While investors are more becoming more hopeful that growth and inflation will improve, this optimism has yet to translate into practice and the average cash balance remains high, according to the Merrill Lynch Survey of Fund Managers for January.

While investors are more becoming more hopeful that growth and inflation will improve, this optimism has yet to translate into practice and the average cash balance remains high, according to the Merrill Lynch Survey of Fund Managers for January.

This month’s survey showed that broad economic sentiment had improved significantly from the lows of late 2008: among the fund managers surveyed the proportion predicting lower inflation has fallen to a net 64 per cent, down from 82 per cent in December.  At the same time, 35 per cent of fund managers surveyed now believe that interest rates will rise in the next 12 months, compared to 10 per cent in December.

Investor gloom is beginning to lift, but the average cash balance remains high at 5.3 per cent – only marginally down from December’s level of 5.5 per cent.

The Eurozone is the most unpopular region globally, with a net of 31 per cent of asset allocators underweight (closely followed by the UK with a net 28 per cent).

European cash positions have also reached their highest levels since the first Merrill Lynch fund manager survey in 2001.  This month, a total of 43 per cent of regional respondents are overweight cash, up from 29 per cent in December.

Merrill reports that every respondent to the regional survey expects a European recession. This expectation, combined with concerns about company earnings, is reflected in a fall in the proportion of investors who believe that European equities are cheap.  This percentage has almost halved, falling to 22 per cent in January, down from 40 per cent in December.

“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,” said Karen Olney, Banc of America Securities-Merrill Lynch lead European equity strategist.

As part of the prevalent defensive stance on Europe, investors are flocking to food and beverage stocks, a sector which in this month’s survey hit its highest ever overweight (net 11 per cent of fund managers). 

In another record, a net 46 per cent of fund managers are overweight healthcare, while a net 47 per cent are underweight banks – the largest gulf in sentiment between the two sectors ever found by the survey.

“Pharmaceuticals are largely immune to the credit crunch and economic slowdown that has hit banks,” said Ms Olney.

Ms Olney also pointed out that while European markets may have priced in a recession, Europe is not pricing in a severe recession.  Company profits have only fallen around 10 per cent, and many think that they have a very long way still to fall.

This contrasts strongly with attitudes towards the US where there was a sharp increase in optimism towards profit expectations.  The survey revealed that only 27 per cent of portfolio managers now expect further earnings deteriorations, compared to 70 per cent in December.

Nevertheless, the survey found that overweights in US equities had been trimmed back.  While 25 per cent of asset allocators were overweight the US equity market in December, that figure fell to 7 per cent in January - to the benefit of global emerging markets rather than Europe and Japan. 

The number of investors underweight global emerging markets fell to 7 per cent in January, down from 17 per cent in December.  GEM investors regional allocation reveals a strong preference for Asia (net 50 per cent overweight), a neutral stance on Latin America (flat) and a strong disinclination towards EMEA (net 44 per cent underweight).

Some are of the view that the Chinese economy could be the first to recover, citing counter-recessionary measures such as the government’s RmB4 trillion programme of infrastructure spending.  But in spite of flows into emerging markets, investors are still cautious over China - only 10 per cent of regional investors surveyed expect the Chinese economy to improve in the next 12 months.

“China remains the big global growth wildcard in 2009.  Despite the announcement of a huge fiscal stimulus package investors remain very sceptical about Chinese and Asian growth,” said Michael Hartnett, Banc of America Securities-Merrill Lynch chief emerging markets equity strategist.

A total of 205 fund managers, managing a total of $597 billion, participated in the global survey, and a total of 167 managers in the regional surveys.

Merrill Lynch, which has conducted fund manager surveys since 2001, was acquired by Bank of America on 1 January 2009.