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UBP in the press 23.03.2017

The “rational exuberance” of the markets

The “rational exuberance” of the markets

Le Temps - On 5th December 1996, Alan Greenspan introduced the notion of “irrational exuberance” for the first time in a famous speech that shook the markets.


In 2000, Robert Shiller’s book, aptly titled, Irrational Exuberance, contributed to the stock market crash that saw the S&P 500 lose close to 50% of its value following excessive valuations linked to the technology bubble that formed at the end of the 1990s.

Since the start of 2017, we have seen a sort of “nirvana” on the markets, with over twenty successive record highs on the major US indexes, the lowest levels of volatility on the majority of asset classes, and a fall in bonds that, surprisingly, has not had any impact on other asset classes.

A climate of blind euphoria

This generalised optimism and absence of volatility is leading some investors to hope that this time, the markets’ exuberance is rational and therefore sustainable. But, beyond hope, is this environment of blind euphoria not a precursor to the next correction?

Since the election of Donald Trump, the prevailing sense of scepticism has given way to a wave of enthusiasm that is sweeping aside any fears. The publication of company results that were for once above analysts’ expectations, the continued European growth recovery and the effects of Brexit on the UK economy, which are so far very limited, have also fed the exceptional rise in stock market indexes in both the US and Europe.

Over the last twelve months, this rebound has exceeded 20% for most stock markets around the world. Several records have been broken and a number of indexes recently moved out of their fluctuation ranges, which is being interpreted by a majority of technical analysts as a new step on the path to highs well above current levels. Some are even claiming that higher interest rates following the multiple Fed hikes expected in 2017, record valuations for US-listed companies, and sustainably low volatility could become the norm in the long term, feeding “rational bubble”.

The new normal

Analysis of the fundamentals should dampen this blissful optimism. Even though Trump’s programme has given new life to the notion of reflation, which has supported the general sense of enthusiasm, the political calendar, with the lack of economic visibility that it implies, is hanging like a sword of Damocles which cannot be ignored by anyone.

The outcomes of the upcoming elections in the major European countries are also highly uncertain and could endanger the foundations of the EU. Brexit will get under way in 2017 and reveal its real consequences only gradually. The positive impact of reflation in the United States should not be felt for several quarters either.

Major break

Last, and most important, the winding up of asset-purchase programmes by central banks (if this happens as announced) will mark a major shift, with the end of the implicit guarantee provided by these purchases over the past five years potentially penalising equity and bond markets.

It is always risky to try and predict how long speculative bubbles will last or when they will burst; and this has in fact been the main subject of study of many a Nobel Prize-winner in recent years. The late 1990s bubble must serve as a cautionary tale: Alan Greenspan’s speech in 1996 came some four years before the dotcom bubble burst. Investors who interpreted these remarks as a sign to pull out of equity markets sold when the Dow Jones was around 6,500 points, yet the index continued to rise until January 2000, reaching close to 12,000. This highlights the difficulty in pinpointing the moment to sell even when worrying factors are building up.

Capturing and preserving

Portfolio managers like us have a duty to capture these recovery phases which contribute significantly to markets’ historical performances, especially in the case of equity markets. However, even in these good times, capital preservation must remain the key objective for long-term asset management, pushing us to protect our investments against a potential wave of corrections that could wipe out our gains.

Today, the main certainties are these: equity valuations in the United States are reaching levels that can only herald accelerated growth for the next few years, and the upcoming elections in Europe will spark a sharp resurgence in volatility in the coming months. The combination of these two factors does not, however, signify that a correction is imminent, and any rash decisions would raise the risk of missing part of the current upturn.

A risky choice

However, investors’ gut reaction to volatility’s return must not be underestimated. We are in a classic phase of market euphoria, where investors are mesmerised by their belief in a paradigm shift and refuse to see the many warning signs. For investment portfolios, this could lead to excessive exposure to risk – a pitfall that active asset managers must avoid.

Analysing stock-market cycles and understanding speculative bubbles lies at the heart of recent economic and financial research. Avoiding massive corrections is certainly the Holy Grail for every active asset manager and is the primary expectation of both private and institutional clients. The current market euphoria as well as the performances seen in recent months, both in equities and in interest rate instruments, require us to protect our positions, and betting on rational exuberance looks like a risky choice.


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Michel Longhini
CEO Private Banking

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Market insight 26.04.2018

The ECB stays cautious due to low and fragile core inflation

The ECB has not changed its current strategy

  • The ECB has recognized that the slowdown in Q1 was broad based, but it was mainly due to temporary factors; so the ECB remains confident on growth.
  • The inflation  should finally converge at/or slightly below 2%, but the ECB has noticed that the core inflation has not shown convincing signals of being on an upward trend; for this reason, a still large monetary accommodation still looks justified according to the ECB.
  • According to M. Draghi, there was no discussion on monetary policy; no pre-commitment of any change in the ECB’s communication in June.
  • As core inflation is not a firm trend, the ECB will take some time before officially shifting its communication and its strategy. This increases the probability of a change in communication only in the next July meeting and favors a smooth end of the QE in Q4-18.

