Flashing Red! Europe bullishness triggers 'sell' signal
Fund managers have grown so bullish on European equities in the last month that a "contrarian" sell signal has been triggered, according to research by the Bank of America Merrill Lynch.
A total of 235 panelists with $643 billion of assets under management participated in a global survey for the BofA Merrill Lynch Global research report. When asked about equity allocation for Europe, a net 46 percent of asset allocators are overweight European equities, up from a net 36 percent September and representing the highest reading since 2007.
"The rise in allocation triggers a contrarian sell for EU stocks," a team of strategists led by European Investment Strategist John Bilton said in the BofA Merrill Lynch Fund Manager Survey for October.
(Read More: European equities looking cheap as recession eases)
Bilton added in press conference on Thursday that this is the first "potentially overbought" signal for a region since December 10, a time when emerging markets showed the same warning signals and sold-off around eight months later.
Last Friday, Bank of America Merrill Lynch indicated just how large the flows have been into European equities. Michael Hartnett, chief investment strategist at the bank said in a research note that there have been 15 straight weeks of inflows to European equity funds, which is the longest streak in 11 years, he said.
(Read More: European Equities Have 'Rarely Been So Appealing')
"The signal warrants caution," Bilton said, but added that valuations are low with a net 28 percent of fund managers seeing Europe as cheap. Hilton is also not sure where investors will go if this contrarian indicator is followed, with a net 68 percent seeing U.S. stocks as expensive, a net 30 percent already overweight on Japanese stocks, and a net 38 percent seeing an unfavorable emerging market profit outlook.
The investment bank iterated that answers from the fund managers "inferred" that it might be a contrarian signal, and BoAML themselves still have a "constructive" view on European equities with a 2014 target of 3,300 points for the pan-European Stoxx 50 Index.
"(We're) not saying 'sell EU stocks' but for contrarians, EM/-EU might be interesting," Bilton told CNBC.
(Read More: Time to Switch Into European Equities?)
The same Euro Stoxx 50 regional benchmark has rallied 9.07 percent year-to-date with a current price-to-book ratio - which is used to compare a stock's value to its book value - of 1.41 percent from a ratio of same ratio of 1.29 percent back in August, with a lower ratio meaning the stock market could be undervalued.
The last time the euro zone climbed out of recession was in October 2009, when the price-to-book ratio for the pan-European Euro Stoxx 50 Index was at 1.5 percent. In contrast, the price-to-book ratio of the S&P 500 now stands at 2.44 percent from an average of 2.42 percent back in August.
— CNBC.com's Matt Clinch. Follow him on Twitter @mattclinch81