Warning: Ride high now, but fall is due

Goldman Sachs is warning investors that valuations across most asset classes including stocks and bonds are at the highest levels since 1900.

The bank report cautions that at some point these conditions could snap and translate into pain for investors.

“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,” Goldman Sachs strategist Christian MuellerGlissmann wrote in a note this week.

“All good things must come to an end” and “there will be a bear market, eventually,” the report 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 pickup.

“Elevated valuations increase the risk of draw-downs for the simple reason that there is less buffer to absorb shocks,” the strategist wrote.

A portfolio of 60 percent S&P 500 Index stocks and 40 percent 10-year US Treasurys generated a 7.1 percent inflation-adjusted return since 1985, Goldman calculated — compared with 4.8 percent over the last century. The tech-bubble implosion and global financial crisis were the two stains on the record.

Low inflation has prevailed in the current period, just as it did during the economic boom times of 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,” the report said.

In the Goldman note’s main scenario of lower but positive returns, investors should “stay invested and could even be lured to lever up.” It suggested putting more in equities, with their greater risk-adjusted returns, and scaling back duration in fixed income.