Market Fragility
An important metric we track is the spread between equity valuations and treasury yields. We often leverage this spread as a relative valuation tool, allowing us to quantify the incremental risk investors take on when moving up the risk asset curve and investing in stocks. The question we as investors must answer - is this incremental risk worth it.
Below is a plot of this spread versus the following one year performance on the S&P500 over the past twenty years. There is a clear positive relationship.
A tightening spread (moving to the left of the chart) represents that investors are willing to take on more risk, or even disregard risk, to reap equity-like returns. Like the fine China resting on the edge of the shelf, it’s a fine strategy unless it gets bumped. Historically, trading below a 450bp spread (highlighted region) has opened the market up to potential violent downside, as ‘bumps’ in the market force investors to reprice and ultimately sell risk.
Today’s S&P500, at 370bps, is in a historically vulnerable range. That’s why I believe the term “fragile” is the right way to describe it, and in a fragile environment, purchasing insurance should be top of mind.
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Information presented reflects the personal opinions, viewpoints and analyses of the employees of Mirador Capital Partners, LP, an SEC-registered Investment Adviser. The views reflected in the commentary are subject to change at any time without notice. Nothing herein constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Mirador Capital Partners, LP manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Visit us at miradorcp.com for more information.