The present combination of overvalued, overbought, overbullish conditions, coupled with rising interest rates and broad dispersion among market internals, is one that most closely resembles only three other points in the post-war period; the first in early-October 1987 (though at less extreme valuations), the second in January 2000, and the most recent in July 2015 (the S&P 500 lost -12% over the next 6 weeks). Relaxing the set to include the nearly 10% of post-war periods that share the more general market return/risk classification we presently identify, the overall expected return distribution is associated with severely negative market outcomes, on average, capturing a cumulative loss in the S&P 500 exceeding -90%. We currently view a hard-defensive stock market outlook as appropriate.
Even in bonds and precious metals, present market conditions are consistent with only modest return expectations. While a near-term rebound in these markets would be consistent with short-term oversold conditions, our main inclination in response to the recent spike in yields is not so much to embrace Treasury debt but to avoid corporate debt, where credit spreads are compressed to the point where rapid adjustments (and steep price losses) appear likely. I have very weak expectations about direction of long-term interest rates here, but much stronger views about the likelihood of widening credit spreads.
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