Merrill Lynch fund manager survey finds investors hopeful but holding onto cash

Broad economic sentiment has improved sharply from the lows of late 2008. The Merrill Lynch Fund Manager Composite Indicator for Growth Expectations has climbed to 30 this month from 25 in December and a low of 17 in October.

The proportion of fund managers who predict lower inflation has fallen to a net 64% from a net 82% in December. Accordingly, there is a growing conviction that interest rates will rise, with 35% of respondents who forecast long term rates to increase in the next 12 months, up from 10% in December.

At the same time the average cash balance remains high at 5.3%, only marginally lower than December's level of 5.5%.

"Investors are talking a more positive story, especially with regards to the U.S., but the fear factor remains.They have firepower to act, but are unconvinced by the modest recent equity rally, suggesting it is a bear market rally in both sentiment and markets. Global sector allocations remain resolutely defensive."

said Gary Baker, Banc of America Securities-Merrill Lynch Head of EMEA Equity Strategy.

European cash positions reach record high as pessimism lingers

Cash positions in Europe have reached their highest level since 2001, reflecting the high level of caution within the region. A total of 42% of regional respondents are overweight cash compared with 29% in December.
The numbers reflect how, while global economic sentiment is lightening, European expectations remain under a cloud with investors embedded in defensive positions.

Every respondent to the regional survey expects a European recession, up from 91% in December. Investors are worried that corporate profits will continue to disappoint. This distrust means the percentage of investors who believe that European equities are cheap has almost halved, falling to 22% in January from 40% in December. "European investors are still dancing the two-step and are reluctant to try out any more adventurous moves," says Karen Olney, Banc of America Securities-Merrill Lynch Lead European Equity Strategist.

"Investors continue to rotate between expensive defensive sectors and beaten, but not broken, industrial cyclicals that hope to piggy-back on any indication of infrastructure-related spending by governments reigniting economies."

As investors flock to Food & Beverage and Pharmaceuticals, two survey records have been broken. Food & Beverage has hit its highest overweight in the history of the survey (net 11% of fund managers overweight). The gulf in sentiment between Banks and Healthcare sectors is also at a record high. A net 57% of European investors are underweight Banks while a net 46% are overweight Healthcare.

"Pharmaceuticals are largely immune to the credit crunch and economic slowdown that has hit banks," says Olney.

Sterling is viewed as undervalued for the first time in seven years. In October a net 58% of respondents viewed sterling as overvalued but this month a net 7% believe it is undervalued. Increasing numbers view both the euro and the yen as overvalued.

Out of U.S. into emerging markets

U.S. equities have become less in favour with global investors. The net percentage of asset allocators overweight the U.S. equity market fell from 25% in December to 7% in January. "There has been a notable dip in the U.S. equity market's popularity and emerging market equities have been the new-year beneficiary of rotation away from the U.S.," says Michael Hartnett, Banc of America Securities-Merrill Lynch Chief Emerging Markets Equity Strategist. The number of investors underweight global emerging markets has fallen to 7% in January, from 17% in December.

Investors view China with caution

In spite of flows into emerging markets, investors retain caution over China. The percentage of regional investors who expect the Chinese economy to improve has risen from 6%, but is still low at 10%. The proportion of respondents who expect Chinese growth to slow in the next 12 months has fallen to 70% from 79% in December.
"China remains the big global growth wildcard in 2009. Despite the announcement of huge fiscal stimulus packages in recent months, investors remain very sceptical about Chinese and Asian growth," said Hartnett. "Indeed, Japanese investors notably reduced their expectations for Japan's growth to close to a record low."