The proportion of fund managers who are worried that equity and bond markets are moving towards a bubble has jumped significantly in recent weeks, according to a closely-watched survey of the global funds industry, after asset prices continued to push higher.
The year so far has been a strong one in general, with the FTSE 100 rising 9.01 per cent over 2015 to date and breaking through the psychologically important 7,000 barrier. However, the FTSE’s advance looks minor compared with that of some of its peers.
While the S&P 500 has lagged with a 7.75 per cent gain, the MSCI World, FTSE 250, STOXX Euro 600 and MSCI Emerging Markets indices have all risen more than 10 per cent. The Nikkei 225 and the Hang Seng, meanwhile, are up more than 20 per cent and the MSCI Russia index is approaching a 45 per cent gain.
In addition, 10-year gilts are trading at 1.53 per cent and the bond yields of much of Europe are at lows, with some trading close to zero. A 10-year US treasury yields 1.88 per cent.
However, the latest Bank of America Merrill Lynch (BofA ML) Global Fund Manager Survey discovered that 54 per cent of asset allocators believe both stocks and bonds have become overvalued. A total of 145 fund managers running a combined $392bn in assets responded to the survey, which was conducted between 2 and 9 April 2015.
Percentage of fund managers saying bonds and stocks are overvalued
Source: Bank of America Merrill Lynch
A net 25 per cent of fund managers polled in the research said equity markets look too expensive. This is up from balances of 23 per cent in March and just 8 per cent in February, making managers their most cautious since 2000.
However, it remains short of the record high level of a net 42 per cent that was set in 1999.
When it comes to bonds, a net 84 per cent of fund managers say the asset class is now overvalued – the highest reading in the survey’s history. Last month, a balance of 75 per cent said bonds were too expensive.
Of course, concerns over a potential bubble in bond markets are nothing new. Commentators have been arguing whether this is the case for some years, after unprecedented quantitative easing (QE) programmes by the world’s central banks pushed yields towards new lows.
However, more and more asset allocators are starting to express worry about the lack of value in the fixed income market and the problems this could eventually lead to.
The tipping point for this appears to be the emergence of negative bond yields in Europe. Earlier this month, Switzerland became the first government in history to sell benchmark 10-year debt at negative interest rates while many believe that Germany’s 10-year bunds, which are trading at around 0.14 per cent, will soon go negative.
In a recent note, Hawksmoor Investment Management head of research Jim Wood-Smith said: “There is one angle to this that I can compute. Paying what is effectively a charge for safe custody of cash can seem reasonable enough when everything else has gone Pete Tong. But beyond that, what are negative yields all about?”
“The case in point is Europe, where economic growth is picking up nicely and core inflation is in positive territory, but where the German 10-year bund yield is heading rapidly the wrong side of zero. The rationale, presumably, is that no matter what price anyone pays, the ECB will pay more.”
“I have long denied that there has been a bubble in bond markets. The dotcom era is still unpleasantly fresh in the memory and there is the world of difference between overvaluation and a bubble. That European bond yields are falling because someone is going to pay more irrespective of price moves us firmly into bubble territory.”
While the consensus is that bonds are on the brink of or are already in bubble territory, fund managers are much more nervous at the moment about the risk of equities being in this condition.
The BofA ML survey found that 13 per cent of asset allocators consider “equity bubbles” to be the biggest tail risk facing markets, a 2 percentage point rise from February. However, that is not the greatest fear of fund managers with that dubious honour falling on geo-political crises and the Federal Reserve “falling behind the curve”.
It’s the US equity market that most fund managers see as being too expensive, with a net 68 per cent of the survey’s global panel highlighting it as the most overvalued.
As the graph below shows, US equities have come a long way since the depths of the financial crisis. Since it bottomed out on 5 March 2009, the S&P 500 has left peers such as the FSTE 100, Nikkei 225 and EuroSTOXX far behind with a 224.88 per cent total return.
Performance of indices since 5 March 2009
Source: FE Analytics
However, other regions of the global equity market still stand out as being better value to fund managers, with Japan and Europe being as areas of particular value despite their strong gains over the year to date.
Both the European Central Bank and the Bank of Japan are engaged in monetary stimulus, while investors increasingly expect the Federal Reserve to lift its interest rates when conditions remain loose in both of the former.
Michael Hartnett, chief investment strategist at BofA Merrill Lynch Research, said: “April’s survey offers further proof that global investors are front-running global monetary policy.”
A net 38 per cent of investors are now overweight Japanese equities, which is a slight fall on the 40 per cent reading last month but is still the fourth highest since 2006.
The country has stood out over recent years because of its low valuation, prompted by a two decade-long deflationary spiral, and the ambitious ‘Abenomics’ stimulus programme designed to kick-start inflation and sustainable growth.
JP Morgan Asset Management global market strategist Kerry Craig recently to FE Trustnet that investors either love or hate Japan, but argued that there are reasons to invest there aside of Abenomics.
“There have been too many false dawns in Japan for any investor to consider its equity market to be a sure thing. Given the depth of the country’s structural problems, it’s admittedly too early to judge whether Abenomics is working,” he said.
“But the Japanese equity market has had an excellent start to the year and there are several reasons to think that it will be supported in the medium term: attractive valuations, decent earnings momentum and continued structural support from official sources.”
When it comes to Europe, a net 46 per cent of fund managers are now overweight the region. This is still high but is down from 60 per cent in March and suggests “the edge has come off the euro exuberance”, according to BofA ML.
Furthermore, a balance of 37 per cent of asset allocators choose Europe as the region they most want to be overweight in the coming 12 months, which is down from 63 per cent in March.
However, a regional sub-survey of fund managers based in Europe also found that a 10 per cent believe European equities are overvalued, up from a net 3 per cent taking the view they were undervalued in March.
Manish Kabra, European equity and quantitative strategist at BofA ML, said: “We are seeing a form of rational exuberance in Europe where a positive view on stocks is supported by fundamentals – but investors no longer believe valuations are cheap.”