Goldman Sachs: High Valuations Mean Pain is Coming

The current environment in which stocks, bonds and credit have been expensive at the same time—a situation last seen in the 1920’s and 1950’s–will eventually bring “pain for investors,” according to Goldman Sachs Group Inc. This according to a recent Bloomberg article.

In a recent note, Goldman argues that the slowdown in quantitative easing is “pushing up the premiums investors demand to hold longer-dated bonds” which will suppress returns over the medium term. Another possibility, it says, is that both stock and bond valuations would suffer a sudden decline, the degree of which would depend on whether it is triggered by a “negative growth shock, or a growth shock alongside an inflation pick-up.”

The market’s elevated valuations, says Goldman strategists, result in the market having less buffer to absorb such shocks. An increase in interest rates, they say, presents a key risk for traditional 60/40 portfolios. These portfolios (with S&P 500 index stocks and 10-year Treasuries), according to Goldman, generated a 7.1% inflation-adjusted return since 1985 compared with 4.8% over the last century.

Given Goldman’s expectation of lower but positive returns, it suggests that investors “stay invested and could even be lured to lever up.” The strategists suggest allocating more funds to equities and scaling back “duration in fixed income.”