MRB's Chart of the Week: Why this equity bull will keep raging

Global equity prices this year have added to their late-2012 gains, with many bourses hitting new cyclical highs. 

Some market participants are now claiming that complacency has set in and, thus, stocks are primed for a tumble. While equities are becoming overbought on a short-term basis, MRB is still positive on a 6-12 month horizon, and expects stock bulls to be well rewarded, while bond bulls face a disappointing year ahead.

Retail investment flows and sentiment gauges have a good record of flagging equity market turning points, as extremes occur just as the tide is set to turn. To this end, a surge of inflows to stock mutual funds in the US during January has raised the fear that the bull run is nearing an end. 

Our chart puts the sudden spike in inflows into perspective: over the past year, there have been near-record outflows from equity funds, while bond funds have received near record inflows over the same period.

While there has clearly been a lift in sentiment recently, one month does not make a trend and it is premature to claim investors are now excessively optimistic and thus ‘fully invested’. Rather, the MRB Risk Appetite Indicator has risen only to neutral levels, implying that there are no technical roadblocks to higher equity prices.

The equity advance should be choppier than in recent months with markets becoming overbought, but valuations remain compelling (and still very negative for government bonds). Moreover, the fundamental backdrop is slowly improving, with US and emerging economies regaining momentum, and global manufacturing surveys recovering to positive territory in January. 

Monetary policies around the world will remain hyper-accommodative until the global economic expansion is decisively back on track.

The bottom line is that investors should stay cyclically positive on stocks, especially relative to bonds.

Warren Smith is a partner at global investment analyst the Macro Research Board