Exuberance and Gloom - Q3 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.

 The quarter saw a sweeping improvement in market sentiment. After regaining their composure in the second quarter, investors were emboldened in the third quarter as they drove the SP500 up 7.2%. With SP500 prices rising more than 10-year earnings the cyclically adjusted P/E ratio rose from 30.4 to 31.8, leading sentiment higher towards the limit of the exuberance zone. Implied volatility dropped from 16 to 12 driving sentiment to just below the exuberance zone. The slope of the US sovereign bond curve flattened, leading sentiment higher above its historical average. High-yield spreads fell over the quarter driving credit sentiment higher towards the exuberance zone.

 In the corporate arena, initial claims remain extraordinarily low maintaining employment sentiment in the exuberance zone. SP500 earnings increased faster than their historical trend leading sentiment higher above the historical average.

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 Exuberance and Gloom - Q3 2018