Measuring the 'contentedness' during this summer of total comfort is tricky. With equities at the year's highs in nominal prices in the US and breaking multi-month highs in Europe, how do we 'know' the relative richness or cheapness (or hope or despair) that is priced into stocks and what the 'fall' ahead looks like. We may have found a way. Europe's economic and implicitly market performance is very much based on the explicit belief that the EMU remains in tact and that Draghi's recent 'promise' will enable sovereigns to go about their economic business (austerity and growth) without the hindrance of those nasty speculating long-only fixed income managers repricing cost-of-funds and eating into the nation's growth. In the US, it's all about multiples - P/E expansion (in the face of lower 'E') has maintained the hope; and so it is in Europe. The following chart shows the extremely high correlation between European equity P/E (hope multiples) and European Sovereign risk. At the end of LTRO2, European stocks were exuberant only to fade away; currently, European stock multiples are once again back to those exuberant 'hope' heights. Trade accordingly.
While European sovereigns have indeed rallied, P/E multiples have expanded in a much more hopeful manner (after notably falling into a much more despairing mood in May and early June). As the lower pane shows, the BE 500 (Europe's S&P 500 equivalent) are around 4pts (or about 2.5%) expensive to sovereign risks - having rallied notably rich from the EU Summit...
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Charts: Bloomberg