Why Equity Investors Should Remain Wary of Market Extremes
The relationship between the value and sentiment investment themes have reached an extreme not seen since the Global Financial Crisis and the dot-com bubble.
Last month, we warned that these extremes could revert to more normal levels; a sharp reversal in expensive stocks with strong sentiment in the first week in September reinforces that warning.
In last month’s commentary, we discussed the extreme relationship between the value and sentiment themes in equity markets, and we warned investors to be wary of reversals in such extreme situations.
The start of September has brought about a reversal in the themes that had been driving some of these extremes, just as we had warned.
Last month, we discussed market concentration in the most extreme expensive and high sentiment pocket of the market; this is the very group of companies that experienced a sharp setback in the first week of September. If we look at the 25 largest companies in the MSCI World Index (see Figure 1), the companies in the top left of this chart – the most expensive stocks with the strongest sentiment – have experienced an average return of -10.6% between August 31 and September 8, while the others have returned -2.5%.