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Deadbeat Worries Haunt Fund Managers

Brett Arends

Fresh news from Merrill Lynch(MER Quote) gives an alarming hint -- and suggests just how vulnerable market sentiment remains.

Two words leap out of the investment bank's latest monthly survey of fund managers around the world: "counterparty risk."

That's supposed to be Wild West stuff -- the fear that the other poker players can't cover their bets, or might fail to pay up if they lose.

You don't expect it to be a big issue on the minds of the kind of blue-chip institutional investors that Merrill Lynch talks to.

But by last week, when they were polled by Merrill, 74% of them cited counterparty risk as a real danger to financial stability. Seventy-four percent.

That figure had trebled just since July. In fact it had soared even from the panicky week in early August when Merrill conducted its last survey.

It shows how deeply and widely this summer's subprime mortgage crisis and the hedge fund blowups have shaken confidence.

No wonder the lending business froze.

When you can't trust the other players, no one's going to ante up.

This worry buttressed other data revealed in the survey. Overall, Merrill found institutional investors had become almost as fearful as they were back in the prewar panic of March 2003 -- 42% said they were holding more cash than normal.

It's no surprise the market had such a good week. The survey was conducted between the 7th and the 13th. When everyone was so afraid, the market by definition was oversold and ready for a bounce.

But not all the questions have gone away.

While hardly any of the fund managers surveyed are talking about a recession, more than 60% nonetheless fear a slowdown in the global economy and cite "business cycle risk" among their fears.

And they aren't just worried about short-term liquidity issues or another hedge fund blowing up.

The big, hidden story may be about corporate profits.

They're already at record levels, here at home and elsewhere. How long can they keep booming?

Fund managers aren't hopeful. No fewer than 54% now fear that global profit margins will fall over the next 12 months.

How many expect margins to rise? Just 10%.

That's a marked rise in pessimism in the last few months. And fund managers may be understating their concerns. For example, fewer and fewer expect rising sales volumes or prices to lift corporate profits over the next 12 months. Instead, an alarming 40% are now left pinning their hopes on "cheaper costs."

If you happen to see any cheaper costs around, do let them know. Energy? Raw materials? Labor? Good luck.

The only thing falling in price lately has been Apple's(AAPL Quote) iPhone.

In other findings, fund managers said they were shunning banking shares even though most of them thought the sector was one of the cheapest around. It's another sign of how nervous they are: They're just too afraid of a blow-up.

On a regional view, they remain heavily overweight European equities, while they are now underweight the Nikkei again as well as Wall Street. Interesting news for contrarians, as usual.