Finance A 'big fall' in markets is coming as traders put record cash to work

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Traders are putting record amounts of cash to work in markets, but Bank of America Merrill Lynch warns that overheated sentiment will cause a late-2017 selloff.

Investors may be setting themselves up for a "big fall," but they're enjoying themselves on the way up. play

Investors may be setting themselves up for a "big fall," but they're enjoying themselves on the way up.

(REUTERS/Stringer)

In global markets, all signs of sentiment are pointing up. And it's that very unbridled enthusiasm that could spell their downfall.

But before we get into the negative implications, let's take stock of everything that shows just how overtly bullish investors are feeling right now.

First, private client cash levels have dropped to a record low as a percentage of total assets, according to data compiled by Bank of America Merrill Lynch. That means investors are feeling more emboldened than ever to put that money to work in the market. They're choosing that over holding money on the sidelines — a risk-averse move typically associated with uncertainty.

Private client cash levels are at an all-time low. play

Private client cash levels are at an all-time low.

(Bank of America Merrill Lynch)

Institutional investors are also holding the lowest levels of cash since the start of the eight-year bull market, survey data compiled by Citigroup show. The measure now sits at less than one-third of a multi-year high reached in 2016.

Second, active equity funds just absorbed their biggest inflows in 2 1/2 years, according to BAML. This is a sign of confidence not just for the market, but for fund managers that make their living picking stocks. It's a rare bright spot for active management, which has struggled alongside the rise of the red-hot ETF industry.

Active stock funds just absorbed the most since early 2015. play

Active stock funds just absorbed the most since early 2015.

(Bank of America Merrill Lynch)

Third and lastly, in perhaps the most direct reflection of swelling confidence, global markets are hitting records. The S&P 500 and its more tech-heavy counterpart, the Nasdaq 100, hit all-time highs this past week. The gauges are up 265% and 466%, respectively, over the course of the bull market.

Meanwhile, credit indexes have done the same amid 30 straight weeks of investment-grade bond inflows, BAML data show.

What's resulted is the so-called "Icarus trade," which has been characterized by the "melt up" seen in risk assets since the start of 2016.

But there's a downside to flying too close to the proverbial sun — sooner or later, your wings will melt. BAML sees that happening in the second half of the year as the bullish conditions outlined above overheat further.

A "big fall in markets" will be an "autumn, not summer event," strategists at Bank of America Merrill Lynch wrote in a client note. "Icarus won't soar forever."

The comments echo ones made by BAML the week before last, when they cited central bank tightening as a threat to the gradual trek higher in risk assets.

So where do we stand right now? Despite the gloomy late-2017 forecast from BAML, it's actually a great time to be an equity investor. Company stock prices are moving more than ever on the earnings reports that are trickling out, representing a big potential windfall in the short-term for traders willing to do their homework.

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