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Chart of the week: "Irrational exuberance” should be warning for investors

22 January 2018

Bob Cunneen, Senior Economist and Portfolio Specialist

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US shares vs Sentiment

Sources: Reuters Datastream, Federal Reserve St Louis.  


There seems to be ‘best of all possible worlds’ scenario for Wall Street as it continues to make record highs in 2018 (black line). Corporate profits are rising and the tax rate will fall from 35% to 21% this year. US retail spending is surging and US interest rate rises should only be “gradual”.

Yet there are warning signs that  US shares are displaying  “irrational  exuberance”. Essentially, some selective investor surveys and market measures show elevated levels of optimism on US shares. This is evident in the Sentiment gauge* (red line) which shows its highest reading in the past 20 years, eclipsing the euphoria of 2000 and 2007.

This high Sentiment gauge result suggests that investors appear to be very confident to the point of complacency on shares. Whether this is actually rational, only time will tell. But recent history suggests that when sentiment appears very exuberant on US shares, experienced investors would be contemplating heading towards the exit.

*Sentiment gauge based on VIX volatility, household share holdings, Sentix investor survey, Margin Debt and Policy Uncertainty Index

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