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2019: Edition 2


Game of (Un)Knowns

A stabilizing macro backdrop, convergent growth, and late-cycle opportunity: each is a reason we do not see winter coming for investors. We believe that strategy will be key—we remain pro-expansion, yet pro-reality, attuned to the evolution of late-cycle conditions.

Here are the knowns: the global economy has transitioned from above-trend to near-trend growth, the expansion has continued, and looking ahead we see activity stabilizing. The US expansion is on track to notch its 121st month in June, which would be the longest expansion in history. Accordingly, absent clearer signs of a long-lasting deterioration in fundamentals, we believe the evolving market environment remains supportive of risky assets. On the back of a solid operating environment, credit performance should remain stable.

The unknowns bear close watch, though as the season progresses we expect more conclusions on several key concerns: an uncertain Brexit process, turbulent trade policy, and the possibility of further populist shocks in election outcomes. Investors, in our view, should prepare for emergent risks even as they seek to capitalize on opportunity.

Consequently, we would emphasize:

  • Pro-risk asset classes—emerging markets may be well-positioned for a comeback
  • A focus on risk allocation over capital allocation, leading to a strategic commitment to alternative investments
  • Income in both public and private markets, which may help build an additional buffer against short-term volatility.

Macro & Market Views

Global policy uncertainty has been elevated...

Geopolitical shifts, trade negotiations, evolving monetary and fiscal policies, volatile oil prices, and ubiquitous media coverage are all forces contributing to elevated global economic policy uncertainty. On the margin, we believe these uncertainties should moderate through 2019, though the political echo chamber is likely to mask progress.

Source: Economic Policy Uncertainty and GSAM.

Top Section Notes: As of March 31, 2019. Bottom Section Notes: As of October 2016, latest available data. ‘Algorithmic Trading’ is the process of automatically executing trades according to a pre-defined set of rules. ‘FX’ refers to the G10 currencies. 'Interest Rates' refers to US Treasuries. ‘Energy’ refers to crude oil. ‘Metals’ refers to precious metals.



The Know
It’s time in the market, not market timing.

Missing just a handful of the best days has resulted in notably lower investment returns.

The Cost of Unsuccessful Market Timing

Over the last two decades, an investor who stayed invested all 5,281 days would have enjoyed more than twice the gains of an investor who missed just the best 10 days. Extending the period to missing 40 or more of the best days would have resulted in negative returns. Even the most sophisticated investors have difficulty “timing” the market with precision. We see a long-term, strategic mindset as the bedrock of investment strategy; unsuccessful market timing can damage long-term performance.

Source: Bloomberg and GSAM.

The How
Maintain a long-term perspective.

Patience and commitment are key to long-term success.

Long-Term Investors Have Been Rewarded over Time

Investors may be hesitant committing money to the market in hopes of a “better” entry point given the aging of the US equity bull market, signs of lateness in the economic cycle, and geopolitical unknowns. We would urge investors to stay focused on the degree to which long-term investors have been rewarded over time. Over the past half century, stocks posted positive one-year returns 77% of the time and positive 15-year returns 100% of the time.

Source: Bloomberg and GSAM.

The Know
Emerging opportunities.

We see emerging markets poised for a comeback as global macro conditions converge.

Convergence Ahead: Favorable Environment for Emerging Markets

US economic growth may converge with the rest of the world, "catching down.” We expect exceptional 2018 US earnings growth to normalize closer to the global trend, and EM earnings to catch up. Additionally, we expect a weakening US dollar, which would also be supportive of EM assets.

Source: International Monetary Fund (IMF), FactSet, Goldman Sachs Global Investment Research, and GSAM.

The How
Weighty decisions.

Many investors are structurally underweight EM, and thus may not fully benefit from EM growth prospects.

Underallocation to EM Assets: Potential Missed Opportunity

Looking at an average international investor’s allocation, we see a structural underweight to EM equity and debt of 4.2 percentage points (pp) and 6.0pp, respectively to our strategic asset allocation. We think that portfolios with higher EM allocations could enjoy enhanced risk-adjusted returns, particularly at a time of softening developed market fundamentals and US convergence.