 

US: Initial jobless claims (Apr.21): 209k vs 230k expected (prior: 233k revised from 232k)

  • Continuing claims: 1837 k after 1866 k.

 

US: Durable goods orders (March): 2.6% m/m vs 1.6% expected (prior: 3.5% revised from 3%)

  • Orders have been boosted by civil aircrafts (44% m/m).
  • Orders for capital goods non-defense ex aircraft (core orders) were down by 0.1% m/m after 0.9% m/m the prior month. By sector, the picture was mixed: a rebound in computers, but falling orders for machinery and flat in equipment.
  • Shipments were up by 0.3% m/m (-0.7% m/m for core orders); inventories were up by 0.1% m/m (+0.3% m/m for core orders).

 

US: Wholesale inventories (March): 0.5% m/m vs 0.7% expected (prior: 1%)

  • Inventories of durable goods were up close to 1% m/m.

 

Germany: GFK consumer confidence (May): 10.8 as expected (prior: 10.9)

  • Some cautiousness on future activity and income, despite good fundamentals.

 

Spain: Unemployment rate (Q1-18): 16.74% vs 16.45% expected (prior: 16.55%)

  • Unemployed has surprisingly decreased by close to 2% over the quarter; this could be viewed as a pause in a still positive trend.
Market insight 25.04.2018

France: consumer confidence under stabilization

France: Consumer confidence (Apr.): 101 vs 100 expected (prior: 100)

  • Sentiment is less negative on personal situation and on standard of living; in details, prices, and unemployment to a lesser extent, were sources of rising concerns.
  • In absolute terms, the index remained well above the levels reached before the financial crisis, pointing towards good fundamentals for households. The index could stabilize around these current levels, which stayed below levels reached in Q4-17.

 

Spain: PPI (March): -0.9% m/m (prior: 0% revised from 0.1%)

  • Prices were up by 1.3% y/y after 1.2% y/y past month. Energy prices have fallen by 3% m/m.

 

Poland: Unemployment rate (March): 6.6% vs 6.5% expected (prior: 6.8%)

  • The decrease of unemployed has accelerated: -35 k after -7 k past month.

 

Brazil: Current account (March): 798 M$ vs -100 M$ expected (prior: 290 M$ revised from 283 M$)

  • Current account has jumped into a surplus for the second month; FDI has also jumped from USD 4.7 bn to USD 6.5 bn over the month.

 

Turkey: Central bank has increased liquidity lending rate from 12.75% to 13.50%.

  • Repo rate was unchanged at 8%, overnight lending rate unchanged at 9.25% and overnight borrowing rate unchanged at 7.25%.
  • In its statement, central bank mentioned that it wanted to implement some tightening in order to preserve price stability, as inflation and expectations have increased.
Market insight 24.04.2018

Richmond Fed manufacturing fell sharply in April, disappointing German IFO survey

US: Richmond Fed manufacturing (Apr): -3 vs 16 expected (prior: 15)

  • The index fell sharply in April for the second consecutive month.

  • The underlying composition was generally weak, with sharp declines in the shipments and new orders components.

US: Consumer confidence (CB) (Apr): 128.7 vs 126 expected (prior: 127 revised from 127.7)

  • The improvement in confidence was spread evenly across the present situation and expectations indices.

US: New home sales (Mar): 694k vs 630k expected (prior: 667k revised from 618k)

  • On a m/m basis: 4% vs 1.9% expected (prior: 3.6% revised from -0.6%)

  • By region, March sales increased in the West (+28.3%), South (+0.8%) but declined in the Northeast (-54.8%) and Midwest (-2.4%). Inventory available on the market edged down to 5.2 months of available supply, towards the lower end of its 12-month range.

US: Housing prices (FFHA) (Feb): 0.6% q/q as expected (prior: 0.9% revised from 0.8%)

Germany: IFO (Apr): 102.1 vs 102.8 expected (prior: 103.3 revised from 103.2)

  • Expectations: 98.7 vs 99.5 expected (prior: 100 revised from 103.2)

  • Current assessment: 105.7 vs 106 expected (prior: 106.6 revised from 106.5)

  • The headline decline was driven by a drop in expectations. From a sector perspective, sentiment in manufacturing eased further from high levels, while construction and retail sentiment improved slightly.

  • Note that there have been methodological changes to the survey this month, which in theory should make it a better guide to German GDP growth.

France: Business confidence (Apr): 108 as expected (prior: 109)

  • Manufacturing: 109 vs 110 expected (prior: 110 revised from 111)

Further reading

Market insight 26.04.2018

The ECB stays cautious due to low and fragile core inflation

The ECB has not changed its current strategy

  • The ECB has recognized that the slowdown in Q1 was broad based, but it was mainly due to temporary factors; so the ECB remains confident on growth.
  • The inflation  should finally converge at/or slightly below 2%, but the ECB has noticed that the core inflation has not shown convincing signals of being on an upward trend; for this reason, a still large monetary accommodation still looks justified according to the ECB.
  • According to M. Draghi, there was no discussion on monetary policy; no pre-commitment of any change in the ECB’s communication in June.
  • As core inflation is not a firm trend, the ECB will take some time before officially shifting its communication and its strategy. This increases the probability of a change in communication only in the next July meeting and favors a smooth end of the QE in Q4-18.

