The quarterly outlook released by Russell Investments suggests investment managers are preparing for the long haul for the remainder of 2008—but they are not completely downtrodden.

When asked to select two factors they thought could negatively affect equity performance in the second half of this year, the largest number of managers (46%) identified economic growth as the most significant potential threat, according to a Russell release. Coming in close second and third were inflation (40%) and both the credit markets and energy costs (38%).

“The good investment managers are always mindful of how and why the road can become rocky, but investors can find comfort in economic indicators that currently are not overly worrisome. Core inflation remains under control, consumers continue to spend and unemployment is relatively low,’ said Erik Ristuben, Russell’s CIO for multi-strategy solutions, in the release. “Managers know the economy and markets are ugly now, but they also know it’s time to put their heads down and grind it out.’

The fact that manager bullishness fell steeply for the classically defensive health care and consumer staple sectors, points to a “classic, persistent, mid-cycle slowdown,’ Ristuben said. Manager bullishness for the health care sector dropped 17 percentage points from 71% to 54% from last quarter, and bullishness for the consumer staples sector fell 10 percentage points from 47% to 37% over the same time period. For this quarter, manager bullishness fell for a majority of equity sectors, and not one sector moved up more than five percentage points, the results said.

Low Point for the Dollar?

The shift in bullishness from developed to emerging markets signals that managers believe the dollar has reached its low point, Ristuben said.

Manager bullishness for non-U.S. developed market equities dropped to a record low of 42%, a 12-percentage-point decrease from last quarter, Russell said. For the first time in 12 quarters, non-U.S. developed market equities fell from the top three bullish asset classes, displaced by emerging market equities. This asset class experienced a slight gain from last quarter, rising to 49% manager bullishness from 46%.

“Much of the recent strength in non-U.S. developed market equities performance has been tied to currency, and that competitive advantage could fade as the Federal Reserve and Treasury Department move to strengthen the dollar,’ Ristuben added.

While managers in the latest survey remain bullish on large-cap growth stocks, their enthusiasm for this asset class is waning, Russell said. At 57%, bullishness experienced a slight decline from 64% last quarter, and is off 18 percentage points from a year ago. Mid-cap bullishness remained essentially unchanged at 49%, but small-cap increased to 40% from 36% last quarter.

Technology Rules

As it has for the past three years, technology continues to dominate managers’ outlook and, at 68%, was the highest bullish rating of any sector or asset class in this quarter’s survey, Russell said.

Meanwhile, the integrated oils sector had a significant decrease, falling 12 percentage points to 43% manager bullishness. Manager bullishness for other energy also slipped slightly. Optimism for this sector was at 57% this quarter, compared with 62% in the previous one.

“Managers appear to believe the run-up in integrated oils and other energy is overdone,’ said Ristuben. “Many prominent economists are at a loss to explain the sharp rise in oil prices, and managers may be taking note.’

For the survey, Russell collected the opinions of more than 330 senior-level investment decision-makers at U.S. large- and small-cap equity investment managers, as well as U.S. fixed-income investment managers.