When, in December 1996, Alan Greenspan asked his famous rhetorical question about investors’ capacity for self-delusion, the US stock market had been rising for six years.

Concerned that persistently low inflation was breeding dangerous complacency among investors, he asked the American Enterprise Institute “how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions?”

Today, markets have been rising for almost as long and many people are starting to ask the same question as the former Fed chairman. The trigger for complacency is a bit different – easy money, not low inflation is providing the rocket fuel this time – but the outcome feels similar: investors are pushing markets to new highs in the face of worrying evidence that all is not well.

Nowhere is this more evident than in Europe, where stock markets have risen in a more or less straight line for the past two years. Up by around 50pc over that period, they’ve more than doubled since 2009.

European shares have done this in the face of more or less non-existent economic growth, dangerously low inflation, still high unemployment, an uncompetitive currency and sliding corporate earnings expectations. If exuberance has ever been irrational it has surely never felt more so than in Europe this week.

The past two years have seen a massive re-rating of European equities on the back of improved investor sentiment. But this has had nothing to do with improving results for the region’s companies. Expectations for earnings growth, the ultimate determinant of share prices, have pretty much halved since the beginning of the year.

In terms of what has driven the growth in markets, it has been valuations of low quality and peripheral country stocks, a sign that the gains are not the result of sustainable growth but of relief at Armageddon deferred and hopes for a wave of US-style money printing.

David Fuller's view

Here is a link to Tom Stevenson’s article.

Tom Stevenson’s article casts light on why the investment game is such a fascinating subject.  It also shows us why a narrow analytical perspective, while perhaps appealing, if only because it appears manageable, can also limit one’s investment potential. 

 After all, stock markets have a justifiable reputation for being manic depressive, not least because they are bought and sold by crowds of investors.  You and I, and anyone else who invests, enters those crowds to participate.  We may have our own individual views and objectives, but we are not acting in isolation.  Our investments will be affected, over at least the short to medium term, by the volatility of crowd psychology, to which we are not always immune.

Value investors can do very well by entering the market when the crowd is fearful, following a severe decline as we last saw on a worldwide basis in 2008.  Climactic price chart action will also provide confirming evidence. 

However, value investors may do less well if they reduce market exposure too quickly when valuations are beginning to appear expensive, as we have seen over the last year.  This is particularly true if central banks are mostly persisting with stimulative monetary policies, as we still see today.  Monetary policy remains the key influence, in my opinion, and most bull markets are eventually assassinated by central banks.   

The European Central Bank has bought more time for the recovery by European stock markets, as we can see from Mario Draghi’s latest policies and this is confirmed by the Euro STOXX 50 Index (weekly & daily), as Eoin was pointing out last week.  The Euro STOXX Banks Index (weekly & daily) has firmed but continues to lag somewhat.  Both indices are once again becoming temporarily overbought following these latest gains, although this should not be too much of a concern while they remain above their 200-day moving averages.

Wall Street remains a somewhat greater concern, on valuations and the Fed’s QE tapering, but here also new highs for the S&P 500 Index (weekly & daily) and the Dow Jones Industrial Average (weekly & daily) have reaffirmed their overall upward trends after several months of ranging.  Here also temporary overbought conditions are developing but a challenge of underlying support and the rising MAs would be required to indicate more than temporary reactions.  This represents a flight to quality on Wall Street following this year’s significant shakeout for new tech shares.  Interestingly, both the Nasdaq Composite Index (weekly & daily) and the Russell 2000 (weekly & daily) have rallied from the lower side of their trading ranges over the last three to four weeks.  Breaks beneath the April-May lows remain necessary to indicate more significant corrections. 

In conclusion, risks on Wall Street remain higher this year but low interest rates and weight of money are still supporting the market indices shown above.