Turmoil in credit markets is starting to feed through into equity market fundamentals, but investors have yet to radically shift their portfolios, according to Merrill Lynch's Survey of Fund Managers.

Risk aversion has risen sharply with investors holding cash levels of more than 4.3 per cent, and shortening their investment horizon to an extent not seen since March 2003, with the FMS Risk Indicator standing at 33 in September - the second worst reading ever.

A net 34 per cent described liquidity conditions (market depth, narrowness of bid-offer spread) as 'negative' just two months after being seen as 'positive' by a net 75 per cent.

Growth expectations are deteriorating and concerns of monetary policy being 'too stimulative' have diminished. Business cycle risk has emerged as a significant threat to market stability with 61 per cent saying business cycle risk is above normal, up from 32 per cent in August.

'Investors say they are worried about business cycle risk, but asset allocators have yet to start reshaping their portfolios for a different environment,' said independent consultant to Merrill Lynch David Bowers. 'This begs the question of whether they are in denial about the possible extent of this downturn.'

Respondents continue to favour emerging markets and eurozone equity markets in the middle of the market upheaval, while shunning US and UK stocks.

A net 36 per cent of Global concerns about short term prospects are also evident in the eurozone where 45 per cent of respondents expect growth to slow and no-one expects double-digit profits next year.

In addition investors have slashed holdings in credit or interest-rate sensitive sectors such as banks, autos and construction.

Surprisingly, however, a net 27 per cent still remain overweight insurance, even though global investors are underweight.

Merrill Lynch's own analysts, too, are more cautious. The September Merrill Lynch Analyst survey's measure of sentiment has fallen below 50 for the first time since November 2006, when the survey was created.

'The outlook for earnings momentum has taken a short-term tumble as analysts worry about escalating input and borrowing costs,' said Chief European Equity Strategist Karen Olney.

'But such is belief in the strong structural growth story to the East, that expectations for growth for next quarter are up - not down.'Trade Arabia News Service