Global markets are becoming over-heated and beginning to exhibit signs of euphoria, while the growing clamour for Bitcoin and other cryptocurrencies is a further sign of overheating sentiment, says Robert Lea, head of global equity research at Ashburton Investments.
He noted that markets have made a strong start to the year, with the S&P 500 up more than 4% YTD, while the Hong Kong Hang Seng Index is up close to 5%. The local bourse, the JSE, meanwhile has continued to trade at record highs, above the 60,000 point level in 2018 so far.
This strong performance comes on the heels of a 6.1% rise in the S&P 500 last quarter.
“While our overall equity market view is constructive, we are doubtful that the current pace of gains can be sustained in the near-term. Markets are becoming over-heated and beginning to exhibit signs of euphoria. The equity markets risk-reward profile is deteriorating,” Lea said.
Market sentiment is at its most bullish in years, he said, noting that extreme levels of investor sentiment are often a pre-cursor to a market turning point.
As Warren Buffet once warned investors, “Be fearful when others are greedy and greedy when others are fearful”, the analyst said.
“While we do not question the fundamental reasons behind the market’s positioning, the current extreme level of sentiment and positioning creates an asymmetric risk-reward profile,” Lea said.
The equity research lead said that the growing clamour for Bitcoin and other cryptocurrencies is a further sign of overheating sentiment. “While we see value in blockchain technology, the rally in cryptocurrencies is a textbook example of irrational exuberance.
“Bitcoin neither exhibits the characteristics of a currency, nor an investment. Bitcoin is a bubble, plain and simple. Looking forward, we expect the cryptocurrency market to come under increasing regulatory scrutiny,” Lea said.
Having soared more than 1,500% in 2017, Bitcoin has declined more than 30% from a record high in mid-December.
The analyst added that the current lack of market volatility is another concern. “Does this indicate investor complacency? Perhaps, though we think it serves to further highlight the market’s current vulnerability to negative surprises,” he said.
“While we expect markets to exhibit more volatility in 2018, the outright risk of a bear market remains low. Bear markets are normally triggered by recessions and there appears a limited risk of that currently.”
The growth outlook for the global economy continues to improve, with economic growth currently synchronised across all major geographies, said Ashburton Investments.
Consensus expect global GDP growth of nearly 4% this year, an acceleration from an estimated 3.8% growth seen in 2017 and 3.1% in 2016.
The financial institution said that the US economy should continue to perform well in 2018, with consensus forecasting GDP growth of 2.5%.
“The US labour market remains tight, with employment at, or close to, a cyclical peak. While the inflation outlook appeared benign for much of 2017, we expect the rise in energy prices and recent dollar weakness to result in higher inflation into the second half of this year,” said Lea.
The US PCE Index – the Fed’s preferred measure of inflation – has been slowly ticking up since August and looks set to rise further from here. Core US CPI also rose to 1.8% in December, up from 1.7% during the previous month.
“We therefore continue to think the market is under-estimating the scope for a rise in inflation this year – both in the US and globally.
“We also believe the market has potentially misjudged the Fed’s desire to normalise interest rate policy, as we approach a peak in the economic cycle. Consensus expects the Fed to raise rates between two and four times this year, which should in-turn risks leading to greater US Dollar strength than the market is currently anticipating,” Lea said.
On balance, Ashburton Investments said it expects global equity markets to rise in 2018.
“However, we expect the rate of increase to moderate, following the stellar performance seen in 2017. Current high levels of investor sentiment, coupled with low volatility are a risk to short-term performance.
“As such, we expect markets to exhibit greater volatility through 2018. The easy money has been made in equity markets and we expect 2018 to be a more challenging year than many are currently anticipating.”