21 August 2019

A perspective on market nuttiness

In recent years, meetings with fund managers have been marked by “Groundhog day” elements. A common introduction would be to pass a few congratulatory remarks over recent returns; then a grimace at how tight yields were following the latest rally; followed by some speculative ideas-bouncing regarding how tight valuations can go. And even after the massive rallies in various markets, the introduction to such meetings can still follow the same agenda.

But there is a common market refrain on the relentless rise in asset prices, which runs as follows: although prices do not adequately compensate investors for long-term risk, there is a reasonable probability that the anomaly will only be accentuated over coming months. It is easy for skeptics to point out risks associated with the rally; for example how can current holders be confident they will not be holding the portfolio of overpriced risk the next time the music stops. But those who have put such a contrarian view to work in financial markets in the last two years would probably have lost big.

With risk of systemic collapse all but discounted in current valuations, the overriding impression was one of markets having a single-minded focus on policymakers’ next move, which can only intensify as the suspicion of under-priced risk heightens nervousness. Central banks in turn appear only less focused on bubbles, and more on good old fashioned cyclical indicators, such as inflation and the output gap.

We are not yet willing to take on the role of the brave contrarian voice calling for an imminent asset market reversal. But we recognize a significant risk of asset market overshoot and painful correction.

We expect the Federal Reserve to hike rates by Q2 2015. We think the timing involves leaning on the side of extra accommodation rather than risking derailing the recovery and roiling markets. It could possibly prove to be too little too late in terms of forestalling inflationary pressures and preventing asset price bubbles from spreading.

– Contact us at [email protected]


Director, Asset Management Services at Oxford Economics

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