Expensive Markets Are More Dangerous Than You Think

According to JP Morgan, equity markets have not been this expensive so early into an economic recovery phase in the last twenty years. The Greed vs Fear Index also shows extreme optimism, while the Call to Put ratio in derivatives, that reflects the derivative exposure to a rising market, is also at multi-year highs. Meanwhile, the amount of negative-yielding bonds globally has risen to $18 trillion and the High Yield Index has risen to pre-crisis levels.

Many factors explain this level of optimism in markets. The news about vaccines and estimates of a rapid economic recovery accelerated investors’ bullish bets. However, we must remember that all consensus estimates for 2021 already discounted the end of the pandemic, and that the quick recovery so many hoped for is not happening, and definitely not in a way that would justify the aggressive increase in risk. Furthermore, the OECD released its latest estimate of economic growth for 2021 on December 4 and, opposite to what the most bullish investors hoped, the international body did not upgrade its estimates for the major economies. The same happened with the 2021 outlook published by S&P Global.

Recent macroeconomic figures have not added hopes for a stronger recovery. The manufacturing and services PMI (purchasing managers’ index) for the eurozone showed deep contraction in services and a weakening trend in manufacturing with weak new orders and job losses even in November. The United States economy has published more robust figures, but the jobs slowdown is concerning. While manufacturing and services remain in expansion in November, the U.S. economy added less than a third of the jobs it increased in October, and the labor participation rate fell slightly to 61.5% with unemployment falling to 6.7%, driven mostly by concerns about new lockdowns and more taxes and rigidity in the jobs market if Joe Biden is confirmed as president.  Even the economies that were showing positive surprises in October are showing an important slowdown, as seen in the Daily Activity Index published by Bloomberg.

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