As more investors begin to believe that the global economy is in a recession, fears of inflation are dropping, and money managers are turning their concerns from credit risk to leverage.

"The message from investors to corporates is that if we are headed for a recession, they should clean up their balance sheets and prepare a financial buffer," said Karen Olney, chief European equities strategist at Merrill Lynch. "As banks de-lever, nonfinancial corporates will have to wake up to far less flexible world of credit."

According to Merrill Lynch’s Survey of Fund Managers for August, 18% of the 193 respondents expect global inflation to fall in the next 12 months, compared with 33% who thought inflation would rise in June’s survey.

Among the respondents, 58% said they thought the U.S. dollar is undervalued and 71% said the euro is overvalued.

Many investors who were overweight on energy have begun closing those positions, but Merrill Lynch thinks the energy industry should continue to hold a strong oil price of about $119 for the fourth quarter.

"While we have started to see some demand for oil curtailed in OECD economies, the economic fundamentals in China and other emerging markets support oil at more than U.S. $100 a barrel into 2009,” said Francisco Blanch, Merrill’s head of global commodities research.

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