Professional fund managers now say US stocks are more overvalued today than they have been in nearly 20 years, according to a new survey done last week by Bank of America Merrill Lynch (BAML).
The latest BAML survey found that a net 34% of fund managers now believe US equities are overvalued compared with other areas of the world. That’s the highest level ever in the BAML survey going back 17 years.
But it gets even worse. A net 81% of global fund managers believe that the US is the “most overvalued region” compared with other areas of the world. These professional investors are starting to worry that stock prices are getting out of hand compared with where they should be, especially given that the US bull market just clocked its eighth anniversary.
That’s the bad news. The good news is that even while valuation is a big concern, managers seem to have little fear of a bear market popping up anytime soon, despite worries over a near-term “correction” in the market.
By way of contrast, 44% of fund managers said emerging market equities are undervalued, and 23% said Eurozone equities are undervalued. The chart below illustrates such thinking (GEM represents emerging markets).
There are two primary concerns raised by the latest BAML survey results. The first is that the US equity markets may be long overdue for a significant downward correction.
The second is the fear that US retail investors are increasingly feeling the same way fund managers do and could stage a mass exit from US equity funds just ahead. In fact, it may already be happening.
Investors appear to be putting their money where their mouths are. The BAML survey also tracks changes to asset-class positioning each month, and emerging markets saw the biggest capital inflows, with the US seeing the biggest fund outflows last month.
Here’s what survey respondents said will finally cause an end to the US bull market that now spans eight years – higher interest rates, weaker earnings and protectionist policies were the top three choices. No real surprises there.
Regarding higher interest rates, we just had an earlier than expected Fed Funds rate hike last week, along with the near-promise of two more increases this year and three more next year.
As for weaker corporate earnings, there is concern that the increasing disparity between Treasury yields and the S&P 500 dividend yield could threaten stocks. The thinking is that rising government bond yields could divert money away from lower-yielding equities.
This concern, in my opinion, is overblown. Even if the Fed follows through on its rate hike projections for this year and next, the Fed Funds rate will still be below 2.5% at the end of 2018. That is still extremely low by historical standards.
As for protectionist policies, that fear is also overblown in my opinion. Based on the high-profile corporate types that President Trump has selected for his Cabinet, the odds should be low that they will let him go down the protectionist path. Fund managers agree: only 20% expressed such concerns in the latest BAML survey.
Fears about the global economy don’t seem to be a particularly large concern either. Worries that the world is in a period of “secular stagnation,” or a long-term slowdown that will mute returns, dropped to their lowest level in 5½ years last month. A net 58% of fund managers believe global growth will accelerate over the next 12 months.
So what are we to think? The last time professional fund managers felt US equities were nearly this overvalued was in 2000, just before a serious bear market. Do I think we’re looking at a repeat of that just ahead? Not necessarily – markets can remain overvalued longer than expected – but I do not rule out at least a correction before long.
The fact is the current US economic expansion, weak as it has been, is getting quite long in the tooth. Ditto for the bull market in US stocks which began in the spring of 2009.
Does that mean you should get out of the market? No, but it might be an excellent time to consider actively-managed strategies that can move to cash, and are not highly correlated with stocks and bonds, in the event of a market downturn.
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