Global Growth Expectations Waning

That's according to Merrill Lynch's monthly survey of mutual fund managers around the world.

The Fed's 50-basis-point cut in its federal funds rate in September may have ignited a rally. But the percentage of money managers who say the world economy will get a little or a lot weaker in the next 12 months increased to 69% from 62% in September.

That is a huge difference from July, when only 5% of managers expected global growth to decline. A net 44% see corporate profits deteriorating. Only 12% shared that view in July.

"What is striking this month is how little impact the Fed's aggressive ease has had on global growth expectations," said David Bowers, an independent consultant for Merrill Lynch's monthly fund manager survey. "The survey suggests that while the Fed has succeeded in adding liquidity, it has done so at the price of raising inflation expectations and hurting the prospects for the bond market."

A net 33% of money managers this month vs. 4% in September expect core inflation to rise over the next 12 months. Hence, the bearish outlook on long-term interest rates. A net 43% expect higher bond yields, compared with 26% in September.

Despite the pessimism, only 10% think a global recession is likely to happen vs. 14% last month. And 73% of managers surveyed believe the global economy is operating at or above its long-term trend.

About two-thirds believe the global economy is in a late cycle. They believe earnings growth will increasingly become hard to find in this type of economic environment.

Growth Favored Over Value

More than half prefer growth stocks over value. A net 83% believe large caps will outperform small caps over the next 12 months. The three sectors mostly likely to deliver strong growth are industrials, materials and technology.

In the time between the two surveys, the MSCI EAFE index rose 8.47% and the Dow rose 4.4%. The CBOE VIX index slumped 24%. But the money manager appetite for risk is much lower than in July.

"Interestingly, although equities are currently higher now than they were in July, investor confidence has not yet recovered to the same extent," Bowers said. "The good news is that there are still some investors that are overweight cash and that could yet return to the market."

The average cash balance is 4% this month vs. 4.3% in September.

Of the managers, 57% think it's unlikely that world stocks will be higher in six months, while 39% say they're likely to be higher.

Money managers are most bullish on emerging markets because they think they're best positioned to weather weaker global growth. A net 51% believe those areas have the most favorable earnings outlook.

But they say the quality of those earnings will be the worst; the tech, materials and industrial sectors in emerging markets have the best prospects of delivering profit growth.

A strong euro and tighter ECB monetary policy make euro zone equities more risky. Fifty-eight percent believe the euro is overvalued, while 42% say the U.S. dollar is undervalued.