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A “self-feeding panic” has led to investors ditching equities in their droves and flocking to cash and short-dated government bonds, according to multi-manager FundQuest.

Peter O’Connor, deputy chairman at FundQuest, said the flight to cash and government bonds has been brought about by a hysteria born from deleveraging and deteriorating prospects for global growth and earnings.

“Globalisation across asset classes has exacerbated this self-feeding panic. Bad news has, however, been discounted in valuations, leading to recent stock market rallies,” said Mr O’Connor.

The wobbling 62 per cent of global output generated by the US, the EU and Japan has shattered emerging-market immunity to developed-world recessions, he said.

He added the IMF’s global economic growth forecast of 1.9 per cent in 2009, based on 6.1 per cent growth from emerging economies, will be cut back by the impact of the credit crunch.

According to the deputy chairman, the deleveraging in equity markets that has hurt banks and insurance companies will hit hedge funds and private equity further. The typical hedge fund, for instance, is down roughly 20 per cent this year.

"Excessive risk taking, leverage, poor management and the temporary ban on shorting financials have produced exceptional stress," he said.

Mr O’Connor said government and central bank action to shore up the financial institutions in the US and the EU has eased pressure on short-term lending in money and credit markets.

Central banks elsewhere have also been able to curb interest rates in the face of falling oil, energy, food and other commodity prices.

Yet, as inflationary concerns evaporate, deflation on a Japanese scale is becoming a real possibility, said Mr O’Connor.

“Volatility across all asset classes reflects the instability threatening financial and economic systems in developed and developing countries alike,” he said.

“Just as globalisation facilitates cost manufacturing and world trade, it allows markets to unravel rapidly. This has led to investor panic. As for prospects, there are few certainties.”

He concluded investors should focus on well-managed companies with good and growing market share where a combination of earnings and dividends makes market valuations attractive.