Exuberance and Gloom - Q2 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.

 After a strong Q1, the second quarter was more choppy experience for investors. A resurgence of the US-China trade tensions spooked markets leading to a 6.6% drop of the SP 500 in May. In June, investors became increasingly convinced that the Fed would come to the rescue of the economy and markets by implementing rate cuts in 2019, pushing the SP 500 up 3.19% for the quarter. With SP 500 prices rising more than 10-year earnings the cyclically adjusted P/E ratio rose from 28.1 to 28.4, leading sentiment slightly higher towards the exuberance zone. Implied volatility rose from 13.7 to 15.8 driving sentiment down towards its historical average. The slope of the US sovereign bond curve again declined and became inverted leading sentiment into the exuberance zone. High-yield spreads widened over the quarter driving credit sentiment down towards its historical average.


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 Exuberance and Gloom - Q2 2019