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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.

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 Exuberance and Gloom - Q3 2019