The return of risk appetite has boosted European stock markets, as more investors have rotated out of safe-haven bonds. While new research shows sentiment towards European equities is now at the best level in several years, some strategists are worried.
European equity allocations are at a five-year high, according to a fund managers' survey by Bank of America Merrill Lynch released last week. On Monday, investment bank Nomura also reported a notable uptick in investor sentiment towards Europe.
"The sentiment of European equity mutual fund investors reached the highest level for almost two years last week as measured by our equity mutual flow indicator ... Investors have made positive inflows into European funds in eight out of the last nine weeks and purchased a net $0.6 billion last week," Nomura.
"These recent positive flows stand in stark contrast to the relentless net selling of European equity mutual funds, which had occurred since the summer of 2011," the bank added.
But strategists told CNBC that investors should be cautious, rather than euphoric, over the rally.
"When I see a sudden turnaround, a market or sector rotation or a move from safe-havens into much more riskier assets, I naturally get very pessimistic about it and think, 'How long can this last?,'" Scott Evans, head of equity sales at Espirito Santo Investment Bank, told CNBC on Monday.
"Everybody's chasing the same thing, we know ultimately that it'll all go horribly wrong and just when everyone has given up on safety, that's when you've got to be concerned," he added.
However, Evans told CNBC Europe's "Squawk Box" that he could understand market exuberance as global governments signal an easing of austerity and a focus on growth.
"We will start to see fiscal expansion, we will start to see inflation coming through and we will start to see the impact of quantitative easing coming through which will drive equities further," Evans said. "I think we will still see momentum within the financial sector, momentum in the asset managers but at some stage it does start to unravel unless you get fundamental changes in the macro-economic environment."
Stock markets have rallied on both sides of the Atlantic, with the S&P 500 crossing the key 1,500 level on Friday and logging its longest winning streak since 2004. Stock markets in Europe have rallied 3.5 percent so far this month, with the German Dax reaching five-year highs last week.
Gina Sanchez, director of Equity and Asset Allocation Strategy at Roubini Global Economics told CNBC that such rallies "scare" her and warned that market participants were envisaging too few risks in 2013.
"We're seeing VIX [volatility index] now at incredibly low levels, we're seeing incredible expectations still built into the markets for 2013. The markets have hardly [ever] gone crazy when we're coming up to major events such as the US 'fiscal cliff' at the end of 2012, [we] hardly saw a reaction in the markets," Sanchez said, adding, "I think there's just this incredible complacency taking over the markets."
Jonathan Stubbs, European equity strategist at Citigroup, defended the inflows into stocks by telling CNBC that the rally was plausible.
"Over the next two years, we're looking for around 25-30 percent returns from European equities, which sounds like a lot but is based on very modest assumptions of modest earnings growth, dividends, and a bit of a re-rating so the medium to long-term outlook looks very good for equities, we think," he said.
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