>WHERE ARE THE BEARS ? (MERRILL LYNCH)

■ Fear fizzles out, but optimism only skin-deep
August FMS a feast for contrarian, tactical bears. Headline data reveals strongest market sentiment in two years. Big turnaround from apocalyptic bearishness of March. But underlying data shows lack of conviction. Four out of five investors predict a “below trend” recovery and neither regional nor sector positions are extreme. The optimism is skin-deep.

■ Only 8% of investors expect weaker economic growth
Consensus (75%) expects some sort of global recovery. Few expect a “double-dip”. This means “weaker-than-expected” data in coming months would be negative forequities. Next set of Chinese & US data now crucial for September direction. China growth expectations dipped again (to 49%) in the August FMS.

■ Cash balances plunge to 3.5%, lowest since July’07
Strong inflows now required to fund further equity and credit rallies or investors likely to raise cash. Highest equity allocation (34% from 7%) since Oct’07; bond allocation (-28% from -12%) lowest since April’07.

■ Optimism built with narrow regional leadership
EM equities (52%) by far the big OW. Asset allocators UW every other equity region, although the Eurozone UW was narrowed considerably (from -23% to -13%). Note, GEM investors sharply cut exposure to Chinese equities to neutral.

■ Optimism built with narrow sector leadership
Tech (28%) the most favored sector everywhere. Big monthly jump (-11% to 11%) in exposure to industrials. Defensives (telco, staples, pharma) cut back to neutral, while utilities (-15%) most detested global sector. The underweight in bank stocks narrowed (to -10%), but investors remain UW the credit plays.

■ Contrarian long & short trades
Contrarian longs: Japan, US, Asia utilities, US & UK banks, UK & Eurozone real estate, Asia telco, EM materials. Contrarian shorts: US, Eurozone, Japan, Asia tech, EM consumer discretionary, Asia and Japan banks, Russia.

■ Our view: there will be dips…buy them
Short-term pullbacks often coincide with a bullish FMS. That’s happening. But August optimism feels grudging and only skin-deep to us. We remain cyclical equity bulls and buyers of dips. August FMS resembles June 2003 FMS, when big reduction in cash balances (4.9% to 3.9%) and increase in equity allocation (3% to 22%) caused a nascent cyclical bull market to pause for breath. The bull market resumed a few months later.

To see full report: FUND MANAGER SURVEY