The sovereign debt crisis coupled with persistently high unemployment rates in the United States and continued fears over the 2008 financial meltdown has rocked investor confidence, so much so that investor mood has completely turned around in the past month.

According to the Bank of America Merrill Lynch Survey of Fund Managers for July, which was released on Tuesday, 12% of respondents expected the global economy to deteriorate in the next year, compared with June’s results when 24% forecast the economy to strengthen. July’s results were the first negative forecast since February 2009.

BofA Merrill Lynch Global Research and market research company TNS conducted the survey of 202 fund managers managing a total of $530 billion from July 1 to July 8. A total of 170 managers, managing $393 billion, participated in the regional surveys.

“The sovereign debt crisis with Greece having to be rescued, Spain on the brink, and Portugal downgraded today, has made investors sensitive. The last crisis is still fresh for many people and the realization that the global economy is connected and a crisis in one place can ripple through other nations makes people very aware these days,” said Alois Pirker, research director at Aite Group. “Before the crisis investors wouldn’t have paid attention to what’s happening outside the U.S., but people are very sensitive these days.”

Four percent of respondents expect corporate profits to deteriorate in the next year, compared with 28% forecasting earnings growth in June. One percent of respondents say that profit margins will slide in the coming year, compared with 31% who predicted improving margins in May.

Meanwhile, risk appetite has fallen causing investors to shift into cash and reduce exposure to cyclical stocks. Cash now comprises 4.4% of an average portfolio, up from 4.1% in May.

“July’s survey echoes the sentiment that investors expressed during the recession in early 2009,” said Gary Baker, head of European Equities strategy at BofA Merrill Lynch Global Research, in a press release.

The good news is that four of 10 investors predict the Federal Reserve will not raise interest years before July 2011 and inflation concerns have eased as well as worries over growth have come to the forefront. Twelve percent of investors predict inflation to fall in the coming year, compared with June when 12% were forecasting higher inflation. As a result investors are pushing back the date they expect next to see a rate hike in the U.S. or eurozone.

“Growth and profit expectations have double-dipped. Should upcoming data fail to confirm a double-dip, risk assets will have a much better third quarter,” Michael Hartnett, chief Global Equity strategist at BofA Merrill Lynch Global Research, said in a press release.

Emotions seem to be ruling investor decisions. Despite the fact investors have acknowledged that equities are increasingly undervalued and bonds increasingly overvalued, those surveyed said they have scaled back positions in global equities, while moving into bonds over the past two months. Those that are overweight equities have fallen to 11% from 30% in May, while the proportion underweight bonds have fallen to 15%, down from 29% in May. The spread in perceived valuations of bonds and equities is at its widest since 2003, the survey said.

Those investors who are still investing in equities seem to be moving out of the U.S. and into emerging markets and Eurozone investments, according to the survey. Investors are now more worried about the outlook for U.S. equities than at any point since November 2006, with 14% of respondents saying it is the region they would most like to underweight. Last month, 14% of respondents said the U.S. was the region they most wanted to overweight.

The winners of this shift are the emerging markets, which despite weakened economic sentiment towards China and Europe have been gaining on U.S. equities.

Pirker said that transaction volumes from large firms have tumbled significantly in the second quarter. “We’ve seen a huge slowdown of trading and investment appetite and it coincided with what happened in Greece and other nations,” he said. “In the first quarter investors thought the economy might show improvements, but the second quarter has shown there is still trouble at hand."

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