‘Irrational Exuberance’ May Rule the Roost in Stock Markets

  • BAML fund-manager survey shows risk taking at all-time high
  • Investors see stocks as overvalued but bullish on growth
Tribeca's Fenton Sees Warning Signs for a Market Pullback

Investors are riding a wave of “irrational exuberance” as they extend bullish positions even as they fret over valuations, according to the latest fund-manager survey by Bank of America Merrill Lynch.

While a record net 48 percent of investors say stocks are overvalued, a net 16 percent say they are taking on above-normal levels of risk, another all-time high. Investors are also taking out less downside protection and holding less cash, the survey shows.

“Icarus is flying ever closer to the sun,” said Michael Hartnett, the bank’s chief investment strategist. “And investors’ risk-taking has hit an all-time high.”

The results highlight the dilemma faced by investors in an era where central bank stimulus has flooded the market with liquidity and suppressed returns from less risky assets like bonds. Even after a $5 trillion gain in U.S. stocks over the past year, a net 49 percent said they are overweight, the highest level since April 2015.

The percentage of investors projecting a “Goldilocks” economic backdrop of steady expansion with tempered inflation rose to a record 56 percent, according to the poll of money managers overseeing $533 billion conducted Nov. 3 to 9. The survey notes a mini rotation out of banks, though investors remain overweight the sector, in favor of laggard energy names and Japanese equities.

Surveyed investors are divided over the likely impact of the White House’s tax agenda next year, with one camp expecting it will yield no change to the economic outlook, and the other saying the reform will spur inflation.

Cash positions fell to 4.4 percent from 4.7 percent last month, the lowest level since October 2013 and below the 10-year average of 4.5 percent, according to the survey.

"A record-high percentage of investors say equities are overvalued yet cash levels are simultaneously falling, an indicator of irrational exuberance,” Hartnett concluded.

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