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Another Case of Irrational Exuberance?

Quoting Fed governor Jeremy Stein — and perhaps channeling Alan Greenspan — Bill Gross, in his latest investment outlook, ponders the question of whether we’re experiencing another bout of irrational exuberance with the recent run-up of the market. Is it sustainable, or are we playing a game of musical chairs? Is now the time to be hovering close to a seat?

Gross looks first at the high-yield credit markets and is concerned, not because of the price spread, but because of the high volume and relatively low quality of the new issuances — with record highs in 2012 at $100 billion. When issuance levels are elevated, future returns tend to be lower. Stock prices, he surmises, will follow high-yield returns.

Conclusions? Today’s 5%-to-6% returns on high yields, when adjusted for defaults, are 3% to 4%, and are more indicative of stock prices compared with recent double-digit returns. So while not investors shouldn’t be diving for cover, Gross cautions that they should exhibit a “rational temperance” rather than “irrational exuberance” — lowering expectations but not abandoning ship.

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