Bank of America thinks investors are suffering from 'Stockholm syndrome' -- and the outcome looks ugly

Poland's Elite Special Forces Unit GROM in conjunction with Poland's Antiterrorist Police Force and Railroad Defence Guard take part in an exercise involving a hostage rescue situation on a train at undisclosed location in northern Poland prior to Euro 2012 soccer championships December 1, 2011. Poland is investing heavily in security for next year's European football championship despite downgrading the number of visitors it expects. Commandoes have been simulating a multiple hostage situation in case criminals target the world's second largest football tournament, which is being co-hosted with Ukraine next June. Picture taken December 1, 2011. REUTERS/Peter AndrewsPolish special forces and police take part in a hostage rescue exercise.

“Stockholm syndrome” is a term used to describe when hostages begin to empathise with, and even trust, their captors.

It’s also what Bank of America Merrill Lynch thinks is happening to investors going big on shares right now — and their captors are central banks.

The bank’s European Equity Strategy has put out a note saying investors are facing a “lose/lose” situation by piling into stocks.

Globally shares are up 5% so far this year as investors embrace risk, while the safer bond market is down 3%. That’s because investors assume central banks who are currently pumping money into economies around the world have their best interests at heart — hence the “Stockholm syndrome.”

But BOAML’s chief investment strategist Michael Hartnett says investors shouldn’t be so quick to put their faith in central bankers and urges investors to take more caution. Hartnett and his team think that the current situation is actually “lose-lose” for investors going big on shares.

The first scenario sees central banks, most importantly the US Federal Reserve, stop pumping cash into global economies in the form of quantitative easing.

This would create more volatility in shares, because part of what has been supporting stock markets around the world is central banks buying up huge amounts of debt and the assumption that this will continue.

Increased volatility means more shares going down as well as up and the chance of burnt fingers for those who haven’t hedged their bets.

The alternative scenario sees central bankers keep pumping in cash — but the only reason this would continue would be fundamental economic indicators like GDP and earnings per share not moving up as desired.

In this case the stock bubble would eventually have to burst, given that rising share prices don’t match up to the economic reality underneath.

This is a particularly serious risk for those betting on companies with exposure to US consumer spending. This segment on the market has been on a strong rally of late despite disappointing underlying spending figures.

Investors are betting it will improve soon, but if it doesn’t they could be in for a shock.

BOAML consumer stock rallyBank of America Merrill LynchCompanies exposed to US discretionary consumer spending been rallying strongly but could be due a correction.

That’s not to say the bank is totally bearish. On it’s nifty “Bull & Bear Index,” the bank it rates itself as almost exactly in the middle.

The key takeaway though is not to go all-in on stocks and hedge investments in less risk assets.

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