US equities suffered their worst loss since October 8 on the last trading day of November.
That sounds dramatic. It wasn’t. We’ve been stuck in a “range-y” grind higher for so long now, that a 0.4% move to the downside counts as “large”.
For the month, the S&P logged a 3.4% gain, the best since June, when stocks rebounded off the May swoon as market participants began to fully price in Fed cuts.
The dollar rose for a ninth session on Friday (the longest streak in nearly four years) and Treasurys were mixed.
Market participants will now have two more lazy days to ponder the likely outcome of the trade discussions, upon which the fate of virtually all assets hinges in December.
Not surprisingly, equities and credit are starting to look expensive again, after cheapening dramatically during 2018’s cross-asset malaise. Bonds are, of course, still near their richest levels ever.
(Goldman)
“Current valuations across assets are still below 2017 levels but have increased materially in 2019”, Goldman wrote on Friday afternoon. Remember, the vast majority of stocks’ performance in 2019 is down to multiple expansion. Earnings growth has flatlined (or worse) both at home and abroad.
Goldman goes on to caution that in addition to “a large part of the equity rally” coming courtesy of valuation expansion, credit spreads “have little room for further tightening”, while “bond yields are close to their all-time lows”.
The good news for stocks is that valuations aren’t a “binding constraint”, as Goldman puts it. “Equities can do well even from current elevated valuations, especially as equity risk premia are still relatively high”, the bank says.
And yet, that can’t last forever. Sooner or later, valuations become an issue. Here’s a handy visual that shows you the distribution of subsequent returns from different valuation levels:
(Goldman)
At the risk of stating the obvious, with bond valuations stretched to the breaking point (i.e., yields at or near record lows), it’s not clear that they can serve as a buffer in an equity drawdown. That’s the risk with years like 2019 when bonds and stocks rally simultaneously. The concurrent rally “increases the vulnerability of multi-asset portfolios to higher real yields, and in the event of growth shocks diversification might be worse”, Goldman warns.
The bank also updated a crucial chart that, perhaps more than any other, tells the story of the past two years.
(Goldman)
“After a ‘balanced bear’ in 2018, when most assets underperformed USD cash, 2019 has been a ‘bull market in everything’”, the bank writes, underscoring the incredible nature of this year’s rally, during which virtually all asset classes have found an excuse to log positive returns.
Goldman continues, noting that “such combined rallies have been common in periods with much easier monetary policy when global real yields declined”.
But beware: These kinds of cross-asset bonanzas can set the table for a “nowhere to hide” dynamic down the road. After all, if everything is overvalued, where can you turn for safety in a pinch?
As Goldman puts it, “the bull market in everything might end in diversification desperation”.
