Investors flag up overheating bonds and equity markets

A closely watched survey of global investment managers reflects how diverging central bank policy continues to drive sentiment for bonds and equities.

Expectations that interest rates will rise in the US this year, while the European Central Bank and the Bank of Japan are engaged in quantitative easing, has compelled investors to flag over heating bond and equity markets, according to a Bank of America Merrill Lynch fund manager survey released on Tuesday.

More than four in every five investors think bonds are overvalued, the highest proportion since the survey began in 1998, said the bank, while a quarter of investors believe global equities are currently overvalued, the highest such estimate since the internet bubble era peaked in 2000.

This comes after relentless investor appetite for fixed income fuelled the largest quarterly flow into global bond-exposed exchange traded funds during the first three months of the year. Some $37.6bn poured into fixed income, the second successive record breaking quarter, according to Markit.

Fund managers believe in regional terms that the US represents the greatest risk of having overvalued asset prices, but thanks to differences in monetary policy, all other regions, including Europe and Japan remain undervalued.

"These assessments come as investors increasingly accept that US rates will rise at a time when the European Central Bank and the Bank of Japan are engaged in monetary stimulus," said BofA Merril Lynch.

Surging stock markets against the backdrop of central bank stimulus efforts have set alarm bells ringing recently. The Shanghai stock exchange has doubled over the past 13 months, and the Eurofirst 300 is up 20 per cent this year.

In turn, 13 per cent of those surveyed believe a bubble in equities represents the "biggest tail risk" for markets, a concern that has risen from a ranking of 2 per cent in February.

Fund managers have reduced their enthusiasm for eurozone equities after funds enjoyed record inflows in the first quarter, with the launch of the European Central Bank's QE programme, driving yields on €1.5tn, or a quarter of sovereign debt, into negative territory.

Now 46 per cent of fund managers remain overweight eurozone equities, a decline from the record 60 per cent seen in March.

"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," said Manish Kabra, European equity and quantitative strategist at Bank of America Merrill Lynch.

Didier Saint-Georges, managing director at Carmignac Gestion, said the ECB "has done too much and too late", adding that starting QE when rates were already very low has compressed rates even further, making bonds very expensive.

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