Pushing Against A String?

I received in my email inbox the following update yesterday.

(Zerohedge) When Goldman warned on Friday that a “big drop” in the market is possible before the S&P hits the firm’s year end price target of 2,100, one of the bearish reasons brought up by the firm’s chief strategist David Kostin is that stocks are now massively overvalued. In fact, according to Goldman , while the aggregate market is more overvalued than 86% of all recorded instances, the median stock has never been more overvalued, i.e., it is in the 100% valuation percentile, according to some key metrics such as Price-to-Earnings growth and EV/sales.

This is what Goldman said:

Valuation is a necessary starting point of any drawdown risk analysis. At 16.7x the forward P/E multiple of the S&P 500 index ranks in the 86th percentile relative to the last 40 years. Most other metrics paint a similar picture of extended valuation. The median stock in the index trades at the 99th percentile of historical valuation on most metrics (see Exhibit 3).

Why is this important? Given that most public retirement systems and Taft-Hartley DB plans have dramatically reduced fixed income exposure during the last 15 years, while increasing equity and alternative exposure, an overvalued market such as the one described above could potentially set up these plans for dramatic underperformance relative to both the plan’s liabilities and the stated ROA.

With Funded Ratios low and falling, and the plan’s poor Funded Status large and growing, DB plans cannot afford (nor can the entities that fund them) to suffer out-sized losses. We believe that plans should undertake to transition a percentage of their portfolio to meet near-term benefit payments, which will improve liquidity, transform interest rate sensitive fixed income portfolios to more of a risk reducing tool, and importantly, extend the investing horizon for the riskier assets in the portfolio to weather stormy markets. Now is the time to begin to act and not after the red ink from the equity market losses has dried.

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