Returns likely to be lower across all assets in medium term
Risk scenario sees inflation jump that ushers ‘fast pain’
“Elevated valuations increase the risk of draw-downs for the simple reason that there is less buffer to absorb shocks,” the strategists wrote. “The average valuation percentile across equity, bonds and credit in the U.S. is 90 percent, an all-time high.”
In the Goldman strategists’ main scenario of lower but positive returns, investors should “stay invested and could even be lured to lever up.” They suggested putting more in equities, with their greater risk-adjusted returns, and scaling back duration in fixed income.
Other findings in the report include:
- 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.