Christian Mueller-Glissmann, a portfolio strategist for Goldman Sachs, examines how exceptional the ongoing streak of equity and bond gains is in his recent report, The Balanced Bear. Here he talks to Andrew Holt about his findings.
How long-lived and pervasive is the current bull market?
Well, to sum it up, we’re closing in on a record. When we analyzed the cumulative gains and losses for a typical balanced portfolio, made up of 60 percent of the S&P 500 and 40 percent of US 10-year Treasury bonds, we find we’re nearing the longest bull market for balanced equity-bond portfolios in more than a century. This simple portfolio has not had a drawdown of more than 10 percent since the global financial crisis in 2009. That’s about 8.7 years. During that time it’s delivered a 143 percent return, or 11 percent per year. The longest run was in the 1920s just before the Great Depression. That bull market lasted 9.1 years.
How do you explain this winning streak?
We find that the last 40 years were among the best periods for balanced portfolios in history, with strong real returns and few large and lasting drawdowns. Since 1985, a 60/40 portfolio had a 7.1 percent per year real return compared with only 4.8 percent in the last 100 years. What accounts for this outperformance? It’s a ‘Goldilocks’ macroeconomic environment in which economic growth accelerates while inflation pressures remain muted. Equities tend to rally alongside bonds as they are supported by better growth, which boosts net income margins due to operating leverage but there are limited cost pressures. Such a favorable growth-and-inflation mix usually occurs in a recovery after a deep recession when there’s plenty of spare capacity.
So where does this leave investors with balanced portfolios?
In a tricky spot. This ‘bull market in everything’ has left valuations across many assets expensive compared with history, which reduces the potential for returns and diversification. And elevated valuations increase the risk of drawdowns for the simple reason that there is less of a buffer to absorb shocks. The average valuation percentile across equity, bonds and credit in the US is 90 percent, an all-time high. While equities and credit were more expensive in the ‘tech bubble’, bonds were comparably attractive at the time. The current valuation percentile is most comparable to the late 1920s – which resulted in the Great Depression – and the 1950s.
What are the consequences of such historically high valuations?
Such valuations result in what we call negative asymmetry – less upside but more downside risk. Valuations have a mixed track record in forecasting returns but high valuations usually provide a speed limit for long-term returns. We think a period of lower balanced portfolio returns is more likely than a bear market, at least in the near term, because of persistent low volatility and the lack of inflation so far.
