INTERNATIONAL. Investors are at their most optimistic about the global economy since December 2005, according to the Merrill Lynch Survey of Fund Managers for March. However, the prolonged banking crisis seems to be stopping them from putting cash into equities.

For the first time in more than three years, investors do not predict lower global economic growth over the next 12 months. Renewed optimism about China’s economy lies at the heart of this revival. Just two months ago, a net 70% of respondents thought China’s economy would worsen in the year ahead. That figure fell to a net 1% this month.

At the same time, risk appetite has dropped with investor pessimism towards banks at a record high. A net 48% of asset allocators said they are underweight banks this month, up from a net 39% in February. A total of 22% said they are aggressively underweight banks, versus 17% in February.

Respondents are noticeably bearish about Japanese and Eurozone equities.

“March’s survey shows signs that investors want to believe in an economic recovery. However, caution on banks is firmly capping risk appetite,” said Gary Baker, Banc of America Securities-Merrill Lynch co-head of international investment strategy.

"How investors resolve this anomaly between growth optimism and risk reluctance will determine the fate of equity markets this spring," said Michael Hartnett, Banc of America Securities-Merrill Lynch co-head of international investment strategy.

Risk appetite in equities took a marked downward turn in March despite the improved economic outlook. Respondents say they have reduced their equity exposure in the past month while increasing cash holdings and fixed-income investments.

A net 41% of respondents are underweight equities, up from a net 34% in February. World equities fell by 15.5% during the days the survey took place. Investors appeared to have flooded into bonds with a net 26% of the panel overweight the assets class, up sharply from a net 7% the previous month. Average cash balances rose to 5.2% from 4.9% in February.

Signs of an early recovery phase have appeared, however. A net 42% of the panel believe equities are undervalued, up from a net 24% in February. Changes in sector allocation indicate a movement out of the most defensive stocks, such as in Pharmaceuticals, where a net 30% are now overweight the sector, down from a net 37% in February. At the same time the panel has increased exposure to Technology, a much more cyclical industry. A net 28% of respondents are overweight the sector, up from a net 15% in February.

BRIC is back but Eurozone and Japan shunned

While the US continues to fuel economic optimism, investors have become more bullish about emerging markets, especially China.

Respondents have taken a net overweight position in emerging markets equities for the first time since August 2008. A net 4% are overweight the sector compared with net 4% being underweight in February. At the same time, commodities have made further gains with the number of investors underweight the asset class falling to a net 6 percent, down from a net 25% in January.

“Optimism on growth has been expressed with higher weightings in emerging markets equities and commodities,” said Michael Hartnett.

In contrast, investors have further reduced equity investment in the Eurozone and Japan. “Investors might look to review their extreme underweight positions in eurozone and Japanese equities if economic data follow growth expectations higher,” Hartnett said.

A net 40% of respondents are now underweight eurozone equities and a net 39 percents are underweight Japanese equities.

A total of 213 fund managers, managing a total of US$533 billion, participated in the global survey from March 6 to March 12. A total of 183 managers, managing US$365 billion, participated in the regional surveys. The survey was conducted by Banc of America Securities-Merrill Lynch Research with the help of market research company TNS. Through its international network in more than 50 countries, TNS provides market information services in over 80 countries to national and multi-national organizations. It is ranked as the fourth-largest market information group in the world.

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