- Balanced equity/bond portfolios are enjoying their longest bull market in more than 100 years as growth has accelerated while inflation remains muted.
- This has been a boon for investors, but stocks, bonds and credit worldwide are now at their most expensive since 1900, suggesting trouble ahead.
The stars have really aligned for global markets in recent years.
Aided by a so-called Goldilocks environment of strong growth without inflation, portfolios containing a healthy balance of stocks and bonds are enjoying their best bull market in more than 100 years, according to Goldman Sachs.
But don’t get too excited yet – that has resulted in valuations across equities, bonds, and credit getting the most stretched since 1900, a development Goldman sees portending tough times ahead for investors.
“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,” a group of Goldman strategists led by Christian Mueller-Glissmann wrote in a client note. “While in the near term, growth might stay strong and valuations could pick up further, they should become a speed limit for returns.”
Mueller-Glissmann and his colleagues do lay out what they see as the two most likely medium-term scenarios:
- Scenario 1 (“slow pain”) – “Low yields and high valuations persist as macro is stable, but there are less windfall gains from rising valuations and less carry – as a result, returns are likely to be lower across assets. There might be some gradual mean reversion in valuations as a result of the withdrawal of QE, higher term premia and bond yields.”
- Scenario 2 (“fast pain”) – “There is either a material negative growth or inflation/rate shock, or a combination of both, which drives a drawdown in 60/40 portfolios … A sharp rise in inflation could weight on valuations across assets … This leads to some mean reversion in valuations.”
Goldman says Scenario 1 is a far more likely outcome than the bear market outlined in Scenario 2. But the mere fact that the firm is entertaining the idea of a major market downturn should be cause for investor concern.
“There will likely be a balancing act with slowing growth and rising inflation,” Mueller-Glissmann wrote. “And at current low yield levels and with the ‘beginning of the end of QE,’ bonds might be less effective hedges for equities and are likely a larger drag on balanced portfolios.”
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