The repeated take-off of stocks on Wall Street no longer surprises anyone. The Dow Jones Industrial Average crossed another important milestone (24 thousand), and the statistically stronger S&P 500 rose by 17% since the beginning of the year.
Emerging markets are performing even better, just like European equities in dollar terms.
Political concerns over trade disagreements, the threat of war with North Korea, and numerous scandals in the White House cause only a brief weakening of investor confidence.
Not surprisingly, the Bank of International Settlements (BIS )’s latest quarterly report notes that “according to traditional long-term pricing criteria, some stock exchanges certainly look foamy,” and “there is foam in the corporate lending sector.”
Concern about the unreasonably expensive market is expressed not only by the authors of the BIS report. A recent Bank of America Merrill Lynch survey of fund managers showed that 48% of respondents (a record high) said stocks were overvalued.
However, despite this, 49% of managers surveyed have a higher than usual presence in the stock market.
How do fund managers justify this apparent discrepancy?
First, they are more optimistic about the economy: a record number of players believe in the Goldilocks scenario (that is, growth is above average and inflation is below average).
Secondly, investors are much more worried about bonds, another major asset class: 81% think bonds are overvalued.
In other words, they invest in stocks, because they see no alternative, believes the British magazine The Economist.
The improvement in economic performance triggered a recent surge of enthusiasm. Alan Raskin of Deutsche Bank points out that in the South African industrial sector alone, purchasing managers' expectations are below 50 points, the dividing line between expansion and contraction.
Another impetus is the expectation that Congress will pass a law on corporate tax cuts, which will allow companies to send more money to shareholders.
Confidence is also supported by good Q3 results: companies from the S&P 500 managed to increase annual earnings per share by 8.5%.
At the same time, long-term profit expectations are "incredibly high", BCA Research consulting firm states: earnings are projected to grow by 14% per yearboth in America and Europe.
This means that even higher the share of GDP will be directed to profit and even less to workers. If this happens, then the support of populist parties will rise even higher.
Analysts rarely predict a drop in profits. But Andrew Smithers of Smithers & Co points out that earnings per share of listed companies have become more volatile since 1992 compared with earnings volatility in national accounts.
One of the reasons for this is the increased importance of foreign profit in the final statistics of American companies (the foreign share increased from 18% in 1982 to 38% in 2015).
Smithers argues that it is in the interest of managers to increase profits when stock prices rise and to lower profits in a bear market.
In the first case, higher profits allow managers to achieve targets and get their share option.
Conversely, in a bear market, managers are interested in following the kitchen sink approach: throwing out all the bad news so that the next set of targets is set at a lower base level.
Share buybacks add another factor to this equation. Companies tend to be trend followers rather than bargain hunters when they buy their own stock. Since the beginning of 2005, only two quarters (II and III quarters of 2009), when corporations were not net buyers.
This was the period when the cost estimate was the lowest.
All this threatens with the fact that when the market finally unfolds, the recession will be significant. Share repurchases will cease and profits will plummet.
But determining when this moment comes is not so simple. While the economy is improving and interest rates are low, it is extremely difficult to predict the next recession.
As one fund manager said, investors feel like former Citigroup CEO Chuck Prince, who was asked in mid-2007, shortly before the financial crisis, why his bank continues lending.
"While the music is playing, you have to get up and dance," he said in response.