Investors’ faith in equities may have been restored this week as the FTSE broke through the 5,000 mark for the first time in a year.

But analysts are still reluctant to call a bull market, with many suggesting that shares are now due for a correction.

Inflows of retail investor money into equity funds have been growing fast as the stock market has risen in recent months. Statistics from the Investment Management Association (IMA) show that in July equity funds were almost as popular as corporate bond funds, which have been the preferred sector for nine months in a row.

“Plenty of disbelievers think equity markets aren’t justified in being where they are and plenty of others, who wished they had bought into the recovery story earlier in the year, are hoping for setbacks or bouts of profit taking but not getting them,” says Mike Lenhoff, chief strategist at Brewin Dolphin, who predicts the FTSE 100 could be as high as 5,500 in the next few months.

The surge in equities could mark the end of bumper returns on corporate bond funds. Investors have been piling into these for almost a year, attracted by the high yields they offer at a time when interest rates are close to zero.

Bond fund managers had stressed that spreads – the difference between yields on corporate bonds and government bonds, or gilts – were at historic highs, and were bound to narrow, offering investors the opportunity for good returns.

But there is now a growing consensus that the best returns on corporate bond funds have been and gone.

“The 40 per cent-plus returns from some funds over the past six months will be a lot lower in the next six months,” warns Brian Dennehy of Dennehy Weller & Co, the financial adviser.

There are also concerns that funds that have bought financial bonds may not receive repayments. The Financial Services Authority last week intervened to forbid Royal Bank of Scotland from making a proposed payout to investors on some of its subordinated bonds.

Even if investors are disillusioned with corporate bonds, is now the time to jump back into equities?

Many people believe that defensive stocks – such as telecoms, utilities and pharmaceuticals – could be set to do well after a period of underperformance. These stocks, which tend to be in mega-cap companies, have underperformed this year’s rally, which has been focused on cyclical stocks as expectations of an economic recovery have taken hold.

Dennehy says that funds that own deep value – or defensive – stocks and have underperformed the rally so far, such as Neil Woodford’s Invesco Perpetual Income fund, could outperform.

Others are making the case for small-cap companies, which tend to do well when the market is rising, and have been significantly outperforming other equities this year.

The managers of Gartmore Growth Opportunities, a small-cap investment trust that announced its annual results this week, said small caps had been “vastly oversold” because of investor fears over liquidity during the credit crunch.

They concluded that “although the equity market will continue to be volatile, there is great potential for small caps to benefit from this environment” – arguing forcefully enough to inspire analysts at Oriel to state that their views “should not be dismissed as marketing hype”.

Giles Hargreave, manager of the Marlborough Special Situations fund, says part of the reason small caps have outperformed this year is simply that they fell by so much in 2008. While his fund is up about 40 per cent this year, it is flat compared with a year ago.

However, Hargreave believes that the economy is set for a U-shaped recovery – a slow improvement where interest rates stay low, making it a good environment for small caps. “I think you could see a further improvement in small caps and in Aim stocks,” he says, while warning that small-caps can be volatile.

Bill Mott, manager of the PSigma Income fund, agrees with the U-shaped recovery scenario, arguing that the UK economy is set for “anaemic growth”. He believes investors could see a return of 10 per cent per year over the next five years, much of which will come from dividends, making an equity income fund a good bet.

Other managers are tipping Asian equities. Analysts at Oriel are bullish on the three Asian income investment trusts – Aberdeen Asian Income, Henderson Far East Income and Schroder Oriental Income.

They argue that companies in the region are likely to grow dividends faster than in the UK. They suggest investors should have as much as 10 per cent of their portfolio in Asian income.

Still, equities are not being favoured indiscriminately. A recent survey by Chelsea Financial Services of a group of fund managers from different companies found that just 3 per cent favoured Europe over other countries – compared with 32 per cent favouring the UK. This is backed up by IMA statistics – funds in Europe excluding the UK accounted for the largest outflows of retail investor money in July.

Merrill Lynch Global Wealth Management says that while it is positive overall on risk assets, it is “awake to the risk of a sharp correction, possibly before year-end”.

The rise in the gold price, which this week hit $1,000, is in part the result of investors hedging their positive bets on the stock market.

Still, corporate bond funds are hardly dead in the water. The top earners are still yielding around 6 per cent a month. Dennehy points out that, next to poor deposit returns and uncertain equities, corporate bond funds still look attractive.