Valuation Signals for Asset Allocators
From an active #AssetAllocation or #MultiAsset investing standpoint, it is critical to develop valuation indicators for each asset class to identify moments of extreme risk...
Here's a case study -- that rare moment in 2022 when both stocks AND bonds fell materially: shattering at least temporarily the 60/40 investing paradigm.
This was preceded by *both* stocks and bonds showing up as extreme expensive in 2021 – something that has not happened before, and something that conceptually should be very rare given the differing drivers for each asset.
In that instance, you could have effectively considered cash as "cheap" by comparison, especially given the combined 60/40 portfolio view of valuations rising to one of the most extreme expensive readings on record (indicating elevated risk of adverse future returns).
As it turned out, given the lack of offset from bonds (which are typically expected to be a diversifying asset), 2022 was the second worst total return for the 60/40 portfolio in over 150 years.
And if you think about it — if your bond valuation signal is saying extreme expensive, you can’t look at that asset to perform its usual capital preservation role when it itself is at risk.
So valuation signals can provide advance warning to even seemingly novel and far tail risk scenarios, and present important information on the risk vs opportunity set at both the individual asset level as well as at the portfolio/asset allocation level. $S&P 500(.SPX)$ $NASDAQ(.IXIC)$ $DJIA(.DJI)$
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https://twitter.com/Callum_Thomas/status/1756594428897304835
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