3 Signs Irrational Exuberance Is Back

U.S. stocks opened higher this morning, with the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) down % and %, respectively, at a.m. EDT.

3 Signs irrational exuberance is back
Irrational exuberance is back, and the process by which it returned is well-documented. As legendary hedge-fund manager Leon Cooperman of Omega Advisors
told Barron's this month (sign-up may be required to view article):

Everyone is in the process of moving up the risk curve. We have an investor who put all of his money in T-bills when he retired, because he didn't want duration risk or credit risk. So for the guy who bought T-bills, he can't get any return anymore, so he migrated to T-bonds. The guy who bought T-bonds has migrated into industrial credits. The buyers of industrial credits have migrated into high yield. The high-yield buyers have migrated into structured credit, where we are now in our credit exposure at Omega, and the structured-credit people are increasingly looking at equities.

And the equities people, you ask? They're funding biotech start-ups (see the third sign below).

I'll take mine covenant-lite, please
The Financial Times is reporting today that fixed-income investors, desperate for yield, are forgoing traditional protections on loans to high-risk companies. Indeed, "the proportion of so-called 'cov-lite' loans has soared to more than 50 per cent of all leveraged loan issuance so far this year, twice the level seen during the credit boom in 2007." "Cov-lite loans" are loans issued without covenants that may require borrowers to maintain a certain level of profitability or constrain their ability to take on additional debt. As one strategist commented, "This is a new market, and this is a new norm." All this talk of "new" reminds me of another concept that ended tragically for investors: the "new economy."

5%: The new high yield
When the yield on high-yield bond indexes fell below 7% last year, that was enough to raise my eyebrows, but I could not then imagine that they would go on to break 5%, a milestone they achieved earlier this month. I suspect this has to do with the popularity of the
iShares iBoxx $ High Yield Corporate Bond Fund (NYSEMKT: HYG  ) and the SPDR Barclays High Yield Bond ETF (NYSEMKT: JNK  ) . Shareholders in these funds ought to beware: The junk-bond market looks a bit like a house of cards. Poor-quality issuers have been able to refinance their debt at record low rates, but that is dependent on the Fed's zero-interest-rate policy and quantitative easing. In other words, it must end at some point -- and at what cost to investors?

Biotech funding is booming
According to another article in today's
Financial Times, 10 biotech start-ups have raised $725 million this year, and both numbers could double in the next several months. In explaining the warm reception these high-risk companies received, one investment banker told the newspaper: "What's helping push the current market is that more generalist investors are taking a look at this asset class."

The 60% return that Vertex Pharmaceuticals (NASDAQ: VRTX  ) achieved in a single day last month on the test results of a cystic-fibrosis drug is the sort of thing that gets investors' salivary glands flowing. (This is not an illiquid micro-cap stock, by the way; with a market capitalization that exceeds $17 billion, Vertex is a large-cap issue.)

Even if you don't invest in leveraged loans, high-yield bonds, or biotech start-ups, you ought to be aware of these signs of exuberance, which can be found in virtually all corners of different asset markets: The U.S. stock market cannot continue to rise at the blistering pace it has maintained since the beginning of the year.


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  • Report this Comment On May 28, 2013, at 11:49 AM, CUTIGER75 wrote:

    Excellent article ! This is what I've been saying for the last 2 1/2 months but the irrational exuberance continues aided by the FED and it's printing press. Which makes me wonder ,with all this lack of fear due to the FED expanding balance sheet, how they can possibly taper without serious repercussions to equity and bond markets ? When the rush for the exit starts ....just like in a crowded theater, it is going to be bad. The only thing left to happen is for the suckers to buy into this sky high market.

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