We expect higher US rates to be underpinned by evolving monetary policy, accelerating global growth, shrinking excess capacity, and reflationary policy. Following over three decades of a bond bull market, implementing strategies to pursue additional sources of returns may be upon us. Historically, equities and alternatives have generated higher returns in rising rate environments, with the latter providing the highest risk/return improvement. Finally, alternatives implementation can reduce portfolio drawdowns in equity bear markets.
The trend of falling interest rates cannot last forever – we think it has already begun to reverse.
We see a transition toward a rising interest rate environment driven by accelerating global economic growth, the evolving composition of monetary policy, and a sustainable shift towards higher US inflation. Tighter Federal Reserve policy and greater fiscal stimulus may add to the trend.
We consider alternative strategies to be a core portfolio allocation.
Although equities and alternatives have each experienced higher returns and lower volatility in rising rate environments compared to their long-term performance, we see more notable risk/return improvement for alternative strategies. In five rising rate periods since 1990, although fixed income risk did edge lower, returns fell sharply.
Chart Notes: Goldman Sachs Global Investment Research (GIR) and GSAM as of January 2017. Global Manufacturing Purchasing Managers’ Index (PMI) monthly data is from January 2010 to current, the largest available dataset. Global PMI is calculated by GIR by creating a Gross Domestic Product (GDP)-weighted composite of 33 countries’ PMI data. A reading above 50 implies an expanding global manufacturing sector, while a reading below 50 implies a contracting global manufacturing sector. The implied global GDP growth rate of 4.4% is based on analysis from GIR that regresses quarterly real GDP growth for the 33 countries against the Global Manufacturing PMI data. Bottom Chart Notes: GIR and GSAM as of 2/2/2017. Chart shows the Goldman Sachs Current Activity Indicator (CAI), an alternative monthly measure of economic growth, designed to reduce data reporting lags. The CAI is shown over the last 6 months with most recent readings highlighted on the right, in addition to the readings of CAI’s 5 subcomponents. The aggregate economy is represented by the CAI, which is the sum of the 5 subcomponent values. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this presentation. Text Notes: Buy-Write strategies are represented by the CBOE S&P 500 2% OTM (Out of the Money) BuyWrite Index. A Buy-Write strategy refers to an investment strategy that consists of receiving call premiums on an underlying equity position to generate income from the premiums. CBOE S&P 500 2% OTM BuyWrite Index’s performance is not necessarily reflective of all Buy-Write strategies. Past performance does not guarantee future results, which may vary.
Top Section Notes: As of November 30, 2016. Municipal represents the Bloomberg Barclays Municipal Bond Index, Investment Grade Corporate represents the Bloomberg Barclays Investment Grade Corporate Index, Agency represents the Bloomberg Barclays US Aggregate: Agency Index, and Treasury represents the Bloomberg Barclays U.S. Treasury Index. Chart shows a line of best fit of Tax-Equivalent Yields for 3, 5, 10, and 20 year bonds versus their durations. Tax-Equivalent Yield adjusts for tax-free earnings of municipal bonds, to make muni yields comparable with taxable yields. Current tax rate is 43.4%, reflecting a 39.6% Federal Rate and a 3.8% Affordable Care Act Tax. The 33% tax rate reflects Trump administration tax proposals. Goldman Sachs does not provide accounting, tax, or legal advice. Lower interest rates may reduce the duration of callable securities. As a result, the municipal and corporate indices used in this analysis have significantly lower duration, though similar maturity, as the government indices. Bottom Section Notes: As of November 30, 2016. Chart rankings are relative to 5yr single A performance and are a reasonable representation of an intermediate, investment grade rated portfolio. Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold, or directly invest in the company or its securities. These illustrative results do not reflect any GSAM product and are being shown for informational purposes only. No representation is made that an investor will achieve results similar to those shown. Goldman Sachs does not provide accounting, tax or legal advice. Please see additional disclosures at the end of this document. Past performance does not guarantee future results, which may vary.
The theme we see dominating markets at present is one of quantity: more growth, more uncertainty, more record highs, and more risk. US economic growth is advancing, while Europe and Japan are improving modestly. Washington is issuing a blitz of new policy initiatives whose contours are largely unknown. We expect the global expansion to gain strength with broadening contributions from manufacturing, consumers, and policy. Yet we do see one key exception to the trend of “more” – returns. Equity multiples are full and 2017’s global political calendar is packed. We think modest returns are likely from major asset classes on account of valuations and political realities. Read More
Following more than 30 years declining US interest rates, we believe that this trend is coming to an end and has already started to reverse. In addition, during the five major rising US rate periods since 1990, alternative strategies offered the most attractive risk-adjusted return improvement compare to traditional equity and fixed income investments. Read More
Japan's macro and market indicators point to a meaningful advancement over the past 5 years. Abe’s reform agenda has reached several milestones, particularly around corporate governance. Importantly for equity holders, the number of firms in the Tokyo Stock Exchange with outside directors has more than doubled since 2012. In addition, while economic fundamentals have improved we believe the Yen could weaken further as a result of the BoJ policy and interest rate differentials, particularly versus the US Dollar. Historically, a weaker Yen has tented to boost equity performance. We believe Japanese equities offer attractive valuations and earnings growth prospects. Read More
Negative trade-oriented sentiment towards emerging markets (EM) may have finally receded in favor of a focus on fundamentals. From the recent December low, EM equities and debt have rallied 14% and 5%, respectively, a repricing that was almost as swift as the post-US election slump. We expect earnings growth to continue rising off last year’s trough, and that the same trend could act as the dominant driver of forward EM returns. Read More
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