Fund Managers Are Bullish but Wary

Top money managers have turned sharply more bullish since the start of the year. But with that comes a problem: Inflation fears, they say, are back on the table. These are the findings from Merrill Lynch's latest global survey of institutional investors.

"Asset allocators increasingly believe that the Fed should be more concerned about the risk of higher inflation than about the risk of slower economic growth," says Merrill adviser David Bowers, who produced the report.

It's no wonder the yield on 10-year Treasuries, which reflects inflation fears, has risen to 4.7% from just over 4.4% at the start of December.

The warning appears to put institutional investors at odds with Fed chief Ben Bernanke, who made cheerful hints about interest rates last week. The survey was conducted before last week's testimony and before fresh data suggesting the U.S. economy was softer than expected in the fourth quarter. The warning also reflects concerns about rising prices overseas.

On the positive side, the 206 money managers surveyed this month have become significantly less pessimistic about the global economy. The net balance of money managers who believe the economy will weaken in the next 12 months has halved since November.

The money managers have dropped their cash balances to some of the lowest levels since Merrill began tracking the figure back in 1997, and they haven taken on more risk, and more equities, in their portfolios. An increasing number are also pressuring company CEOs to borrow more money and spend it expanding their businesses, a sure sign of bullishness.

In short: Asset allocators, says Bowers, are "in love with equities."