January 19, 2023 | 4 Minute Read
Tighter monetary and fiscal policies were the main drivers of financial conditions and market behavior last year. The Federal Reserve raised rates more quickly than at any time since the 1980s, driving asset prices—including those for equities, bonds, and real estate—lower, while the European Central Bank lifted rates out of negative territory for the first time in nearly a decade as energy prices soared. In 2023, the focus may shift to slowing economic growth. The US economy may be able to narrowly avoid a recession, but even if it does, we expect growth to be tepid. While inflation may ease, it may settle above the Fed’s long-term target of 2%, in part due to a persistent scarcity of workers and strong wage growth. That suggests monetary policy may remain tighter than it has in recent decades, with rates likely to stay higher for longer. In the euro area, reduced energy demand owing to mild winter weather, along with resilient activity data, may mean the bloc is able to avoid a recession this year. In the UK, we expect a recession given persistent headline inflation, rising mortgage rates and structural headwinds to labor supply.
Source: Robert Shiller, Haver Analytics, DataStream, and Goldman Sachs Global Investment Research. As of December 14, 2022. For illustrative purposes only. Past performance does not predict future returns and does not guarantee future results, which may vary. Please see additional disclosures at the end of this publication.
We believe investors may want to consider a defensive approach in the near term while looking for opportunities to re-risk throughout 2023. A complex macro backdrop of decelerating growth, sticky inflation and still-restrictive monetary policy implies investors are in an alpha-driven environment in which active security selection will trump simple beta exposures.
For equity markets, 2022 was mostly about valuations de-rating, particularly in growth equities. The focus in 2023 is likely to shift to a lack of corporate earnings growth. We expect the low-growth environment to cause margin compression in most sectors, with energy a notable exception. How much margins compress will depend on whether economies slip into recession—and if they do, how deep the recession turns out to be. In these conditions, we think equity investors will want to favor exposure to profitable companies with strong balance sheets and earnings. Opportunities may exist in high-quality, defensive sectors that have typically held up well in similar conditions, including energy, consumer staples and healthcare. For credit investors, we believe a focus on earnings stability, liquidity positions and key credit metrics such as net leverage and interest coverage, may be warranted in the current environment. For equity investors, a binary approach to looking at either 'growth' or 'value'—the dominant prism through which investors viewed the markets in the cycle following the 2008 Global Financial Crisis (GFC)—may no longer be the correct one.
Maintaining exposure to high-quality, investment-grade fixed income assets—the foundation of a core bond allocation—can add balance to a portfolio amid market volatility and downside risks such as recession. The combination of high inflation and aggressive monetary tightening in 2022 blunted the balancing potential of core bonds, but we think peaking inflation and higher starting yields will allow high-quality fixed income to provide more cushion in 2023, potentially offsetting declines in speculative-grade fixed income, equities, and other risk assets. In a hard landing scenario, we believe short-duration Treasuries, Bunds, Gilts and other developed-market government bonds would likely rally in anticipation of policy easing, while US agency mortgage-backed securities should prove resilient due to low cyclicality. We would expect exposure to investment-grade credit issued by companies in defensive sectors with healthy balance sheets and limited margin pressure to also provide ballast to a diversified portfolio by offsetting potential weakness in riskier assets such as high-yield credit and equities.
Longer duration exposure may provide a more durable source of long-term income and a hedge against recession if one arrives. If it doesn’t, we still expect US yields to peak at some point in 2023 as the current Fed hiking cycle nears an end. Having exposure to the somewhat stickier yields on intermediate-duration bonds may provide a reliable longer-term cash flow for income-oriented investors.
Liquid Alternatives may offer greater flexibility in a downturn by providing investors with broad, liquid exposure to the hedge fund universe. Diversified exposure among hedge fund strategies may help investors weather fluctuating economic uncertainty and the unknowns that lie ahead in 2023. Last year, persistent US dollar and energy market strength along with a steady rise in global yields boosted macro trend-driven strategies such as managed futures. Equity long-short strategies, on the other hand, struggled amid the re-rating of many of the top performing stocks from the pandemic period. The highest-returning strategies in 2023 may be different. For investors with sufficient risk tolerance, strategic allocation to liquid alternatives may complement existing long-only allocations, add return potential in a more muted return environment and help to cushion portfolios should major economies suffer a hard landing and a sharp decline in equities and other risk assets.
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Energy security is the uninterrupted availability of energy sources at an affordable price.
Inflation is the rate at which prices for goods and services rise.
Risk assets those with a high degree of risk and volatility, such as such as equities, high-yield credit, commodities, and currencies.
Alpha measures the difference between a portfolio’s actual return and its expected return given its risk level as measured by its beta.
Beta measures the historical market risk of a portfolio or the volatility of a portfolio relative to an underlying index over a defined historical period of time.
Growth-oriented refers to areas of the market more likely to realize high earnings growth in the future and likely trade at a higher price relative to their earnings than the broader market.
Value-oriented refers to areas of the market less likely to realize earnings high growth in the future and likely trade at a lower price relative to their earnings than the broader market.
The “right side of disruption” refers to companies that in our view are aligned with key secular growth trends and/or are creating new innovative solutions.
Green economy refers to investments leading the climate transition.
