Investors skeptical of the bull market may be avoiding stocks at their own peril.
A preference for safety seems to be pulling vast quantities of money out of U.S. equity funds and into higher-quality bonds, as well as other perceived safe havens.
But that kind of positioning has not historically paid off in "late-cycle environments," Richard Bernstein, chief executive and chief investment officer of Richard Bernstein Advisors in New York, said in a note.
"In addition to investors misunderstanding the pitfalls of pure income investing, mutual fund flows appear to show they don't have a historical sense of asset class performance during a late cycle."
Last week, Merrill Lynch reported net outflows of $16.9-billion (U.S.) from U.S. equity funds in the week up to May 4. That weekly withdrawal was the largest since last September, when concerns over China, the global economy, and the commodity correction tested investor sentiment.
Meanwhile, bond funds have seen inflows in nine of the last 10 weeks, showing a preference for risk-off asset allocation, Merrill Lynch said.
The exodus from equity funds and into bond funds is likely the product of fear, Mr. Bernstein said.
"Because bonds outperformed stocks during the 2008 bear market, investors believe investing for income is safe," he said. "Investors' myopic search for income may be leading them to take considerably more investment risk then they believe."
Both the bull market and the U.S. economy appear to be entering the "late-cycle phase," which tend to coincide with beginning of rate hikes, such as the U.S. Federal Reserve did in December for the first time in a decade.
That kind of macro environment is characterized by rising interest rates, commodity prices, inflation expectations and investor optimism, Mr. Bernstein said.
Selling equities and buying bonds is not a trade best suited to those conditions, he said. Comparable macroeconomic transitions over the past 30 years have favoured just the opposite, with the average return on the S&P 500 index nearly doubling long-term treasury returns in late-cycle environments.
Historical performance by sector is tougher to generalize, as late-cycle climates can last through both corporate profit upturns and downturns, the report said.
The U.S. corporate sector is in the midst of a profits recession, which may have troughed in the fourth-quarter, giving way to an earnings rebound over the rest of this year, Mr. Bernstein said.
Combining late-cycle economics and profit growth finds the best positioned sectors to be information technology and energy. Consumer stocks, meanwhile, fared the worst on average when both conditions were present.
Positioning in accordance with those expectations seems to be at odds with consensus, which recently has more of a defensive bias, Mr. Bernstein said.
"The second-longest bull market in the post-war era has been largely missed by most investors. The fear of repeating 2008's bear market remains central to both individual and institutional portfolios. That on-going caution seems to us to present significant opportunity."