Leading investment banks have warned that global stock markets may have risen too far and too quickly.
Investors may only have seven months left to savour a bull run that has added €22.7 trillion to global equity markets this year, said Credit Suisse Group strategists.
A prolonged bull market across stocks, bonds and credit has left a measure of average valuation at the highest since 1900, a condition that at some point is going to translate into pain for investors, according to Goldman Sachs.
Credit Suisse said that while they predict economic growth and steady profits will help add another 6% to the MSCI All-Country World Index by mid-2018, stocks are unlikely to push any higher after that.
Risks that could make the second half “more difficult” include a flare-up in junk debt markets, China’s tightening policy and accelerating wages in the US, according to Credit Suisse.
“There is likely to be one last hurrah for equities in 2018,” strategists led by Andrew Garthwaite at Credit Suisse wrote in the note. “We do see rising risks in the second half of 2018, however, and hence forecast flat markets,” they said.
Europe is a bright spot for Credit Suisse. The region has missed out on the double-digit gains seen in Asian and US markets this year. The brokerage increased its overweight recommendation for Europe, saying its discount to global peers and European banks’ exposure to rising bond yields make it the best place for equity investors in 2018.
Credit Suisse joins strategists at Goldman Sachs and Morgan Stanley in warning that investors won’t have it so easy next year.
Despite missile launches from North Korea, a deleveraging campaign in China, political wrangling in the White House, the UK and even Germany, and a slowdown in monetary stimulus, global equities are at a record.
The MSCI gauge extended this year’s gain to 20% this week, boosted by optimism over tax reform in the US.
At Goldman Sachs, “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,” strategists including Christian Mueller-Glissman wrote in a note this week.
“All good things must come to an end” and “there will be a bear market, eventually”, they said.
As central banks cut back their quantitative easing, pushing up the premiums investors demand to hold longer-dated bonds, returns are “likely to be lower across assets” over the medium term, the analysts said. A second, less likely, scenario 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.
“Elevated valuations increase the risk of draw-downs for the simple reason that there is less buffer to absorb shocks,” the Goldman strategists wrote. “The average valuation percentile across equity, bonds and credit in the US is 90%, an all-time high.”
A portfolio of 60% S&P 500 Index stocks and 40% 10-year US Treasuries generated a 7.1% inflation-adjusted return since 1985, Goldman calculated — compared with 4.8% over the last century. The tech-bubble implosion and global financial crisis were the two taints to the record. Low inflation has prevailed in the current period, just as it did alongside economic growth in the 1920s and 1950s, according to the Goldman report. “The worst outcome for 60/40 portfolios is high and rising inflation, which is when both bonds and equities suffer, even outside recessions.”
An increase in policy rates triggered by price pressures “remains a key risk for multi-asset portfolios”, they wrote.