Investors have slashed their growth expectations on fears that central banks will be hawkish for longer to fend off inflation, according to Merrill Lynch’s Survey of Fund Managers for June.

Fund managers have also responded with a “textbook” country rotation, in which U.S. stocks have proved far more resilient to stock market turmoil than either emerging market or Japanese equities.

During the four weeks between the close of May and June’s fieldwork periods, world equities fell by 9% over all and by 20% for emerging market assets.

“Investors who have been overweight emerging market and Japanese stocks must be feeling the heat,” said David Bowers, chief global investment strategist at Merrill Lynch. “The question is whether the domestic investment case for these regions can withstand an extended period of tighter monetary policy.”

The Merrill Lynch survey has charted a radical shift in sentiment over the past three months. In April, the survey flagged growing complacency about macroeconomic risks to world equities. In May, as the recent market turbulence began, the survey found that investors were becoming increasingly concerned about a global economy operating above trend.

This month, more fund managers than ever believe the economy is operating above trend, a development which may prompt central banks to engineer a period of below trend growth to be sure inflation is held at bay. It is this concern that lies at the heart of the negative growth shock that June’s survey highlights. Inflation worries are typical of a late-cycle mindset and 60% of the panel now believes the global economy has moved into this phase of the business cycle.

Nearly half the panel expects the global economy to weaken over the next 12 months, versus 14% who took this view in May. This is the most pessimistic view in nearly six years. A net 34% of participants expect corporate profits to deteriorate during the same period, a much larger proportion than the 9% who expressed this view last month. In fact, fund managers appear to have given up on the idea that volume will be the key driver of corporate profits and are turning their attention once again to cost cutting.

The survey found that cash levels have shot up to 4.5% from 4.1% in May. A net 29% of asset allocators describe themselves as being overweight cash, which is one of the highest readings the fund manager survey has recorded. Combined with quite high levels of risk aversion, this suggests there is ample liquidity to be put to work if inflation concerns recede.

Equities are still seen as fair value or undervalued and, in a new question this month, a net 59% of the panel think it unlikely that equity markets will be lower six months from now.

One of the strongest messages in June’s survey is that quality and size are what count. Between May and June’s surveys, Japanese equities fell by 16% and Indian shares by 30%. U.S. equities, by contrast, were down a mere 4%, even though this was the survey’s most unloved regional asset class just one month ago.

Looking ahead, a net 28% of asset allocators expect to increase their weighting in U.S. equities over the next year and a corresponding 12% intend to shrink their allocation in emerging markets. A net 71% of this panel expects large caps to outperform small caps over the next 12 months.

A total of 194 fund managers participated in the global survey from June 2 to June 8, managing a total of US$568 billion. A total of 166 managers participated in the regional surveys, managing US$392 billion.