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Exuberance and Gloom - Q4 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.

 2019 finished on a high note with the SP 500 rising 8.5% in Q4 to finish the year up 29%. A Fed rate cut in October, the dovish stance of Central Banks and a moderation of the US-China tariff war all contributed to a multiple expansion that drove-up equity valuations. This excellent equity performance was not limited to the US as developed and emerging markets also showed strong results for Q4 and the year.

 SP 500’s prices rose more in Q4 than 10-year earnings leading its cyclically adjusted P/E ratio up from 28.1 to 30.0 thus pushing sentiment higher towards the exuberance zone. Implied volatility declined from 16.2 to 13.8 driving sentiment up and away from its historical average. The slope of the US sovereign bond curve, which had been inverted, steepened and returned to normal, taking sentiment out of the exuberance zone. High-yield spreads narrowed over the quarter increasing sentiment away from its historical average.

 In the corporate arena, initial claims rose only slightly maintaining employment sentiment well within the exuberance zone. SP500 earnings again rose slower that their historical trend pushing sentiment down towards its historical average and ending the sentiment runup of 2018.

Download the full study here.

 Exuberance and Gloom - Q4 2019

 
Exuberance and Gloom - Q3 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.

 Market turbulence was dampened in Q3 following the Fed’s dovish turn and implementation of two 25bp rate cuts. The US central bank’s more accommodative posture provided support for equities and drove up bond valuations. Global trade skirmishes and particularly the US/China tariff dispute continue to weigh on global growth. This led to US equity outperformance in Q3 with the SP500 rising 1.19% while Asian markets in particular had a weak quarter.

 SP 500’s prices rose less in Q3 than 10-year earnings leading its cyclically adjusted P/E ratio down from 28.4 to 28.1 thus pushing sentiment slightly lower and away from the exuberance zone. Implied volatility rose from 15.1 to 16.2 driving sentiment down towards its historical average. The slope of the US sovereign bond curve again declined, increasing its inversion and maintaining sentiment in the exuberance zone. High-yield spreads narrowed slightly over the quarter leaving credit sentiment little changed and above its historical average.

 In the corporate arena, initial claims fell slightly maintaining employment sentiment well within the exuberance zone. SP500 earnings rose slower that their historical trend pushing sentiment down towards its historical average and capping the recent sentiment runup.

Download the full study here.

 Exuberance and Gloom - Q3 2019

 
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

 
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