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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.

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 Exuberance and Gloom - Q4 2019