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Exuberance and Gloom - Q2 2018

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 an edgy first quarter, investors regained their composure in the second quarter leading to a 2.9% rise of the SP 500. With SP 500 prices and 10-year earnings rising in parallel, its cyclically adjusted P/E ratio remained at 30.4 just below the exuberance zone. Implied volatility fell from 20 to 16 pushing sentiment, which had been in the gloom zone in February, to above average levels. The slope of the US sovereign bond curve flattened slightly returning sentiment to its upward trend. High-yield spreads and sentiment were unchanged. In the corporate arena, initial claims remain very low maintaining employment sentiment in the exuberance zone. SP500 earnings remain close to their historical trend keeping sentiment close to its average level.

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 Exuberance and Gloom - Q2 2018