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'Bond shock' and pricey stocks worry money managers

Global fund managers are raising cash because they increasingly believe that both bonds and stocks are too pricey.

That was the view found in the latest monthly survey of fund managers from Bank of America Merrill Lynch. The results match what some big investors were discussing Tuesday as a risk for investors at CNBC/Institutional Investor's Delivering Alpha conference.

Bearish views from the conference added to the negative tone and sell-off already underway in markets. The sell-off in Treasurys drove the yield on the 10-year to 1.73 percent, its highest level since early June. A poorly received 30-year bond auction on Tuesday added to the selling pressure. The Dow was down 250 points in afternoon trading.

Traders pointed to comments at Delivering Alpha from Paul Singer of Elliott Management, who was extremely bearish on long-term bonds.

"With the rates that currently exist in global bond markets, the term 'safe haven' [that's] applied to G7 bonds is just plain wrong. These are not 'safe havens.' There is a tremendous amount of risk in owning 10-, 20-, 30-year bonds at these rates," he said.

Mark Carhart, chief investment officer and founding partner at Kepos Capital, told the conference "the 60/40 portfolio is the biggest risk" for investors. That is the long-popular investment strategy where investors hold 60 percent stocks and 40 percent bonds. "I would take as much out of that as you feel comfortable and put it into alternatives" like emerging markets, he said.

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Stuart Fiertz, co-founder, president and director of research at Cheyne Capital Management, agreed. He told the conference the top risk is "an unwillingness to step outside of the main asset classes of rates and equities. Investors who are heavily positioned in those two are going to have a difficult time in the next couple of years." He urged investors to look for nontraditional parts of the market, saying rates and equity markets are distorted right now.

BofA's survey showed fund managers raised cash to 5.5 percent in September from 5.4 percent in August, and the most popular reasons were their bearish views on the markets and a "preference for cash over low-yielding equivalents." The cash level was at an all-time high of 6.3 percent after 9/11 in October 2001. It currently is at the higher end of the range of 4.2 percent to 5.8 percent, since 2013's "taper-tantrum" sell-off.

BofA's survey also showed that 42 percent of fund managers who have taken higher cash positions held bearish views. But now, the fund managers are holding a level of equities to cash at the lowest level in four years, and that normally is a good entry point for stocks, according to BofA. It sees cash levels above 4.5 percent as a potential buy signal.


U.S. equities fell to a net 7 percent underweight from a net 11 percent overweight in August.

BofA said a net 54 percent said see both stocks and bonds as overvalued, the highest level since the record 55 percent in April 2015. The percent of fund managers who see stocks as being overvalued was the highest since May 2000, said BofA.

The global fund managers surveyed see the biggest tail risk for markets as a disintegration of the European Union, at 23 percent.

Second to that were the 22 percent who see a risk in a Republican winning the White House in November, and 15 percent who worry most about the risk from China devaluing its currency. The concern about the Republican candidate rose from 21 percent in August.

But there was also a big jump in the number of fund managers — 61 percent — who are now expecting higher long-term rates over the next 12 months. That had been 47 percent last month. Thirty-two percent of the fund managers also believe Treasurys will be the biggest driver of stock prices over the next six months, and 25 percent believe the driver will be the dollar — both sensitive to Fed rate hike expectations.

Eighty-three percent do not expect the Bank of Japan or the European Central Bank to eliminate negative rates over the next 12 months, up from 78 percent in August. But 53 percent also do not see "helicopter money" in the next 12 months, also up slightly from 52 percent in August.

Michael Hartnett, BofA chief investment strategist, said in a note that the survey shows: "Investors see an unambiguous vulnerability to 'bond shock' among risk assets, with the most crowded negative interest trades and EM equities susceptible should the Fed and especially the BOJ fail to reduce bond volatility in September."

The most crowded trades were long high-quality stocks and long high-quality corporate bonds. A net 57 percent expect high-quality stocks to outperform low quality and 39 percent expect high dividend stock to outperform.