Markets: Unbridled optimism

While many investors remain cautious, markets continue their upward climb. Stocks, credit, bonds: everything is rising, driven by almost unwavering confidence in the Fed's ability to support the economy and prevent any slippage. But this optimism, which has become almost automatic, rests on a fragile balance: still-abundant liquidity and a growing tolerance for risk.

When the Fed lowers its key interest rates when the economy shows no signs of an imminent recession, it risks fueling a new phase of euphoria in the markets.

This is what economists call a melt-up: a rapid, sometimes irrational, rise in stock indices.

By reducing its rates, ending quantitative tightening and, above all, constantly minimizing the risks of a bubble, the Fed is in reality reaffirming an old bias: that of a deeply asymmetric monetary policy.

Far from adopting a restrictive position, it is in practice giving the green light to a new phase of generalized growth, both on risky assets and on safe-haven assets.

Striking parallels with 1999

This is exactly what happened in the late 1990s, when the Fed loosened its monetary policy after the LTCM fund crisis: the Nasdaq soared by 86% and the S&P 500 by 20%.

The current context presents some similarities: a resilient economy, an easing cycle underway, and a boom in private investment.

In the late 1990s, it was the Internet; today, it's artificial intelligence. In both cases, enthusiasm has prevailed over caution.

Excess liquidity, relaxation of vigilance

These periods of euphoria are often accompanied by a relaxation of vigilance. The recent cases of fraudulent defaults by Tricolor and First Brands in the United States are evidence of this: they led to write-downs at several major banks, including JPMorgan, and more visibly affected the valuation of certain regional banks such as Zions or Western Alliance.

In the United States, the vast majority of bank credit production now feeds into shadow banking, that is, non-bank and unregulated financial institutions. And it is often where the flows are most abundant that vigilance tends to wane.

Promising markets, but already highly valued

In this context, we believe that equity and credit markets have already priced in much of the good news.

They should remain highly valued in a resilient macroeconomic environment supported by still significant flows.

But this abundance argues for increased selectivity, both in the choice of companies and in the choice of asset classes, whose performance trajectories will probably be very contrasting.

Regarding interest rates, a cycle is coming to an end in Europe.

In the bond market, it seems to us that the downward cycle is now over in Europe.

In the United States, the market continues to anticipate an excessive number of rate cuts given the persistent strength of the American economy.

Here again, caution remains essential: an excess of liquidity maintained by central banks could prolong a state of complacency, even as inflation remains high, particularly in the United States.

A market with excessive confidence

Markets remain buoyant, supported by the actions of the Federal Reserve, which is more concerned about risks in the employment market and tensions in the money market than about potential bubbles that its actions could generate in the future, with all their associated drawbacks.

In this environment, discipline and selectivity are no longer mere virtues: they become imperatives.

Opinion piece by Etienne Gorgeon, Head of Bond Management at Sanso Longchamp AM (LinkedIn).