The stock and bond markets have seen an incredible surge over the last few years, with unprecedented gains for individual investors and asset managers alike. The gains are so great that some experts are now referring to it as `Irrational Exuberance 2.0.’
However, what goes up must come down, and this recent surge in the stock and bond markets is unlikely to last. While it can be hard to resist the allure of high returns, there are certain truths that are easy to overlook in the midst of the euphoria.
In the near-term, the sheer size of the gain in stock and bond prices is unsustainable. Investors have been ignoring fundamentals such as the weak economic growth data reported recently, in pursuit of quick, healthy returns in the buoyant markets. This is unlikely to continue in the face of deteriorating economic data.
Moreover, stock and bond markets are forward-looking instruments, which means that while there is still money to be made, much of the gain has already been absorbed. This means that even if prices continue to rise, the gains available to investors are likely to be much smaller.
At the same time, central banks across the world are tightening, which will put pressure on interest rates and stock prices alike. While the Federal Reserve has indicated that it is in no hurry to raise rates, this could change quickly if inflation starts to take hold and the economy begins to cool.
Finally, the bond market could also take a hit as fears over defaults and rising credit costs start to take hold. This could trigger a stampede of investors towards safer investments, which could lead to a significant decline in prices across the board.
The bottom line is that Irrational Exuberance 2.0 could soon come to an end. While the current rally has been a boon for many investors, it is important to be aware that the gains are unlikely to continue unabated. Investors should therefore be prepared to exit the party before the music stops.
