Fund managers think that stocks are overvalued with positioning disproportionately long, creating the risk of a rush for the exits at some point in the future.
However, despite those views, they continue to double down on stocks.
That’s the brief synopsis of the latest Fund Manager Survey from Bank of America Merrill Lynch (BAML) with money managers seemingly content to follow the prevailing trend despite the perceived risks.
The first chart featured look at the percentage of fund managers who are currently carry an overweight position in stocks.
According to the latest survey, a net 48% said they were holding an overweight position, near the highest levels since early 2015. According to BAML, the current allocation is high at 0.8 standard deviations above its long-term average. It’s fairly unsual, in other words, but not unheard of.
Interestingly, while an unusually high proportion of fund managers are heavily invested in stocks, a record percentage also believe that global equities are overvalued.
On a three-month moving average basis, BAML says a record 45% of fundies think stocks are overvalued. At the same time, average cash positions being held are falling, something BAML says is a sign of “irrational exuberance”.
Speaking of exuberance, a large proportion still believe that stocks are currently a crowded trade, especially tech stocks in the US and China. At 29%, the number who believe being long tech stocks is second only to Bitcoin at 32% in regard to being the most crowded trade.
A crowded trade is one where investor positioning is disproportionately skewed in one direction. Put bluntly, everyone is looking for the same thing to happen.
Shorting volatility — another trade that has allowed stocks to rally this year — is also regarded as crowded by 14% of those surveyed.
That’s clearly a risk for stocks — particularly bond proxies — given 77% of fund managers expect that global long-term interest rates will rise over the next 12 months, along with 83% who say that bonds are overvalued.
Reflecting that sentiment, 14% indicated that the biggest risk for markets next year will be a crash in the bond market, second only to a policy mistake from the Fed or ECB at 23%.
So what gives?
Fund managers think that stocks are overvalued and crowded8, with plenty of risks to navigate. But despite this, they’re reluctant to take risk off the table even with stocks sitting at record highs.
These final two charts may explain the rationale.
After a solid acceleration this year, a net 31% think that the global economy will grow at a faster pace next year — well below the peaks seen in prior years, but still comfortably in positive territory.
So the majority think the improvement in the global economy has further to run — an outcome that usually works well for corporate earnings.
And, at the same time global growth accelerates further, inflation is still expected to remain low, creating what is deemed to be a “Goldilocks” scenario for risk assets by BAML.
54% of fund managers expect that scenario to play out next year, just off the record high struck in the previous survey.
So despite the risks, many retain the view that macro conditions will remain conducive to stocks, helping to explain why stocks remain in vogue.
However, given everything that’s been seen in the December FMS, the clear overarching risk appears to be if inflationary pressures were to suddenly stir.
Few expect that given the experience of recent years, but as spare capacity is slowly absorbed as economic conditions improve, it remains a threat given markets aren’t positioned for such an outcome to occur.