Wed 18 August
By Steve Hays

LONDON (Reuters) - Fund managers' views on corporate profitability worldwide have turned sharply negative over the past month for the first time in three years, a Merrill Lynch survey of fund managers shows.

"It's the first time fund managers have turned negative on profits since April, 2001," David Bowers, chief global investment strategist at Merrill Lynch told reporters.

"There's a veritable collapse in expectations; they are abandoning corporate earnings and focusing on cash."

The survey of 293 fund managers polled in global and regional surveys between August 6-12, showed 51 percent of respondents expected corporate profits to deteriorate over the next 12 months compared with 40 percent in the July report.

The majority of fund managers now want cash flow generated by companies to be returned to shareholders. Some 41 percent are in favour of increasing share buybacks and/or dividends, up from 34 percent in July and 32 percent in June.

"With investors at the moment, it's a case of show me the money," Bowers said. "Many of them have given up believing in global economic growth, so if nothing better can be done with the corporate cash they want in back."

Fund managers' cash holdings have risen sharply with their average balances now standing at 4.8 percent -- the highest since March 2003. Over 40 percent of respondents said they were overweight in cash, up from 30 percent in July.

Merrill said this cash position is one of the highest it has seen, surpassed only by the aftermath of the September 11, 2001 terror attacks on the U.S., the market uncertainty prior to the Iraq war and the credit crunch of October, 2002 on the Enron/WorldCom balance-sheet debacle.

Previously, high fund cash levels have augured well for equities as they have helped provide the liquidity for subsequent market rallies, Bowers said.

But this time around, unlike previous occasions, equities are not seen as especially overvalued. Bowers said a sharp drop in the oil price could still trigger a rally in share markets.

Average earnings per share (EPS) growth expectations in the survey for the next 12 months declined to 5.6 percent in August from 8.1 percent in July.

"This month fund managers woke up to the fact that top-line sales growth (both volume and pricing) was at risk. And there was a significant number of panellists that had started to look at cost cutting again," Merrill Lynch said in the survey.

It is difficult to find genuine value in either equities or bond markets, Bowers added.

EQUITY PREFERENCES POLARISED

Fund managers' regional equities preferences have become more polarised. Japan remains the market they would most like to overweight, with the most favourable corporate profits outlook, although this has waned to 32 percent from 36 percent in July.

The U.S. equities market is seen as most overvalued with 51 percent of managers rating it their least-liked region.

Investors are most overweight in global energy stocks, with pharmaceuticals a distant second -- though this is the sector seen as most undervalued in a more defensive stocks environment.

Global bank stocks are the least favoured equities sector.

"Banks have been major beneficiaries of the extended credit cycle. But now with the flattening of the yield curve, credit growth is not as strong and there is an M&A (mergers and acquistions) slowdown indicating the banks may be going ex-growth," Bowers said.

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