Institutional investors are much less confident in the outlook for the global economy and corporate profitability, amid concerns about the direction for monetary policy, according to the latest survey from BofA Merrill Lynch.

The firm reports that a net 32% of respondents to its October survey expect the global economy to strengthen over the next 12 months. “This is the lowest reading in two years,” it says, adding that inflation and earnings expectations have slumped too. Indeed, there’s a growing consensus that the world is experiencing both below-trend inflation and below-trend growth, the survey found.

Merrill says that monetary policy underpins the shift in sentiment. It says that only a net 18% of fund managers now view policy as too stimulative, down 14 percentage points. Additionally, fund managers are worried about fiscal policy, Merrill reports. It says that a net 19% of global fund managers now regard fiscal policy as too restrictive; which represents the highest reading on this measure in more than a year.

In response to this gloomier view, investors are reducing riskier exposures, Merrill says. It reports that cash balances have risen to 4.9%, investment horizons have shortened, and equity overweights have fallen rapidly (down a net 13 percentage points month-on-month), it says. At the same time, underweights in commodities have also risen, the survey found.

“Cash balances are high, but investors are retreating to benchmark positions rather than staging an exodus from markets,” said Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research.

The survey found that investors have lost their appetite for both emerging markets and European equities. And, they are turning instead to the U.S. market and even Japan.

“Performance in European equities is reverting to fundamentals. As our view remains downbeat, we continue to favor defensive dividend yield stocks and expect any rallies in cyclical stocks to be short-lived,” added Manish Kabra, European equity and quantitative strategist.

Merrill reports that expectations over Europe’s growth have declined markedly, with only a net 16% of regional fund managers now expecting the continent’s economy to strengthen over the next year, down from 45% last month.

It notes that investors are uncertain over the direction of monetary policy in Europe, with 26% now not expecting the European Central Bank (ECB) to initiate a program of quantitative easing (QE), up from last month’s 19%. The outlook for corporate profitability is heavily affected by the gloomier view for European growth. It says a net 52% now does not expect double-digit earnings growth in the region, and a higher proportion of fund managers say earnings estimates for European companies are too high.

As a result, only a net 4% of global investors are overweighting the region now, down 14 percentage points from last month.
Conversely, appetites for exposure to Japan have increased, Merrill says, noting that fund managers’ inflation expectations are on the rise in Japan too. “Investors’ increasingly negative outlook for the yen contributes to these assessments,” it says.

A total of 220 panelists with US$640 billion of assets under management participated in the survey from October 3 to 9.