Economic optimism hits a two-year high among investors as Trump gets ready to take office

Professional investors entered the new year — and a new day for U.S. politics — with high expectations, tempered with caution over what could go wrong.

Optimism for economic growth hit a two-year high among those responding to the latest Bank of America Merrill Lynch fund managers survey.

The biggest bets among respondents are on banks, the U.S. dollar and real estate investment trusts, while some of the biggest areas of scorn are emerging market stocks, industrials and commodities. A record level of respondents indicated small-cap stocks will outperform.

However, investors also are keeping cash on hand as a buffer against what could go wrong. Investors believe the three biggest risks to be a trade war, U.S. policy error and China problems including a currency devaluation or a real estate bubble.

Donald Trump takes office as the 45th president Friday amid expectations that his promises of lower taxes, less regulation and higher spending will spur the economy, which has seen steady though lackluster growth since the financial crisis and accompanying recession.

"Ahead of the U.S. presidential inauguration, investors are positioned for stronger growth and inflation, but are not willing to turn fully bullish with China-related risks on the horizon," Michael Hartnett, chief investment strategist at BofAML, said in a statement.

Cash is at 5.1 percent of investor portfolios, up from 4.8 percent in December and above the long-term average of 4.5 percent. BofAML believes cash allocations serve as contrarian indicators, with balances above 4.5 percent indicating a "buy" for stocks. Equity allocation was at a 13-month high in the survey.

Also notable: Investors believe the most crowded trade is the U.S. dollar "by a country mile," BofAML said, with the percentage of respondents who think the greenback is overvalued the highest since November 2006.

The trends point to investors of a positive mindset but reluctant to press the accelerator.

"Investor sentiment seems to have greatly picked up since the election, but it will be interesting to see how companies feel given the uncertainty that exists with all the policy speculation," Jeffrey Saut, chief investment strategist at Raymond James, said in a note Tuesday morning. "If managers are mostly in 'wait and see' mode when it comes to future investments and strategic action, it could delay the impact Trump's and Congress's policies have on corporate earnings."

Investors expecting the global economy to expand over the next 12 months hit a net 62 percent — the difference between those believing the economy will grow against those who think it will contract — while inflation expectations were at the fifth highest on record. Similarly, the portion of investors looking for above-trend growth and inflation is at a 5½-year high.

Respondents also took on a question that has become more pressing lately: namely, what yield the 10-year Treasury note would have to hit for it to trigger a strong negative reaction in stocks. Of those surveyed, 53 percent picked a 4 percent yield, 20 percent said 5 percent, while just 16 percent believe it would be as low as 3 percent.

Bond gurus Bill Gross at Janus and Jeff Gundlach at DoubleLine recently gave opposing views, with Gross believing 2.6 percent to be the critical level while Gundlach put the number at 3 percent. Portfolio mangers, then, believe stocks could sustain considerably higher bond yields before slipping into a bear market.