The second longest bull market in history in stocks, bonds and credit has left a key measure of average valuation at its highest level since 1900, which is going to translate to pain for investors, says Goldman Sachs Group Inc.
“It has seldom been the case that equities, bonds and credit have been similarly expensive at the same time, only in the Roaring ’20s and the Golden ’50s,” said a groupd of Goldman Sachs International strategists including Christian Mueller-Glissman in a note this week. “All good things must come to an end,” they said.
DOOM?
Goldman thinks that as central banks reign in QE and raise rates, premiums on long-dated bonds will pushed higher, and returns are “likely to be lower across assets” over the medium term. A second scenario, albeit less likely, would involve “fast pain.”
Stock and bond valuations would both get hit, with the mix depending on whether the trigger involved a negative growth shock, or a growth shock alongside an inflation pick-up. –Bloomberg
“Elevated valuations increase the risk of draw-downs for the simple reason that there is less buffer to absorb shocks,” reads the note. “The average valuation percentile across equity, bonds and credit in the U.S. is 90 percent, an all-time high.”
Other findings in the report include (via Bloomberg):
- The exceptionally low volatility found in the stock market — with the VIX index near the record low it reached in September — could continue. History has featured periods when low volatility lasted more than three years. The current one began in mid-2016.
- Valuations have a “mixed track record” for predicting returns, explaining less than half the variation since 1900.
- Major draw-downs in 60/40 portfolios over the past century amounted to 26 percent in real terms on average, lasting 19 months. It took two years to get back to previous peaks, on average.
- Bonds are probably less good hedges for equities nowadays — a point also made by Pacific Investment Management Co.
- Central banks “might not be able or willing to buffer growth or inflation shocks,” especially if they judge that imbalances and excesses are building. They also face fewer options to ease monetary policy given low rates and big balance sheets.
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Goldman warns, muppets obey.