Every month Merrill Lynch surveys nearly 300 global fund managers to gauge market sentiment and its August report paints a fairly gloomy picture û except for Asia, which seems to be one of the few bright spots. Of the 292 fund managers directly responsible for $706 billion of assets responding to the survey, only 25 are Asia-Pacific specialists and another 22 Japan specialists.

The best outlook for corporate profits is in global emerging markets, according to 35% of the 292 respondents, and the bulk of those markets' capitalization is Asian, says David Bowers, chief investment strategist in London.

Only 7% felt emerging markets offered the last favourable outlook for corporate profits, versus 29% who were most bearish on the United States.

Moreover, emerging markets are also widely felt to offer the best value. Whereas 52% of respondents felt US stocks were the most overvalued in the world, versus only 7% citing emerging markets, a plurality of 30% said emerging markets are the most undervalued.

Managers say that as they rotate investments regionally over the next 12 months, most will overweight emerging markets (29% of respondents) and underweight the US (43%).

Bowers notes the survey overall highlights that fund managers are rethinking the outlook for corporate profits but are also surprisingly short of cash. Moreover Bowers notes a discrepancy between expectations on economic fundamentals, which are poor, and on market prospects.

Investor confidence and corporate profit expectations has fallen. Although a slim majority expect global economic recovery, investors are giving up on sales growth. They are urging companies to use finances to repair balance sheets, not to build inventory, and any movements toward doing so have been put on hold following further market turmoil.

At the same time, however, Bowers notes that fund manager activity does not reflect this negativity. A majority still believe stock markets will improve over the next 12 months and a third still expect equities to provide double-digit returns. More than 60% also expect equities to provide a better return than bonds, and 72% say they are satisfied with their current asset allocation.


Bowers thinks this is "latent optimism" that is not justified and he expects the mood to further sour when these expectations are not met.

One reason for him to feel such optimism is misplaced is to note that fund mangers' cash levels are at record lows of 4.7%. Fund managers are fully invested. This does not sync with a poor outlook for corporate profits; last October following September 11th, cash levels were as high as 7%. More important, it begs the question of what source of liquidity will drive markets up once positive signs emerge. "Who will be the margin buyer?" Bowers wonders.

This as well as a static attitude toward risk aversion makes him believe fund managers are either very long-term investors, or simply have not adjusted to the reality of corporate earnings.