Optimism on the Japanese economy and earnings have picked up since November, while global risk appetite has risen strongly, according to Bank of America Merrill Lynch's fund manager survey for January.

A net 63% of the regional respondents expect a stronger Japanese economy in 2010, up from 30% in November. A net 87% expect improved earnings, up from 59% in November.

Global respondents identified Japanese equities as the most undervalued in the world and, over the past two months, Japanese stocks have become more popular than eurozone stocks. Japan is the region that 20% of those polled would most like to overweight in the coming year, compared to 10% citing Europe.

Investors are also rotating back towards other "deep cyclicals". Banks are also benefiting, with investors more bullish on the financial sector.

Asia-Pacific investors have moved further towards consumer-related sectors, raising overweight positions in tech, retail, energy and materials. They have reduced overweights on China, Taiwan and South Korea, while Australia and Malaysia remain the region's biggest underweights.

Meanwhile, investors globally have rediscovered their risk appetite and are putting cash reserves to work across the equity markets.

For the first time since January 2006, the survey shows investors are taking above-average risk, relative to their benchmark. A net 2% are taking higher-than-normal risk, compared with a net 7% taking below-normal risk in December. These figures follow several months of investors displaying optimism about the economy, but maintaining a more cautious risk and investment profile.

Average cash balances among global investors have fallen to 3.4%, the lowest reading since mid-2007 and down significantly from 4% in December. Appetite for equities is strong, with a net 52% of asset allocators being overweight equities, up sharply from a net 37% in December.

Moreover, fewer investors are protecting themselves against a fall in equities. A net 55% have no protection against a fall in the next three months, compared with a net 48% in December. Investors have been moving into cyclical stocks, are positive about profits and are urging management teams to invest in growth.

Indeed, fund managers this month view capital expenditure as more important than debt reduction. Four out of 10 respondents say capital spending is what they most want to see corporates use their cash for. Improving the balance sheet, which has been investors' priority for the past year-and-a-half, is now in second place.

"This survey is one of the more bullish we have seen and suggests that investors buy into the idea that this recovery has legs," says Gary Baker, head of European equities strategy at BofA Merrill Lynch Global Research.

"We are, however, seeing early signs that might alert contrarians looking for a selling opportunity," says Michael Hartnett, chief global equities strategist at BofA Merrill Lynch Global Research. "Namely, low cash allocations and possible complacency against a sell-off in stocks."

A total of 209 fund managers, managing a total of $539 billion, participated in the global survey from 8 to 14 January. A total of 169 managers, managing $404 billion, participated in the regional surveys. The survey was conducted by BoA Merrill Lynch Research with the help of market research company TNS.