Stocktake: Bullish investors wrongfooted by Covid

Prior to yesterday’s big selloff, fund managers were bullish – too bullish, perhaps.

Bank of America’s latest monthly fund manager survey is the most bullish of 2020, with investors underweight cash for the first time in more than seven years.

Cash levels have fallen to just 4 per cent, which triggered BofA’s sell signal for equities, as very low cash levels are indicative of overconfidence and typically associated with poor one-month returns. In contrast, managers are more overweight with equities than at any time since January 2018, when markets topped out after a rapid run-up.

BofA's survey is no outlier. Deutsche Bank's Jim Reid notes his survey of more than 900 investors showed a risk-on outlook for 2021 is "extremely consensus". In the 25 years he has been doing the survey, said Reid, "I can't remember a time when so few (if any) disputed the central narrative".

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Similarly, an Absolute Strategy survey shows a large majority expect valuation multiples to expand next year – a potentially dangerous assumption, as S&P 500 valuations are already two standard deviations above their 30-year average.

Excessively bullish sentiment can be a red flag. Yesterday’s big Covid-related selloff is a reminder of what can happen when wrongfooted investors are not positioned for bad news.