• Optimism is growing, but are valuations too high?
• Leading risk indicators signal caution as confidence soars.
• Investors face a difficult balancing act in today’s market.

The market has come a long way since the October 2022 low, with optimism returning. But with this renewed confidence comes the need to act with caution. As investor sentiment heats up, some key factors require greater attention.

Is optimism too high?

Howard Marks, a respected voice in investing, often breaks down market cycles into two broad phases: aggressive periods and cautious periods. Right now, we are likely entering one of those times where caution is crucial. If you have followed my analysis over the past few years, you will know that I was one of the first to take a positive view during the 2022 bear market, and I have maintained this position throughout 2023 and into ‘in 2024.

But today? After a strong recovery, optimism is making a comeback – and maybe, just maybe, it’s becoming a little too excessive. In fact, market sentiment could reach levels that could soon challenge the bullish outlook we’ve seen in recent months.

Take a look at the graphics I shared this morning on my Telegram channel. They paint a clear picture of the current market climate.

On the one hand, the valuation of the US stock market is at the fourth highest level on record, based on current P/E ratios. This, combined with other indicators, reveals that investor confidence – and their appetite for risk – are at high levels. It is clear that optimism is widespread, but is it becoming excessive?

The charts below show that spreads on high-yield securities (which typically move in sync with stocks) and riskier instruments like leveraged ETFs are all warning signs of extreme optimism. When these indicators reach such high levels, it is a sign that investors are willing to take on more risk in the hope of achieving higher returns. Market confidence is high, but is it too high?

The big question on many minds is whether this signals the start of a bear market. The truth is that no one can predict this with certainty. As history shows, bull markets can extend far beyond what logic would expect. While we may face increased risk, it is also possible that markets will continue their upward march, potentially pushing valuations even further.

What to do now

So, what should the investor do in these uncertain times? It’s a balancing act. We are at a time when valuations are high and optimism is at an all-time high, but there is also the risk of missing out on further gains if the market continues to rise. An “expensive” market could become even more “expensive”. And while the potential for a pullback exists, staying on the sidelines could mean missing out on the next phase of market growth.

The answer, as always, probably lies somewhere in between. We must remain aware of current risks while continuing to position our portfolios to capture upside potential in the months and years to come. The key is to maintain flexibility, that is, to prepare for a potential downturn while remaining open to the possibility of further gains.

In summary, the environment is not easy and future returns may be lower than in the past due to high valuations and the need for greater caution. But be prepared. At some point, when things look worse than they do today, there will be an opportunity to step back aggressively, ready to seize the moment when the time is right.

Until next time!

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Disclaimer: This article is written for informational purposes only. It is in no way intended to encourage the purchase of any assets nor does it constitute a solicitation, offer, recommendation or suggestion for investment. I want to remind you that all assets are valued from multiple angles and are very risky, so any investment decision and associated risk belongs to the investor. We also do not provide investment advisory services.