If you’re searching for a great bargain this holiday season, don’t bother looking on Wall Street.
Thanks to the ferocious bull market in stocks and decades-long boom in bonds, asset prices are looking very expensive these days — and that could signal trouble down the line.
The average valuation of stocks, bonds and credit is more expensive than at any time since 1900, according to a Goldman Sachs report published late Tuesday.
“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,” strategists at the investment bank wrote.
But Goldman Sachs warned that “all good things must come to an end,” adding that “there will be a bear market, eventually.”
Guggenheim Partners offered another reason for caution: The economic recovery from the Great Recession is “showing signs of aging.” The firm predicted in a report on Wednesday that there is a “high probability of a recession starting in late 2019 to mid-2020.”
Few on Wall Street seem worried about a recession. U.S. stocks neared another milestone on Wednesday, when the Dow flirted with 24,000 before retreating. It has spiked about 5,500 points since President Trump’s election last year.
High valuations don’t mean the party is necessarily about to end. Prices could stay lofty for some time and even go much higher. Goldman Sachs said stock market valuations could eventually reach peaks seen in the 1920s and during the dotcom bubble of the late 1990s.
Still, history shows that “elevated” valuations often signal that investment returns over the medium and long run will be lower, according to Goldman.
In other words, don’t bank on massive gains continuing.
“Valuations don’t tell you when the rally will stop. They do indicate that investors need to lower their expectations for long-term returns,” said Kate Warne, investment strategist at Edward Jones.
In the most likely scenario, Goldman Sachs predicts “slow pain” caused by lower returns across assets.
But the firm also warned of another outcome: “fast pain” for stocks and bonds alike caused by an economic recession, an inflation spike or a combination of the two.
That pain would be amplified by high valuations because there is “less buffer to absorb shocks,” Goldman wrote.
Moreover, investors may not be able to count on central banks to come to the rescue as they did in 2008. The Federal Reserve and foreign central banks have fewer options to stimulate growth because interest rates remain extremely low.
The European Central Bank is urging caution.
In a biannual review of financial stability, the ECB said on Wednesday that despite few signs of stress right now, “the risk of a rapid repricing in global markets nevertheless remains.”
To be sure, there are legitimate reasons for optimism among investors. For the first time in years, most major economies are growing at the same time.
The United States has been a particular bright spot. Growth hit a three-year high of 3.3% during the third quarter and the unemployment rate is sitting at the lowest level in 17 years.
Thanks to strong growth, corporate profits look very healthy. Wall Street is betting companies will make even more money if Congress enacts the GOP plan to slash corporate tax rates.
Yet some think the economic recovery is looking a bit stale.
Morgan Stanley believes the U.S. is in a “late cycle environment” for both the economy and stock market. “Late cycle is not bearish for equities but it does eventually turn into a recession,” the firm wrote in a recent report.
While Morgan Stanley doesn’t anticipate a recession in 2018, the firm said that next year investors may start to anticipate one.
–CNNMoney’s Ivana Kottasová contributed to this report.
