Merrill Lynch & Co. Inc. reports that its latest fund manager survey shows a slight improvement in investor sentiment, but that that they also want to see governments provide further fiscal stimulus.

Investor sentiment has stepped back from the brink of despair, but more than a third of investors want to see greater fiscal stimulus, according to Merrill Lynch’s Survey of Fund Managers for December.

It reports that while 88% of the panel believe that the world economy is in recession, December’s survey contains evidence that the rate of deterioration is slowing. The net balance of investors who expect the global economy to worsen in the coming year has fallen to 36%, down from 60% in October. More than a quarter of respondents believe the economy will strengthen in 2009, it adds.

Cash levels now average 5.5%, up from 5.1% in November, the firms says, adding that this is the highest level since 2001. Furthermore, a widespread perception exists that stocks are cheap, both in absolute terms and relative to bonds, it adds.

The proportion of investors who view monetary policy as too restrictive has tumbled to 29% from 68% in October, Merrill says. However, 37% of investors believe that fiscal policy is too restrictive, suggesting further stimulus dollars are needed before investors will commit cash.

“Market sentiment, high cash levels and the prospect of U.S. fiscal stimulus in January point to a possible New Year rally in equities,” said Gary Baker, head of EMEA equity strategy at Merrill Lynch. “It suggests that going into 2009 with textbook defensive positions in a small number of sectors could be dangerous.”

For the third successive month, a majority of fund managers believe equities are undervalued, it notes. But survey data also finds that many fund managers still prefer bonds to stocks, with 21% of asset allocators overweight bonds in December, compared with 7% in November. Following the recent sharp rally in government bonds, 42% of investors believe the asset class is overvalued.

Faced with lower growth and inflation, investors have further increased overweight positions in four global sectors, Merrill reports: healthcare, telecoms, utilities and consumer staples since November; also, 44% of asset allocators are overweight pharmaceuticals and 33% are overweight consumer staples.

European investors are starting to take profits in classically-defensive sectors, it notes. The regional survey shows that European managers are scaling back overweight positions in three defensive sectors in December. Respondents reduced overweight positions by 15% in healthcare, by 11% in food & beverage, and by 8% in utilities. They are yet to commit, however, to more cyclical industries that could be poised for a 2009 rally on any positive news.

“Without any fresh allocations to the deep cyclical sectors, investors could be caught wrong-footed and miss out on a potential bounce back in commodity prices and additional fiscal stimulus targeted at infrastructure,” said Karen Olney, lead European equities strategist at Merrill Lynch. “If the world economy has just experienced a heart attack, infrastructure spending could be the defibrillator that charges it back to life.”

The survey also found that 47% of global asset allocators say that oil is now undervalued after falling by more than 60% in three months. However, investors in Europe have continued moving out of basic resources and oil & gas; and 40% are underweight basic resources, a far cry from its net overweight of 36% in June.

Investors are instead putting their money into sectors they deem to offer relative value, Merrill says. The proportion of respondents who overweight insurance, the cheapest sector in Europe, jumped by 27% up to a net 29%. Telecoms, also among the cheapest sectors in the region, is closing on its all-time high in terms of popularity.

Equity allocations towards emerging markets have fallen to their lowest level since 2001, the firm said, as 17% of global asset allocators are underweight emerging market equities compared to 6% in November.

“It would now be a major surprise for global fund managers if emerging markets were to outperform U.S. equities in 2009,” said Michael Hartnett, chief emerging markets equity strategist at Merrill Lynch.

China remains by far the preferred choice of Asian equity investors and emerging market specialists, as 50% say they would want to overweight Chinese equities; this is despite the fact that eight out of 10 fund managers expect the Chinese economy to slow in 2009. “Ironically, the slowdown is indirectly making investors more bullish on China, thanks to the promise of policy stimulus and falling commodity prices,” said Hartnett.

@page_break@A total of 196 fund managers participated in the global survey from 5 December to 11 December, managing a total of US$582 billion.

IE