China's growth prospects lift investor sentiment

Fund managers polled by Merrill Lynch increase their risk appetite and reduce cash holdings.

Confidence in China's growth prospects has led to a sharp improvement in economic sentiment globally, according to the Merrill Lynch survey of fund managers for February.

Investors are at their most hopeful about the year ahead since the credit crunch took hold in July 2007, with only a net 6% of respondents expecting a worsening global economy in the 12 months compares with a net 24% in January. The majority recognises, however, that the world economy is in recession.

Fears of a prolonged slowdown in China appear to be fading. The number of investors who predict lower growth in China over the coming 12 months has fallen sharply, to a net 21% in February from a net 70% in January.

Meanwhile, severe pessimism about the outlook for corporate earnings has started to ease. A net 43% of respondents expect to see deteriorating profits over the coming year, significantly lower than the 63% who held that view in December. A net 49% of the panel predicts inflation will fall over the coming 12 months, compared with 64% in January and 82% in December.

"Fund manager expectations for Chinese economic growth rose dramatically to their highest levels since 2007, and faint global decoupling hopes now reside solely with China," says Michael Hartnett, chief global emerging markets equity strategist at Banc of America Securities-Merrill Lynch Research.

Further proof of the improved sentiment is the decline in the fund managers' overweight position in cash. The fund managers' average cash balance has slipped to 4.9% from 5.3% in January. Cash positions reflect risk appetite, with many fund managers normally capping their cash at 5% of their portfolios when they are bullish.

Commodities, meanwhile, have enjoyed the sharpest pick-up in terms of changes to asset allocations in the past two months. Investors hold a net 15% underweight position in commodities, down from a net 32% underweight in December.

Bond weightings were trimmed while equity allocations fell back to a net 34% underweight - the same position as in December. Investors have been pruning back their allocations to traditional defensive sectors and moving into more cyclical sectors.

Weightings fell in telecommunications, insurance, staples and utilities. They also increased positions in technology, energy, materials, industrials and discretionary spending.

"Higher risk appetite, rising commodity sentiment and a strong valuation case could encourage further investment in energy and materials sectors. We see this as best played out through sterling-denominated assets," says Gary Baker, Banc of America Securities-Merrill Lynch head of Europe, Middle East and Africa (EMEA) equity strategy.

Appetite for US equities has been reawakened in February, possibly boosted by poor market performance in January. The net overweight position in US equities has risen to 15% this month, up from 7% a month ago. The US benefits from having the best profits outlook, and 31% of respondents want to overweight US equities in the next 12 months.

Allocations to Japan have fallen starkly with investors who hold a net underweight position rising to 26% compared to 15% in January. Traditionally, Japanese equities would benefit from a broad pick-up in sentiment. Japan also suffers from having an overvalued major currency, according to the survey.

For the first time, respondents view the yen as more overvalued than the euro. Pessimism over the euro has broadly moderated, while the euro-region's macroeconomic outlook is somewhat more favourable.

"Eurozone growth expectations picked up to the highest level in 12 months in February," said Baker. "But in contrast with the global picture, the number of European portfolio manager's overweight cash spiked to the highest level since October 2001."

 A total of 212 fund managers, managing a total of $599 billion, participated in the global survey from February 6 to 12. The survey, which was conducted with the help of market research company Taylor Nelson Sofres (TNS), measures net responses of the fund managers.

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