Source: Morningstar, Strategic Insight, Hong Kong Investment Funds Association, and GSAM.

The Know
Clipping coupons.

Yields across a range of asset classes today may provide a significant buffer against potential price losses.

Point Break

In the current benign rate environment, the coupon income from credit asset classes is looking particularly attractive. We estimate that yields could rise by a further ~1% before the offsetting price reduction would reduce returns in various credit sectors to breakeven. For example, rates or spreads would need to rise more than 197 basis points to generate negative returns in US High Yield.

Source: Bloomberg Barclays and GSAM.

The How
Rare potential.

The large rate moves that would be required to offset this substantial income have been exceedingly rare.

Smooth Moves

The present difference between the current and breakeven yields for several sectors is so wide that it has historically been breached just a handful of times. For example, the 197 basis point move in US HY yields has occurred in just 2% of 12-month periods. Given our expectation for stabilizing global growth, contained inflation, and dovish central bank policy, we consider the likelihood of such moves to be particularly slim.

Source: Bloomberg Barclays and GSAM.

The Know
Lower for longer.

Global central banks’ dovish turn potentially elongates the cycle.

Market Now Expects Lower Rates, Potentially for Longer

In our view, the recent dovish turn in central bank policy will have positive implications for risky assets  The chart shows that while at the beginning of the year the market was expecting some tightening from G7 central banks 12 and 24 months out, now global central banks have decidedly turned more patient. Such a shift should have clear benefits for high yield markets.

Source: Bloomberg and GSAM.

The How
A benign default environment is a tailwind for global high yield.

The credit cycle is maturing, not nearing an end.

High Yield Defaults Remain Low in the US and Europe

We believe potentially lower rates are a tailwind for corporate earnings and revenues, and can contribute to keeping cost of debt and leverage in check. Global high yield continues to offer attractive yields versus government debt while defaults, traditionally an important late-cycle indicator, have decreased recently and are now well below historical averages. Corporate fundamentals continue to remain sturdy, particularly in the US, where debt-to-profit ratios are still near the lower end of the historical range.

Source: Moody's and GSAM.

The Know
At the sweet spot between alpha and beta.

Alternative Risk Premia strategies represent a rules-based, systematic approach to investing.

Returns Beyond Alpha and Beta

Alternative Risk Premia (ARP) strategies are a systematic approach to investing that focus on integrating styles that are known to drive returns consistently over time. ARP returns are distinct from those sourced through traditional alpha and beta strategies as they compensate investors for risks and opportunities beyond traditional asset classes. ARP draws on rules-based, long/short investment strategies to harness differentiated returns through an extended set of fundamental and technical factors.

Source: GSAM.

The How
Differentiation without giving up liquidity and transparency.

Accessing ARPs across different styles and asset classes.

Mix and Match: Style Exposures to Generate Returns

Access to ARPs can come in many forms across traditional asset classes and securities. The matrix of opportunities allows investors to pick and choose factor exposures that address their needs. We think of these strategies as offering differentiated sources of return with low correlation to traditional asset classes and a high degree of liquidity, transparency, and efficiency, all at low cost. Given low correlations among ARPs, we favor a diversified allocation.

Source: GSAM.

The Know
Coming of age.

Private equity has been generating more value, attracting more interest, and becoming more accessible to investors.

Private Market Evolution

The private equity (PE) universe has expanded rapidly in recent decades, and is creating more value for companies and their investors. A favorable funding environment has enabled companies to strategically delay public offerings. Individual investors’ barriers to entry have shrunk as asset managers have lowered minimum net worth and investment requirements. We believe this evolution has enhanced the asset class’ attractiveness.

Source: Preqin, CB Insights, and GSAM.

The How
Diversifying private equity.

Investing across managers, funds, and vintages in our view is key to improving client outcomes.

Risk and Return by Private Equity Strategy

Diversifying vintage years enables exposure to different stages of the PE investment cycle. Diversifying across strategies enables access to buyout, distressed, growth, and venture investments. Each strategy comes with unique risk and return tradeoffs; single-strategy performance may be highly variable. A diversified approach, in our view, may mitigate risk and help transform PE into a core allocation.

Source: Preqin and GSAM.


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