Signs Of Exuberance

25/10/2013 at 4:48 pm

The US shutdown is over. Japanese inflation for the year to September reached its highest level for nearly 5 years. And UK GDP data showed signs of a strengthening recovery. The S&P 500 has risen 4% since the beginning of the month, the FTSE 100 has done likewise and the Euro Stoxx 50 is up by a little more.

At the same time, the Norwegian sovereign wealth fund – the world’s largest with $810bn under management – announced that it is waiting for a correction before increasing its equity exposure. (See the widely-read Bloomberg story here.)

Developed-world equity markets have had a strong 2013, to the point where it is difficult to argue on some measures, such as p/e ratios, that they offer value. Are we entering the territory of over-exuberance?

As a starting point let’s have a look at what the CEO of that Norwegian fund actually said:

Our share in the stock market has been stable or falling even though markets are rising, and that means in practice that we’re not using inflows to buy stocks … In general, we see market corrections more as opportunities than as threats, so it’s not something that worries us. If they come, that’s just a positive sign for us as an investor.

According to the interview he did say the fund was “preparing for a correction”. But this is a fund whose rapid growth is underpinned by sizeable petrodollar inflows. They are not selling the market, and in the event of a correction – should it come – they intend to start buying again. In fact this sounds like the Norwegian central bank is offering the market a put!

In addition it is always worth looking at what reported earnings are doing. US news has been dominated by political and monetary goings-on, but the S&P is almost half way through the latest quarterly earnings season: 243 companies have reported an overall EPS increase of 8.4% on the previous year so far, significantly ahead of expectations. If that growth rate can be sustained as predicted the current price level would soon look much easier to bear.

Finally, the rally in risk pricing has not been universal. We took a look at India a few weeks back when the rupee was coming under heavy pressure for instance. Indeed, emerging market equity in general has underperformed its developed-world equivalent by a margin of 23% over the year to date. Selective exuberance may be irrational in some ways but it is not so terrifying as indiscriminate (and price insensitive) optimism.

The Norwegian view looks sensible: no panic, nor any excitement over the major markets at current valuation levels, and a preparedness to buy again should prices come down.

The markets which have performed the most strongly – as ever – may not be offering the most obvious opportunities. But the steady stream of positive data on earnings and economies is encouraging for their investors nonetheless.

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