The results of the French elections have removed a significant portion of the political risk premium previously embedded in European financial assets. With leading economic indicators in boom mode, the mood is becoming euphoric and TV’s talking heads can recite their strategies: Buy European equities (still cheap, while profits are rising), Sell German bonds (the ECB will soon think about adjusting its policy).

The global cyclical upswing is gaining more traction, becoming self-sustained. This context is therefore perfect for the moral comfort of investors. Although living in expensive apartments, driving expensive cars and dining out in expensive restaurants, most investors (at their desk) are obsessed with looking for “cheap assets” and benign economic environments.

This bias is well-known and it is striking to see the extent to which investors are currently affected by it. This behaviour is really strange because the idea that cheap assets do well in a supportive economic context is just wrong. Indeed, the reality is that benign economic contexts are associated on average with poor expected returns from equity indices whereas adverse economic contexts are associated with high expected returns. This is not an opinion, but fact. The previous chart shows the European Commission’s business climate index. It currently stands above 1 and, as a rule of thumb, this level has corresponded historically to periods of economic growth in the 3% range. Then what has been the average performance of European equity indices after such an achievement? Below are the results for the period from December 1986 until today:

It is a simple reminder of what even investors with little experience know: don’t wait for good news to buy stocks. Hence it is bizarre to see such upbeat sentiment among investors, who should be worried, instead, on the grounds of “I know what will come after…”.

Some will disagree but the global economy is neither in a trough nor a recovery phase, but in an expansion phase. In terms of cycle, it means that the top is closer than the bottom. At the micro level, looking at margins, we could conclude that companies are in a top-of-the-cycle phase. This is, for sure, simplistic, because it ignores the structural improvement of margins thanks to best practices, innovations, etc. but we see from the chart below that 56% of the non-financial members of the Eurostoxx 50 index will show an operating margin this year above that of 2007 (the previous macroeconomic top cycle). Thus it is unfair to talk about “recovery” for listed European companies: talk about maturity would be more accurate.

We are not saying that economic and profit recessions will come soon. What we are saying is that investment perspectives are deteriorating for the equity asset class because history has shown that equity returns are low or negative when visibility is strong and profit margins high. Another way of saying this would be to ask: why have equity returns been so high in the past 12 months? The answer is: because there have been walls of worries to climb! Anxiety is a natural and necessary resource for equity bull markets.

These days, the risk perception has collapsed as the remaining identified risks (the Fed and the excessive Chinese debt) no longer impress. Investors have gotten accustomed to these risks, which are slow to materialize. This situation means that there is room for unidentified risks to emerge and this is why equity investment risk is becoming asymmetric. In short, it looks like 2006-2007: the conditions for the start of a bear market have not been met but the upside looks exhausted.

Last word is on the “global cyclical upswing” story. Observing the data, we understand now the malaise and, finally, the imposture. Global growth is not really accelerating. The debate about the divergence between soft data (surveys) and raw data (actual GDP growth) is not closed – it just shows that there is a cyclical upswing at sentiment level but not at economic growth level, as shown in the chart below.

Looking at the ECB’s forecasts for 2017, we notice that between September 2016 and March 2017, real GDP growth was revised up by 0.2 percentage points, from 1.6% to 1.8%. Is a 0.2% upward revision to annual GDP growth enough to characterize the environment as a “cyclical upswing”?

Here we are. Economic growth is not accelerating but, to justify the strong performance of equities, many commentators take comfort from mentioning economic growth. This is either being intellectually dishonest or a denial of reality. In our opinion, we still live in a “great moderation” context, which, by the way, is rather supportive of the valuation regime for equities. A potential investment risk could therefore lie in this misperception. If equities are priced for a global cyclical upswing, there could be some disappointment at some point in time. It has always been the same problem: the markets’ clock is turning faster than the economy’s clock.