in which several cabinet ministers resigned.
Some 80 percent of poll participants who answered this question expect May to succeed, although some said this would be a Brexit in name only, and the risk of a leadership battle had grown.
"It is starting to look like there is no form of Brexit that will command overwhelming parliamentary support," Greetham said.
Investors have cut their UK equity holdings to 9.7 percent, down from 11.6 percent in June 2016, the month Britain voted to leave the EU. UK gilts are down to 7.6 percent from 12.6 percent over the same period, reflecting investor concerns.
Justin Onuekwusi, a fund manager at Legal & General Investment Management, warned that a reversion to the frictions of WTO trade regulations would almost certainly result in a recession, and the pound could collapse in such a scenario.
"Whilst we think the possibility of a hard Brexit remains low, the market implications could be severe," he said.
(Reporting by Claire Milhench and Massimo Gaia, editing by Larry King)