In our asset class perspectives, you will notice that we recommend a neutral or below posture on virtually all public asset classes. The three charts below illustrate why. First, public equity valuations, as measured by the S&P 500 Index’s trailing 12-month price-to-earnings ratio are materially higher than its 10-year average. Valuations can sometimes remain high for extended periods of time; however, the recent bull market has lasted for almost 8 years and is showing signs of slowing down (e.g., Federal Reserve tightening, slowing earnings growth, etc.).
Second, interest rates, as measured by the 10-year treasury yield, remain near the July 8, 2016 all-time closing low of 1.37%. With the Federal Reserve indicating that it is preparing to raise interest rates in late 2016 or early 2017, the risk of holding fixed income, especially of longer duration, outweighs the reward of historically low income.
Finally, credit spreads have tightened substantially since the 2008 crisis and materially since early 2016. Although above all-time lows, spreads remain below historical average levels due primarily to the bidding up of prices as investors search for yield. Any stress in the credit markets could cause spreads to widen quickly, leaving investors in high-yield fixed income with heavy losses in a relatively less liquid market than investment grade fixed income.
In our opinion, these three charts together show that assets traded in the public markets are overvalued, offering limited potential upside. Even a sharp correction would only bring prices back to historical average levels. For this reason, we continue to recommend building cash and taking advantage of the illiquidity premium provided by private markets.