Yesterday’s post cited improved investor sentiment as a reason for near-term caution on prospects for equities and other risk assets. A change in positioning as sentiment has shifted from excessive pessimism in late summer 2012 to moderate optimism now has been a key driver of recent market strength.

Equity hedge funds, in particular, now appear to have relatively high market exposure, suggesting that other investor groups will need to take up the baton if recent gains are to be extended. Exposure can be estimated by examining the sensitivity of the HFRX daily equity hedge return index to the MSCI World index. The beta measured over a 30-day rolling window rose from 0.13 in September 2012 to 0.48 last week – not far from a peak of 0.54 reached in June 2011 before a big decline in stocks.

The suggestion of bullish hedge fund positioning is supported by the latest Merrill Lynch survey, showing weighted net equity exposure of 45%, a seven-year high.