Puzzling times for investors

Excerpt from the latest GOAL publication from Goldman Sachs… I’m just picking a couple of paragraphs that give a good understanding of how difficult it is to do proper asset allocation and not be weary of losing it all when markets are distorted by central banks and the prospects for growth and inflation are dull…

« The dominant effect of QE, by pushing bond yields down towards (or, in some cases, below) zero, has had a huge impact on financial markets by triggering a massive valuation-led rise in prices while also driving an historic search for yield and stable growth.

  1. After seven years of economic recovery, US policy interest rates have only managed to rise once to 25 bp following nine years without an increase. The markets imply a probability of only 15% that the Fed funds rate will hit 1% by end-2017.
  2. Bond markets are at record valuations. With over US$10 trillion of government bonds in negative territory, our bond strategists estimate that most bond markets are 2 standard deviations expensive, even when accounting for macro conditions. UK yields have halved since Brexit and Spanish 10-year yields have fallen below 1% for the first time.
  3. Falling bond yields have resulted in significant valuation expansion in financial assets. The S&P 500 has enjoyed a 75% expansion of its P/E since 2011 – other markets have seen even more.
  4. Meanwhile, low inflation and the impact of QE have fuelled an historic search for yield. Coupled with poor growth, this has enhanced the attraction of defensive, low volatility, stable growth companies, as investors have shunned traditional ‘value’ and cyclicals. The wide valuation spreads that have emerged make equities vulnerable to rotations. The current price to book value of staples in Europe has hit an all-time peak, more than 5x that of banks. But it is likely that these rotations are tactical and short-lived. »


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