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Investors eye correction after summer 'melt-up'

Fund managers' allocations to stocks are looking "stretched", and could be followed by an autumn correction, a new report said on Tuesday.

Equity allocations hit their second-highest level in 13 years this month, with some 61 percent of investors now overweight stocks, according to Bank of America Merrill Lynch (BAML)'s regular global fund management report.

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But sentiment towards equities is starting to "melt-up", said BAML, with equities now the most expensive they have been since May 2000.

"Investor sentiment is beginning to 'melt-up'", said chief investment strategist Michael Hartnett in the report. "The summer 'melt-up' is likely to be followed by an autumn correction."

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Last week, billionaire activist investor Carl Icahn said investors should tread carefully after the run-up in U.S. stocks.

"In my mind, it is time to be cautious about the U.S. stock markets," Icahn told Reuters. "While we are having a great year, I am being very selective about the companies I purchase."

The 228 fund managers polled by BAML also saw valuation extremes in the currency markets. The U.S. dollar is at its cheapest in 10 years, while the British pound is at its most expensive since the collapse of Lehman Brothers.

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"This aggressive positioning for recovery in the second half reflects a significant increase in investors' inflation expectations. A net 71 percent expect global core CPI (the consumer price index tracking inflation) to be higher in 12 months, up 13 percentage points since last month," Hartnett said.

He added that exposure to commodities--an asset class especially sensitive to inflation--has risen to its strongest in more than a year as a result.

By CNBC's Jenny Cosgrave: Follow her on Twitter @jenny_cosgrave

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