Does Exuberance Signal Confidence or Caution?

08/30/2018 5:00 am EST


James Stack

Founder, InvesTech Research

Aging economic recoveries and bull markets carry special risk for anyone who is too easily enamored with the rosy headlines and news reports, cautions Jim Stack, money manager and editor of InvesTech Research.

Early warning flags are usually subtle and sporadic, and often overlooked by the majority of investors. As exuberance reaches extraordinary levels, so does the potential risk of disappointment.

On the surface, sentiment is glaringly positive from Main Street to Wall Street. In fact, media headlines have seldom been rosier. However, historically extreme levels of optimism regarding the hot U.S. economy are allowing inflationary pressures to continue to gain traction.

Business is booming and the National Federation of Independent Business (NFIB) Small Business Optimism Index is at the highest level since 1983. Near-record optimism among U.S. small business owners is being propelled by tax cuts and strong consumer demand.

The tight U.S. labor market is evident, however, as the percent of owners with unfilled job openings reached a record high last month, and lack of skilled employees was cited as a top concern.

The Bloomberg Consumer Comfort Index, a weekly measure of Americans’ perceptions of the state of the economy and personal finances, is at its highest level since February 2001.

Confident consumers are inherently necessary for a strong economy, and today’s extreme degree of both business and consumer confidence should continue to spur investment and economic activity over the near-term. However, history tells us that bull markets come to an end when consumers become overconfident.

Over the past nine years investors have experienced a painfully slow recovery for the U.S. economy and one of the most hated bull markets in Wall Street history. Despite broad price appreciation across all asset classes, it has been a difficult task for many investors to stay the course and remain disciplined and invested in this market.

Today’s U.S. economic backdrop is extremely positive and deserves to be given the benefit of doubt. However, overarching risks remain as U.S. stocks, bonds, and real estate all appear expensive from a historical standpoint.

As the Federal Reserve continues to raise interest rates many investors will find themselves re-evaluating their risk assets – especially if inflation ignites and forces the Fed to abandon their gradual approach.

Our InvesTech Model Fund Portfolio remains focused on balancing growth with value, and most importantly carries a healthy cash buffer out of respect for current risks. Based on the evidence, we are maintaining invested allocation at 72% with a focus on traditional late-stage and less interest rate-sensitive sectors.

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