With financial markets at or near all-time highs, it’s a good time for investors to line up their ducks and figure out how to deal with the volatility that’s likely to manifest as markets lose their upward momentum. ETF Report asked three advisors who are part of our “ETF Strategists Corner” how they were preparing for the day the markets shift gears and possibly turn lower.
All-time price highs, on their own, are not worrying so long as they’re accompanied by reasonable valuations. But that’s where investors may be stuck between a rock and a hard place with a traditional asset allocation.
The rock is equity valuations. The “Buffet Indicator”—defined as total market capitalization divided by GDP—places equities in the 97th percentile of quarterly readings since 1962.
The hard place is the presently basement-level interest rates. Nominal interest rates are a terrific tool to forecast forward bond returns. With 10-year rates near 2%, we can expect 10-year Treasurys to return approximately 2% a year, before inflation, over the next decade.
This is almost the exact opposite environment of the early 1980s, which led to one of the largest 20-year rallies in stocks and bonds the U.S. has ever seen.
That is not to suggest that the next 20 years will be the worst the market has ever seen, and markets need not necessarily even crash from these levels. However, both theory and empirical evidence are aligned that forward return expectations for stocks and bonds are moderate at best for the next five to seven years.
With this forecast, we’re currently consulting with advisors about diversifying their portfolios toward high-carry asset classes. We define “carry” as the expected return of an asset assuming market conditions—including the asset’s price—stay the same. For example, this might be the yield-to-maturity of a bond or the dividend yield of a stock.