When Defensive Assets Stop Working

What if I told you there was a bubble but it wasn't in risk assets? What if I told you that the assets most investors look to for safety and capital preservation could actually be the biggest source of risk in portfolios right now?

OK, if I haven't lost you already, yes that does sound a bit cheesy and smacks of the scaremongering that a lot of pundits use to sell their subscriptions (and why yes, I do have a subscription to sell you, but that's a matter for a different time!). So I apologize for upfront for the douchey intro.

But then again, once you check out some of the charts I'm about to show you, it might actually begin to make a little bit of sense...

On my metrics, the traditionally defensive assets are looking very richly priced, and I guess you can't blame investors for crowding in. You've got NIRP/ZIRP all over the world, QE/"not QE", trade wars, political BS 24/7 (to put it euphemistically), scary headlines, crappy data, and late-cycle lamentations.  Simply put, it's easy to explain why you're overweight bonds, REITs, and gold when the global PMI is below 50 and the next selloff is only a tweet away.

But what if things change?

What if the global economy experiences a rebound instead of a recession?  What if all that other crap starts to fade (or heaven forbid, political risk surprises to the upside)?  What happens to defensive assets if we get a full blown late-cycle-extension? 

1. Valuations: defensive assets are extremely expensive 

As I alluded to, based on my proprietary mix of valuation indicators the average valuations across the defensive assets (treasuries, REITs, gold) is at the most expensive level on record. Meanwhile, the average across US equities, international equities, and commodities (growth assets) is still around quite reasonable levels. Simply put: defensive assets are very expensive, and growth assets are cheap. This is basically a market-based measure of a profound level of fear, uncertainty, and pessimism on the economic outlook. 

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