Equity risk premia refer to the excess return earned by an investor when they invest in the stock market over a risk-free rate.
TINA stands for There Is No Alternative.
TARA stand for There Are Reasonable Alternatives.
Speculative-grade fixed income refers to high yield fixed income.
Duration measures the sensitivity of the price of a fixed income investment to a change in interest rates.
Short duration refers to a bond with a small amount of time to maturity.
Treasuries refers to US Treasury debt obligations.
Inflation-adjusted yields refer to the measure of return that takes into account the time period's inflation rate.
Innovation-oriented equities refer to companies that offer innovative solutions and are in line with long-term secular growth trends, such as technological innovation, environmental sustainability, future health care, and the new-age consumer.
Liquid alternatives are alternative mutual funds that often have characteristics similar to hedge funds but are public vehicles that can be traded easily.
Green bonds are fixed income investments with proceeds used to finance projects with dedicated environmental impact
GDP stands for gross domestic product and refers to the value of finished goods and services produced within a country's borders over one year.
Median return is the middle return in a sorted list of each individual security's return.
Risk premia refer to the amount by which the return of a risky asset is expected to outperform the known return on a risk-free asset.
Leverage ratio is a financial measurement that assesses the ability of a company to meet its financial obligations.
Interest coverage ratio is a measurement used to determine how easily a company can pay interest on its outstanding debt.
Drawdown is a peak-to-trough decline during a specific period for an investment, trading account, or fund.
Low quality companies would rank low based on low return on equity (LOE), high leverage or debt to equity, and unstable earnings.
German 10Y is a bond that reflects the yield received on government bonds issued by the German government maturing in 10 years.
Spain 10Y is a bond that reflects the yield received on government bonds issued by the Spanish government maturing in 10 years.
US 10Y Treasury is a bond that reflects the yield received on government bonds issued by the United States government maturing in 10 years.
United Kingdom 10Y is a bond that reflects the yield received on government bonds issued by the UK government maturing in 10 years.
Italy 10Y reflects the yield received on government bonds issued by the Italian government maturing in 10 years.
US 2Y Treasury is a bond that reflects the yield received on government bonds issued by the United States government maturing in 10 years.
ICE BofA US High Yield Index value, which tracks the performance of US dollar denominated below investment grade rated corporate debt publicly issued in the US domestic market.
ICE BofA Euro Corporate Index value, which tracks the performance of Euro dollar denominated investment grade rated corporate debt.
ICE BofA High Yield Master II OAS uses an index of bonds that are below investment grade (those rated BB or below).
EMBI (Emerging Market Bond Index) is JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries. The Global Diversified limits the weights of countries with larger debt stocks by only including a specified portion of these countries' eligible current face amounts of debt outstanding.
ICE BofA US Corporate Index, which tracks the performance of US dollar denominated investment grade rated corporate debt publicly issued in the US domestic market.
All investing is subject to risk, including the possible loss of the money you invest.
Equity securities are more volatile than bonds and subject to greater risks. Dividends are not guaranteed and a company’s future ability to pay dividends may be limited.
Bonds are subject to interest rate, price and credit risks. Prices tend to be inversely affected by changes in interest rates. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds.
Investments in fixed income securities are subject to the risks associated with debt securities including credit and interest rate risk.
Investments in foreign securities entail special risks such as currency, political, economic, and market risks. These risks are heightened in emerging markets.
Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.
High-yield, lower-rated securities involve greater price volatility and present greater credit risks than higher-rated fixed income securities.
Private equity investments are speculative, highly illiquid, involve a high degree of risk, have high fees and expenses that could reduce returns, and subject to the possibility of partial or total loss of fund capital; they are, therefore, intended for experienced and sophisticated long-term investors who can accept such risks.
Alternative Investments often engage in leverage and other investment practices that are extremely speculative and involve a high degree of risk. Such practices may increase the volatility of performance and the risk of investment loss, including the loss of the entire amount that is invested. There may be conflicts of interest relating to the Alternative Investment and its service providers, including Goldman Sachs and its affiliates. Similarly, interests in an Alternative Investment are highly illiquid and generally are not transferable without the consent of the sponsor, and applicable securities and tax laws will limit transfers.
An investment in real estate securities is subject to greater price volatility and the special risks associated with direct ownership of real estate.
Hedge funds and other private investment funds (collectively, “Alternative Investments”) are subject to less regulation than other types of pooled investment vehicles such as mutual funds. Alternative Investments may impose significant fees, including incentive fees that are based upon a percentage of the realized and unrealized gains and an individual’s net returns may differ significantly from actual returns. Such fees may offset all or a significant portion of such Alternative Investment’s trading profits. Alternative Investments are not required to provide periodic pricing or valuation information. Investors may have limited rights with respect to their investments, including limited voting rights and participation in the management of such Alternative Investments.
The above are not an exhaustive list of potential risks. There may be additional risks that should be considered before any investment decision.
The views expressed herein are as January 17, 2023 and subject to change in the future. Individual portfolio management teams for Goldman Sachs Asset Management may have views and opinions and/or make investment decisions that, in certain instances, may not always be consistent with the views and opinions expressed herein.
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Date of First Use: January 19, 2023 303206-OTU-1729696