Should we worry that there is too much investor optimism? - 21 May 2024
The latest statistics out of the United States have eased investors’ concerns about the US economy overheating. With global stock markets at record highs, are they now at risk from too much optimism?
Following an April jobs report that pointed to moderation, US retail and consumer price statistics have helped to reduce the perceived risk of the country’s economy overheating. Retail sales stagnated last month, and consumer price rises were more measured, with an increase of +0.3% excluding food and energy, down from +0.4% per month in the first quarter. Inflation was also less widespread for the second consecutive month, which is a fairly encouraging sign (cf. chart 1).
As a result, a scenario of US economic moderation with controlled inflation appears to be more likely. However, it remains to be seen if that is how it will actually play out. According to an estimate from the Federal Reserve Bank of Atlanta, GDP could grow by as much as 3.6% in the second quarter, which could hardly be described as moderate. Fed members are therefore not in a hurry to lower rates, but we do not see that as the be-all and end-all for the equity market. What matters is that the Fed is in a position to react quickly should the economy slow a little too much. This requires inflation to stay fairly close to its 2% target, which the latest figures seem to confirm.
As a result, equity markets have risen even further and hit new record highs. Having said that, we do not believe that global equities are currently overvalued, with the MSCI World Equal Weighted Index showing a price-to-earnings ratio of around 16x (cf. chart 2).
With a favourable macroeconomic environment and normal valuations, the residual risk for equity markets probably lies with behavioural finance. If managers and savers are optimistic and well invested, the room for market growth could shrink, and sensitivity to unpleasant surprises could increase. According to Bank of America’s (BofA) much-followed monthly survey, global investor optimism has grown significantly since the beginning of the year (cf. chart 3), with increasingly positive views on the global economy, a higher stock allocation and a sharp decline in cash levels. Although investors are getting more bullish, the optimism measured by BofA remains close to its historical average and some way short of its record 2021 level.
As we can see, the general consensus is increasingly for a scenario of sustainable global growth. This positive sentiment is reinforced by the continuous rise of artificial intelligence. However, we do not believe the optimism seen to date to be excessive. And the available data does not paint a picture of a mad rush to equity funds either. We therefore remain well invested in equities in our various flexible funds for the time being, and we continue to keep a close eye on macroeconomic developments and any signs of excess on the markets.
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