Why irrational investors should curb their enthusiasm

AGF CEO speaks out on signs of 'irrational exuberance' in equity markets, and highlights potential risks and headwinds ahead

Why irrational investors should curb their enthusiasm

Anyone keeping their eye on the financial markets would have to try very hard to not see symptoms of euphoria. Aside from the expansion in bitcoin and other cryptocurrencies (though that trend has seen some hiccups in recent weeks), video game retail company GameStop was thrust into the centre of a firestorm this week as retail investors invested en masse in video game retailer GameStop, inflicting massive pain on hedge funds that had taken huge short positions on the company.

Some market bullishness is certainly warranted, given the brighter prospects that have been opened up by developments on the vaccine front. And many people are positioning their portfolios in anticipation of pent-up demand savings being unleashed as the broader economy is opened. But as noted by Kevin McCreadie, CEO and chief investment officer at AGF Investments, there’s a risk that investors have gotten too bullish.

“It’s one thing for the market to anticipate an economic recovery,” McCreadie said in a recent commentary. “But so much has been priced in already and sentiment has become so one-sided that there are now pockets of froth in the market that are bound to create more volatility going forward as they get wringed out.”

Aside from Bitcoin’s meteoric rise – as of January 27, the cryptocurrency has risen 230.1% year-on-year – McCreadie pointed to a trend of U.S. university students on TikTok talking about how they plan to invest their federal aid checks in a certain stock. In another case, a company saw its stock price soar by more than 2,000% in a couple of days just because it had the same name as another totally unrelated business that was mentioned positively in comments made by Elon Musk.

“So, all of this is evidence of a growing excess that taken together is very reminiscent of the euphoria and irrational exuberance that preceded the Tech Wreck in the early 2000s,” McCreadie said, clarifying that while he’s not predicting a bear market correction, it’s more than reasonable to expect large pullbacks over the next few weeks and months.

Outside the risks of stock-market mania, he said investors should be mindful of bond yields, particularly as a concerning rise in the 10-year U.S. Treasury could, if it continues, create headwinds for stocks. Inflation, he added, could rear its ugly head as soon as the latter half of 2021 as the new White House administration under Joe Biden unveiled plans for an additional US$2 trillion in stimulus spending.

“While the U.S. Federal Reserve has signalled its willingness to leave interest rates untouched for the next couple of years … it could be dangerous to assume the Fed won’t necessarily hike rates if inflation rises more aggressively than anticipated,” McCreadie said.

He also underscored the possibility that markets are not properly pricing in the political discord in the U.S., noting that on the day of the assault on the U.S. Capitol, stocks rose while government bonds sold off. There’s an air of tension as a significant percentage of the American population still consider Donald Trump their de facto leader, and the possibility of the new administration pursuing an aggressive re-regulation and taxation agenda hangs could gestate and develop into reality.

“Perhaps it’s yet another example of market excess, but investors can’t ignore the potential for more turmoil ahead,” McCreadie said.


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