 

US: Initial jobless claims (Apr.21): 209k vs 230k expected (prior: 233k revised from 232k)

  • Continuing claims: 1837 k after 1866 k.

 

US: Durable goods orders (March): 2.6% m/m vs 1.6% expected (prior: 3.5% revised from 3%)

  • Orders have been boosted by civil aircrafts (44% m/m).
  • Orders for capital goods non-defense ex aircraft (core orders) were down by 0.1% m/m after 0.9% m/m the prior month. By sector, the picture was mixed: a rebound in computers, but falling orders for machinery and flat in equipment.
  • Shipments were up by 0.3% m/m (-0.7% m/m for core orders); inventories were up by 0.1% m/m (+0.3% m/m for core orders).

 

US: Wholesale inventories (March): 0.5% m/m vs 0.7% expected (prior: 1%)

  • Inventories of durable goods were up close to 1% m/m.

 

Germany: GFK consumer confidence (May): 10.8 as expected (prior: 10.9)

  • Some cautiousness on future activity and income, despite good fundamentals.

 

Spain: Unemployment rate (Q1-18): 16.74% vs 16.45% expected (prior: 16.55%)

  • Unemployed has surprisingly decreased by close to 2% over the quarter; this could be viewed as a pause in a still positive trend.
Market insight 25.04.2018

France: consumer confidence under stabilization

France: Consumer confidence (Apr.): 101 vs 100 expected (prior: 100)

  • Sentiment is less negative on personal situation and on standard of living; in details, prices, and unemployment to a lesser extent, were sources of rising concerns.
  • In absolute terms, the index remained well above the levels reached before the financial crisis, pointing towards good fundamentals for households. The index could stabilize around these current levels, which stayed below levels reached in Q4-17.

 

Spain: PPI (March): -0.9% m/m (prior: 0% revised from 0.1%)

  • Prices were up by 1.3% y/y after 1.2% y/y past month. Energy prices have fallen by 3% m/m.

 

Poland: Unemployment rate (March): 6.6% vs 6.5% expected (prior: 6.8%)

  • The decrease of unemployed has accelerated: -35 k after -7 k past month.

 

Brazil: Current account (March): 798 M$ vs -100 M$ expected (prior: 290 M$ revised from 283 M$)

  • Current account has jumped into a surplus for the second month; FDI has also jumped from USD 4.7 bn to USD 6.5 bn over the month.

 

Turkey: Central bank has increased liquidity lending rate from 12.75% to 13.50%.

  • Repo rate was unchanged at 8%, overnight lending rate unchanged at 9.25% and overnight borrowing rate unchanged at 7.25%.
  • In its statement, central bank mentioned that it wanted to implement some tightening in order to preserve price stability, as inflation and expectations have increased.
Market insight 24.04.2018

Richmond Fed manufacturing fell sharply in April, disappointing German IFO survey

US: Richmond Fed manufacturing (Apr): -3 vs 16 expected (prior: 15)

  • The index fell sharply in April for the second consecutive month.

  • The underlying composition was generally weak, with sharp declines in the shipments and new orders components.

US: Consumer confidence (CB) (Apr): 128.7 vs 126 expected (prior: 127 revised from 127.7)

  • The improvement in confidence was spread evenly across the present situation and expectations indices.

US: New home sales (Mar): 694k vs 630k expected (prior: 667k revised from 618k)

  • On a m/m basis: 4% vs 1.9% expected (prior: 3.6% revised from -0.6%)

  • By region, March sales increased in the West (+28.3%), South (+0.8%) but declined in the Northeast (-54.8%) and Midwest (-2.4%). Inventory available on the market edged down to 5.2 months of available supply, towards the lower end of its 12-month range.

US: Housing prices (FFHA) (Feb): 0.6% q/q as expected (prior: 0.9% revised from 0.8%)

Germany: IFO (Apr): 102.1 vs 102.8 expected (prior: 103.3 revised from 103.2)

  • Expectations: 98.7 vs 99.5 expected (prior: 100 revised from 103.2)

  • Current assessment: 105.7 vs 106 expected (prior: 106.6 revised from 106.5)

  • The headline decline was driven by a drop in expectations. From a sector perspective, sentiment in manufacturing eased further from high levels, while construction and retail sentiment improved slightly.

  • Note that there have been methodological changes to the survey this month, which in theory should make it a better guide to German GDP growth.

France: Business confidence (Apr): 108 as expected (prior: 109)

  • Manufacturing: 109 vs 110 expected (prior: 110 revised from 111)