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Positive economic sentiment has helped drive investor appetite for global equities to its highest level in 3.5 years, according to the BofA Merrill Lynch Survey of Fund Managers for January.

A net 55% of asset allocators say that they are overweight global equities, the highest reading since July 2007. It represents a significant increase from December, when a net 40% was overweighting the asset class. At the same time, bond allocations fell. A net 54% is underweight bonds, up from a net 47% a month ago.

Behind this rise is growing confidence in the global economy and corporate profits. A net 55% of investors expect the world's economy to strengthen in 2011, with 39% predicting "above trend" growth in the coming 12 months, the highest reading since the question was introduced in February 2008. A net 57% believes that corporate profits will rise 10% or more this year, up from 45% in December.

A growing majority expects global inflation to increase this year - a net 72% in January, up from a net 48% two months ago. But higher inflation is not seen necessarily as a threat. A net 42% of investors believe monetary policy is "too stimulative," fewer than in November.

"The combination of growth optimism and a benign view towards higher inflation provide a potent case for equity investment," says Gary Baker, head of European Equities strategy at BofA Merrill Lynch Global Research.

"Investors believe monetary easing is working; in the absence of either tighter policy or weaker data, equity enthusiasm looks contagious," adds Michael Hartnett, chief Global Equity strategist at BofA Merrill Lynch Global Research.

U.S. and Japan Sentiment Improves

Growing belief in U.S. equities, already evident in December's survey, has firmed significantly this month. A net 27% of the global panel is now overweight U.S. equities, the highest reading since November 2008 and surpassing December's level of a net 16%.

A net 15% of the panel would like to overweight U.S. equities more than any other region, up from a net 7% in December. A net 43% expects the U.S. dollar to appreciate versus the euro or the yen on a trade-weighted basis, up from a net 14% two months ago.

Japan has also benefited from improved sentiment. Global investors have moved overweight Japanese equities for the first time since May 2010 and for only the fifth month in 3.5 years. A net 5% of the global panel is overweight Japanese equities, compared with a net 29% being underweight in November.

Domestic Japanese sentiment is strengthening. A net 57% of respondents to the regional Japanese survey expect the country's economy to improve this year, up from a net 42% in December. Sentiment has improved steadily since September last year when there was an even split between those predicting a stronger economy and those expecting weakness.

Global emerging market support remains high but has continued to decline. A net 43% of asset allocators are overweight GEM equities, but this is lower than the net 56% two months ago. A net 20% of investors want to overweight GEM equities more than any other region. This reading has slipped from a net 31% in December. These lower readings come as belief in China's economic prospects has eroded. A net 19% of respondents to the regional survey say that China's economy will weaken this year. Two months ago, a net 16% forecast a stronger Chinese economy.

Commodities investment, a bellwether for emerging market optimism, has fallen with a net 16% of asset allocators overweighting the asset class compared with a net 22% a month ago. This fall comes despite the fact that commodities traditionally benefit when investors expect higher inflation.

European Investors Feel New Year Joy

European fund managers have started 2011 in stronger spirits. The proportion of the panel predicting a stronger European economy has leapt to a net 44%, from a net 26% last month. An increasing number believe European companies will deliver improved earnings in 2011. This optimism comes as global concerns about EU sovereign debt fund risk have fallen away from the highs of December.

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