Investor optimism gets close to euphoria levels

The first quarter of 2017 is over, Brexit has been finally triggered and a period of political turmoil in Europe is ahead, with elections in France and Germany, and perhaps Italy too.

So far, it seems like nothing has been serious enough to give investors reason to pause the rally in stock markets. Both the US and the UK indices hit record highs — this could be a sign of confidence, but it could also mean the central banks’ easy monetary policies are still inflating asset prices.

According to data from Bloomberg, global stocks have gained $4.8 trillion in market capitalisation in the first quarter, the most since 2012. A bounce on corporate earnings, as well as acceleration of global growth, were given as reasons for this jump.

But is sentiment too euphoric? Bank of America Merrill Lynch’s measure of investor sentiment is dangerously close to its “sell” signal.

The Bull & Bear indicator has reached 7.0, the highest level since July 2014. But the analysts at the investment bank advise investors to remain long risky assets until sentiment reaches the “euphoric territory of 8.0”.

Of its six components, three — hedge fund positioning, credit market technicals and equity market breadth — are very bullish. Equity flows are neutral, while bond flows and long-only positioning are bearish.

In the first quarter, stocks rose 7%, outperforming the 2% rise in bonds, while the dollar was the first quarter’s biggest “pain trade,” as it fell by 2% when most investors were expecting it to strengthen.

The weaker dollar helped emerging markets to shine, both in terms of equities and bonds.

For the second quarter, the analysts at Bank of America Merrill Lynch have expectations of stronger growth, which will be the driver for markets.

The risks to this bullish call are what they call the three Cs: China, commodities and credit. On the back of People’s Bank of China tightening, a global profit top might form that would put a lid on risky assets.