While analysts are currently very optimistic about the market, the combined risk of high valuations and the need to rebalance portfolios in the short term may pose an unanticipated threat.in the market. It is fascinating how quickly people forget the painful beating of taking on excess risk and revert to the same thesis of why “this time is different.”which showed a visual of the 2021 market surge versus 2023-2024. While this time is may be different, don’t be surprised if it ends the same.
Historically, the stock/bond ratio remained between roughly 1:1 to 2.5:1. Today, that ratio has skyrocketed since the flood of liquidity following the pandemic as money chased risk assets over safety. At a ratio of 6.5:1, we suspect that, at some point, a reversion will take place.
For example, in March 2023, S&P Global predicted that 2024 earnings would grow by 13% for the year. In reality, earnings grew by just 9% despite the market rising nearly 28%. Historical data indicates that markets with elevated valuations are more susceptible to downturns. For example, during the dot-com bubble, excessive valuations led to a significant market correction. Similarly, the 2008 financial crisis was preceded by high valuations in the housing and stock markets.
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