But a world where animal spirits are running wild is also one that has temporarily divorced from fundamentals. Experience tells us this often doesn’t end well.
This matters because the US is now a hyper-financialised economy. Economic conditions and financial markets are inextricably linked. Consumers, business leaders and politicians take their cues from the stock market, and the feedback between the two can be highly reflexive. Much of the strength we see in the US economy today may depend on the level of asset prices.
To date, this reflexive loop has only worked in one direction. Up. But this comes at a price. US asset valuations are expensive. Only three times since the Second World War has the S&P 500 Index managed three consecutive years of double-digit returns. Are we really going to see a third year this time?
Asset prices scream optimism, and they have become a fundamental in and of themselves. We see the need for caution. Valuations, though not a good indicator of the timing of any correction, are at levels that imply poor long-term returns. Sentiment and positioning are stretched, and the potential for disappointment is high. Geopolitics and monetary and fiscal policy point to more volatility, not less.
The vibes on the ground are important, but so are the fundamentals. For now, the US consumer and US asset markets are feeding off each other. Yet the excesses can unravel quickly. At Ruffer, we think it’s crucial to be positioned for when, not if, the exuberance comes to an end.
