‘Bull capitulation’ starts for stock markets; sell signal is near

It’s hard to find a more bullish start to a year than this one. There were “blockbuster” inflows of capital into stocks, as well as corporate and emerging markets bonds, according to the latest analysis by Bank of America Merrill Lynch.

Around $24.4 billion flowed into equities last week, the sixth-largest inflow on record. US stocks saw strong inflows of $6.4 billion, while Japan also attracted $3.2 billion.

European stocks are reversing the December outflows, and have received $2.2 billion in the last week. But emerging markets are the stars of the equity universe, which have received their largest inflows in 73 weeks: $4.3 billion.

Investors’ appetite for risk was visible in fixed income assets, too. High yield bond funds saw their largest inflows in 48 weeks, worth $1.5 billion, while emerging markets debt saw their second-largest inflows on record, of $3.6 billion.

But the clock is ticking. Bank of America Merrill Lynch’s Bull & Bear indicator jumped closer to a sell signal, although it still did not hit the “extreme bullish” region.

Bear/Bull BofAML Indicator

Bear/Bull BofAML Indicator

Looking at its components, hedge fund positioning and credit market technicals are very bullish, equity flows, market breadth and long only positioning are bullish, and only bond flows are bearish.

The bank will release its fund managers survey on Tuesday. Watch out for cash levels – if they fall below 4.3%, that is a sell signal.

Also, inflows of around $15 billion into risky assets like high yield bonds and emerging markets equities and debt would indicate the time to sell is near.

“Peak positioning [is] on its way but we expect asset prices to overshoot first,” the analysts at Bank of America Merrill Lynch wrote.

If the yield on the 10-year Treasury bond remains below 3%, greed will still be stronger than fear. But if wage inflation picks up and yields jump above 3%, or we see a trade war starting in earnest, they will be enough to prevent asset prices from overshooting.