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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.

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 Exuberance and Gloom - Q1 2019