With little fanfare, equity markets have started to rally, investors have become sated with government bonds and cash levels are high enough to prompt a search for better yield.

Heading into a new week, it is time to ask whether investors are adequately positioned for a potential return to risk.

Reuters global asset allocation polls, published in the past week, show equity holdings among leading international investors at the lowest level in at least 6 years and bond holdings at the highest.

But in both cases, the pace of decline/rise was levelling off. (For a graphic: http://r.reuters.com/duf48n )

With cash a solid 5.8 percent of portfolios, this reflects a highly cautious state, but also one that could be taken as a contrarian indicator. Indeed, ING said that money markets saw a $4.1 billion outflow in the week to September 1.

Some technical analysts, meanwhile, are scenting a shift in the wind.

Bearish sentiment is pervasive, fear is elevated, conviction is non-existent, confidence is broken, volumes are anaemic, yields de minimus ... the perfect recipe for an incendiary advance, Richard Ross, global technical analyst at U.S.-based brokerage Auerbach Grayson, wrote to clients.

There are some signs of change. World stocks as measured by MSCI have risen more than five percent in a little over a week as investors have returned from the Northern hemisphere summer break.

They are still down 3 percent for the year, but 10 percent above their 2010 low.

The frenzy for government bonds, meanwhile, is easing as yields have tumbled. The Reuters polls show allocations to the sector dropping to 55.8 percent in August from 61.2 percent three months earlier.

Instead, investors have been snapping up investment grade corporate debt, still a defensive play, but further up the risk food chain. And some have been running from government debt in anticipation of a sell-off.

We sold our 30-, 25- and 10-year bonds last (week), Charlie Morris, head of absolute returns at HSBC Global Asset Management told Reuters.

We think that the big (government bond) rally over the past three months is nothing to do with deflation at all. It is a short squeeze ... by hedge fund managers. So the thing to do is sell your bonds.


Taking heavily cautious positions, of course, is no guarantee that things are about to turn around. There is no reason why investors cannot become more cautious.

But the indications are that a level has been reached.

The CBOE Volatility Index <.VIX>, the implied volatility measure of the S&P 500 index <.SPX>, settled into a range in July and August that implies some risk aversion but not retreat.

The index was at 23 on Friday, more than 50 percent below its risk averse May high.

Vols have certainly come back to the lower end of the range, said David Shairp, global strategist at JPMorgan Asset Management. Equities (also) look very cheap on a risk premium basis to bonds.

But he said countering this are mixed macroeconomic data -- U.S. jobs data on Friday was better than expected -- and questions about whether central banks are going to embark on a new round of quantitative easing, essentially buying bonds.

Some focus on the latter is expected in the coming week when the Bank of England meets, although it is far from clear that the UK economy is in enough trouble to warrant action.

July trade numbers from across Europe are also due, following on from World Trade Organisation data showing world trade volumes up 25 percent in the first half of the year.

Europe's economy has been expected to slow but a surprisingly robust Germany appears to be dragging at least some of its peers along with it.

A generally unspoken issue, in the meantime, is what impact the mid-term elections -- early next month and seen as punishing President Barack Obama's Democrats -- may be having on U.S. markets.

Since 1914, the Dow (.DJI> has gained 49.2 percent on average from its mid-term election year low to its subsequent high in the following election year, Auerbach Grayson's Ross noted.

(Additional reporting by Mike Dolan; Editing by Toby Chopra)