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Exuberance and Gloom - Q2 2019

Exuberance and Gloom is a global financial markets analysis made by Stephen Rufino Ph.D, CIIA, Galeo's financial analyst.

 We look at four US market indicators (equity valuation, 10y bonds, corporate bonds and options) and determine whether these reflect rational expectations of market participants or excessively optimistic (Exuberance) or pessimistic (Gloom) ones. Similarly we look at two indicators affecting companies, corporate earnings and new jobless claims. For each indicator the Exuberance and Gloom zones are defined on the basis of its historical behaviour. To facilitate reading of the various charts we have constructed them to ensure that observations in the upper part of the chart indicate Exuberance and those in the lower part Gloom.

 When several indicators are in the Exuberance zone it is a strong indication that investors are allocating their capital based on irrationally optimistic assumptions and that markets are susceptible in the midterm to considerable downside. Conversely when several indicators are in the Gloom zone there is potential for substantial upside.

 After a strong Q1, the second quarter was more choppy experience for investors. A resurgence of the US-China trade tensions spooked markets leading to a 6.6% drop of the SP 500 in May. In June, investors became increasingly convinced that the Fed would come to the rescue of the economy and markets by implementing rate cuts in 2019, pushing the SP 500 up 3.19% for the quarter. With SP 500 prices rising more than 10-year earnings the cyclically adjusted P/E ratio rose from 28.1 to 28.4, leading sentiment slightly higher towards the exuberance zone. Implied volatility rose from 13.7 to 15.8 driving sentiment down towards its historical average. The slope of the US sovereign bond curve again declined and became inverted leading sentiment into the exuberance zone. High-yield spreads widened over the quarter driving credit sentiment down towards its historical average.

 

Download the full study here.

 Exuberance and Gloom - Q2 2019

 
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 Inside Risk

 
Exuberance and Gloom - Q1 2019

Exuberance and Gloom is a global financial markets analysis made by Stephen Rufino Ph.D, CIIA, Galeo's financial analyst.

 We look at four US market indicators (equity valuation, 10y bonds, corporate bonds and options) and determine whether these reflect rational expectations of market participants or excessively optimistic (Exuberance) or pessimistic (Gloom) ones. Similarly we look at two indicators affecting companies, corporate earnings and new jobless claims. For each indicator the Exuberance and Gloom zones are defined on the basis of its historical behaviour. To facilitate reading of the various charts we have constructed them to ensure that observations in the upper part of the chart indicate Exuberance and those in the lower part Gloom.

 When several indicators are in the Exuberance zone it is a strong indication that investors are allocating their capital based on irrationally optimistic assumptions and that markets are susceptible in the midterm to considerable downside. Conversely when several indicators are in the Gloom zone there is potential for substantial upside.

 The quarter saw a strong rebound in market sentiment as the Fed shifted to a significantly more dovish stance. Emboldened investors pushed the SP 500 up by 13% to recover most of its Q4 decline. With SP 500 prices rising more than 10-year earnings the cyclically adjusted P/E ratio rose from 26.4 to 28.2, leading sentiment higher towards the exuberance zone. Implied volatility dropped from 25.4 to 13.7 driving sentiment to well above its historical average. The slope of the US sovereign bond curve declined to nearly to flat, leading sentiment to the edge of the exuberance zone. High-yield spreads fell over the quarter driving credit sentiment to well above its historical average.

 In the corporate arena, initial claims declined maintaining employment sentiment in the exuberance zone. SP500 earnings increased in line with their historical trend maintaining sentiment above its historical average.

Download the full study here.

 Exuberance and Gloom - Q1 2019

 
Article in Financial Risk Management

Paradoxes of Portfolio Performance Calculation for Wealth Management: Avoiding Reporting Pitfalls

 This year, we have worked on a paper with Prof. Emmanuel Fragnière that has been published in the Journal of Financial Risk Management.

 Abstract:

 Clients of wealth management banks are usually informed about their portfolio through regular reporting. To maintain client trust, it is important that this reporting be both comprehensive and comprehensible. This reporting is grounded on complex mathematics in order to calculate myriads of profit and loss, performance and risk indicators. As the amount of information provided to clients increases so does the chance that certain elements will be confusing to them, at the risk of undermining their confidence in their wealth management bank. This risk is compounded by the general increase in portfolios of complex financial products involving different time horizons. The reporting is typically a decision aid tool for the client to monitor and control and make investment decisions. One example of such risk is that the calculated risk and performance indicators are delivered to the client with no explanation and can, in some cases, lead to incorrect perception due to misunderstanding of these numbers, even if calculations are correct. A typical example could be that the client is informed that the performance of the portfolio is 7% and in reality, the portfolio is losing money. In this paper, we want to address this kind of problem. As such we have identified a set of typical pitfalls that we are faced within the profession. Then, based on a rigorous reference to the scientific literature we have popularized these pitfalls and employed a series of simple and didactic illustrations to provide an appropriate toolbox in order to reduce the risk of financial reporting misunderstanding. In order to maintain client confidence, we highlight the importance of identifying areas of potential misunderstanding prior to providing reports to clients and of offering clear explanations for unusual numbers. We address the following themes: Profit and Loss Analysis, Performance Calculation, Performance Contribution, Realized and Unrealized Profits and Losses, and Bond Yields.

Download the paper here.

 Journal of Financial Risk Management