Cash levels averaged 5.5% in December, up from 5.1% in November. A net 40% of respondents are still overweight cash. These indicators may reflect investors’ desire to put aside cash for end of year redemptions. Such a backdrop suggests that a number of raw ingredients are in place to sustain the recent rally in equities into the New Year.

For the third consecutive month, a majority of fund managers believe equities are undervalued even if they continue to view them with scepticism. A net 21% of asset managers were overweight bonds in December. “Problems could be in store for those who stay heavily invested in fixed income,” notes the report. Following the sharp rally in government bonds in the third quarter of 2008, 42% believe that the asset class is overvalued.

European investors are displaying signs of fatigue towards defensive stocks. The survey shows that managers have reduced their overweight positions by 15% in healthcare, 11% in food & beverage and 8% in utilities. “They are yet to commit to industries that could be poised for a 2009 rally on positive news.”

The survey also points to a rise in the percentage of managers who expect Europe to fall into recession in 2009 from 80% in November o 91% in December. UK interest rates at 2% and sterling weakness have combined to persuade UK managers that monetary policy is now sufficiently accommodative for the first time since early 2007. “This has helped growth fears moderate, with just 70% of UK managers now expecting weaker growth compared to 91% last month and only 60% expecting earnings to deteriorate in the coming year versus 73% in November.”

State Street Global Markets depicts a less optimistic scenario. Its investor confidence index declined from 54.5 in November to 48 in December. Since October 31 institutional investors have been deleveraging roughly two out of every three days, according to State Street. "The most recent decline in confidence is somewhat surprising, as it occurs against the backdrop of modest gains in equity prices over the period. This suggests that instiutional investors may be on the side of providing liquidity to other market participants whose risk appetite has improved somewhat."

VB