Investors are looking forward to 2010 as a year of moderate economic growth, benign inflation and solid returns in global equities, according to the BofA Merrill Lynch Survey of Fund Managers for December.

Optimism about the economy strengthened this month. A net 80 percent of respondents expect the world economy to grow over the next 12 months, compared with a net 69 percent in November. Two-thirds of investors expect equity markets to return to traditional growth levels or better.

Expectations for corporate profits are at their highest level since December 2003, supporting demand for greater capex. A net 48 percent of investors say that companies are under-investing. At the beginning of 2009, most investors thought companies were over-investing. Concern about inflation remains subdued. A growing proportion of survey respondents do not expect interest rate hikes from the Fed before the second half of the year, a view echoed by European investors on the ECB.

"Investors are nervous but optimistic heading into the new year, and respondents are looking for a 7.7 percent total return from global equity markets," said Michael Hartnett, chief global equity strategist at BofA Merrill Lynch Global Research.

The positive outlook comes in spite of sharp movements out of bank stocks. A net 28 percent of respondents are now underweight bank stocks compared with 11 percent in November, a monthly swing of 17 percent.

"A year ago, strong pessimism over bank stocks would have spread across the market, but now it appears to be isolated to the banks. Investors seem to be saying they can be optimistic on markets even without bank support," said Gary Baker, head of European equity strategy at BofA Merrill Lynch Global Research.

Europeans rush to embrace equities before year-end: After months on the sidelines observing an economic recovery but sticking with defensive equities, European investors have taken the plunge into riskier assets. Respondents to the European regional survey have reduced their cash holdings and shifted towards cyclical stocks.

A net 6 percent of the panel is underweight cash, compared with a net 18 percent in November. A net 82 percent of the regional panel expects improved earnings in 2010, a five-year high and up from a net 69 percent in November.

Among the sectors benefitting from the newfound optimism were Chemicals, Basic Resources and Construction. For example, Chemicals experienced a positive swing of 37 percent with a net 6 percent of investors overweight the sector in December, compared with a net 31 percent underweight in November.

"Investors have moved from a concentrated defensive portfolio to a more balanced allocation that actually lowers their risk of underperforming the benchmark," said Patrik Schowitz, European equity strategist.

Mirroring the trend seen in the global survey, European investors have become significantly more bearish on bank stocks. A net 37 percent of respondents are underweight the sector, up from 26 percent in November.

Korea and Taiwan seen fueling Asian growth: China is seen driving growth within emerging markets with 61 percent of the panel in Asia-Pacific (excluding Japan) believing China's economy will be stronger 12 months from now, up from 44 percent the previous month. But confidence is also rising in Korea and Taiwan with 20 percent of the panel expressing a desire to overweight equities in each market next year. A month ago, only 4 percent of respondents backed South Korea and a net 4 percent were underweight Taiwan.

Conviction grows in a stronger dollar while gold seen as overvalued; Investors' views on the fortunes of major world currencies have firmed significantly in the past two months, with the panel convinced that the U.S. dollar will strengthen and the yen weaken. A net 37 percent project the dollar will appreciate over the coming 12 months, compared with just 5 percent taking that view in October. A net 35 percent predict the yen will depreciate, up from a net 11 percent in October. While the dollar is expected to gain, gold is tipped to fall in value with 50 percent of the global panel saying the metal is overvalued, up from 40 percent in November.

Survey: A total of 213 fund managers, managing a total of US$617 billion, participated in the global survey from 4 December to 10 December. A total of 179 managers, managing US$390 billion, participated in the regional surveys. The survey was conducted by BofA Merrill Lynch Research with the help of market research company TNS.