Fund managers are rushing into equities. The Bank of America Merrill Lynch survey of global fund managers for January shows that the cash level with them has dropped from 4.7% in December to 4.4% now.
Are the markets heading into a frenzied “melt-up" phase?
Most of the cash has gone into equities, with allocations at their highest since March 2015. So gung-ho are fund managers about stocks that the proportion of them taking out protection against a near-term correction in the markets has dropped to a four-year low. Net hedge fund equity market exposure is the highest since 2006.
Most investors still believe in a combination of above-trend growth and below-trend inflation that has been dubbed the Goldilocks scenario. In December, investors had pointed to higher inflation as problem number one for Goldilocks. In January, inflation expectations are at their fourth highest since 1995, but at the same time they are determined to stay long on equities until they see signs of inflation affecting earnings.
What could cause the party to end?
Inflation and a bond crash is the main tail risk. Close to half the fund managers surveyed cite second quarter or third quarter of 2018 as the likely peak, whereas 30% see equity markets peaking in 2019 or beyond. In December 2017, almost all of them said equities would peak in 2018.
“By end-Q1 we expect peak positioning to combine with peak Profits & Policy to create spike in volatility," says the Bank of America Merrill Lynch survey.