Merrill Lynch’s Survey of Fund Managers for September shows fund managers getting gloomier on the global economy.

September’s survey, conducted in the aftermath of Hurricane Katrina and in the context of further sharp rises in the price of oil, reveals something of a retreat from the positive views on global growth expressed in recent months, Merrill reports. It notes that 26% of fund managers now expect the global economy to weaken over the next 12 months, up from 14% last month.

The outlook for corporate profits has also fallen. A net 24% expect worldwide corporate profits to deteriorate over the next year, down from 11% last month. Earnings-per-share forecasts, meanwhile, are down to an average of 4.5% from 5.9%, the lowest they’ve been since 2001. More than a third of respondents see corporate operating margins falling within the year.

In light of a deteriorating growth outlook, investors are less certain that interest rates have to rise, Merrill adds. A net 69% expect short-term interest rates to rise within the year, down from 78% last month. Higher long-term rates are expected by a net 65% of the panel, down from 71% in August.

Despite concerns about global growth, survey participants believe companies have plenty of cash on their balance sheets, Merrill says. A net 55% of the panel describes corporate balance sheets as under-leveraged, up from a net 48% in August.

Investors are also becoming more strident in their call for higher capital expenditure. In September’s survey, 53% said companies were under-investing in their businesses, up from the 50% last month. Asked what they’d like companies to do with excess cash, a net 42% of fund managers favour reinvestment in the business, close to the 44% who want to see cash returned to shareholders. This represents the narrowest gap seen between these two options in a year.

On the geographic front, fund managers are favouring Japan as the region with the best outlook for corporate profits, Merrill says. In the survey, Japan is tapped as the region in which the outlook for corporate profits is viewed most favorably, where the quality of these earnings is improving, and whose currency is seen as the most undervalued, Merrill reports.

This month, 37% of fund managers rank Japan Number 1 for company profits. More than a quarter of managers describe Japanese equities as the most undervalued region and a net 46% of asset-allocators say they are overweight the country.

“Investors’ preference for Japanese rather than U.S. equities is one of the most extreme we’ve seen,” said David Bowers, chief Global Investment Strategist at Merrill Lynch. “Because this view has historically been associated with expectations of higher inflation, it could come under pressure if a faltering global economy starts to undermine companies’ ability to pass on higher costs.”

Also, almost two thirds of fund managers on the European regional panel describe themselves as overweight German equities Only 14% say they are underweight the country at this time. By contrast, September’s poll shows a correspondingly negative view on U.K. equities, 47% of European fund managers say they are underweight this sector, the most negative reading in a year.

A total of 300 fund managers participated in the global and regional surveys from September 1 to 7. These institutional investors manage a total of US$1.05 trillion.