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:
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.
The past 30 years have seen dramatic changes in the trading environment. In this evolution, algorithmic trading now dominates many asset classes. Speed has replaced capital, creating vast pools of liquidity during periods of stability and vacuums of liquidity during crises. This structural shift should create awareness among investors to differentiate between fundamentally and algorithmically driven markets.
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.
Missing just a handful of the best days has resulted in notably lower investment returns.
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.
Patience and commitment are key to long-term success.
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.
Top Section Notes: As of March 31, 2019. Chart shows annualized returns of various hypothetical investments in the MSCI World Net Total Return Index ($) from January 1999 to March 2019. Best days are defined as the days with the highest daily returns. 'Invested All 5,281 Days' assumes an investment in all days from January 1999 to March 2019 while 'Minus 10 Best Days' assumes an investment in all 5,281 days minus the 10 best days. January 1999 is the inception date of the daily version of the MSCI World Net Total Return Index ($). Bottom Section Notes: As of March 31, 2019. Chart shows the frequency of positive rolling returns over 1-year, 5-year, 10-year, and 15-year horizons for the MSCI World Net Total Return Index ($). January 1970 is the inception date of the monthly version MSCI World Net Total Return Index ($). Past performance does not guarantee future results, which vary.
We see emerging markets poised for a comeback as global macro conditions converge.
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.
Many investors are structurally underweight EM, and thus may not fully benefit from EM growth prospects.
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.
Top Section Notes: As of March 31, 2019. ‘Change in Gross Domestic Product (GDP) Growth’ is represented by the difference in GDP growth (%, YoY) from the previous year’s GDP growth. For example, a 0.6 percentage point (pp) change means that the pace of GDP growth was 0.6pp faster than its prior year. ‘Earnings Growth’ refers to top-down consensus earnings per share (EPS) growth. Bottom Section Notes: As of March 31, 2019. Average international investor allocation is estimated based on EM equity and debt funds’ weight as a percent of the total European domiciled onshore and offshore fund market, Hong Kong onshore fund market, and Japanese onshore fund market. The universe includes active and passive mutual funds and ETFs (except for in Hong Kong and Japan), and excludes money market funds, fund of funds, and alternative funds. The Illustrative GSAM Strategic Asset Allocation is composed of 70% Core Equity and Diversifiers and 30% Core Fixed Income. Diversifiers are defined as non-traditional asset classes. Diversifiers include Emerging Market Debt (USD), Emerging Market Debt (Local Currency), Global High Yield, Emerging Markets Equity, Global Small Cap Equity, Global Real Estate, Global Infrastructure. Core Equity includes Developed Markets Equity. Core Fixed Income includes Developed Markets Investment Grade Fixed Income.
Yields across a range of asset classes today may provide a significant buffer against potential price losses.
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 large rate moves that would be required to offset this substantial income have been exceedingly rare.
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.
Top Section Notes: As of March 31, 2019. ‘Current Yield’ refers to the current stated yield to maturity. ‘Breakeven Yield’ refers to the estimated yield at which total returns would be negative based on current yield to maturity and current modified duration. ‘US 10-Year Treasury' refers to the Bloomberg US Generic Government 10-Year Yield Index. ‘Euro HY’ refers to the Bloomberg Barclays Pan-European High Yield Index. ‘EM Debt Local’ refers to the Bloomberg Barclays Emerging Market Local Currency Government Index. ‘EM Debt USD’ refers to the Bloomberg Barclays Emerging Market USD Aggregate Index. ‘US HY’ refers to the Bloomberg Barclays US High Yield Index. Bottom Section Notes: As of March 31, 2019. Analysis is from June 2008, earliest common inception, to March 2019 on a rolling monthly basis. High-yield, lower-rated securities involve greater price volatility and present greater credit risks than higher-rated fixed income securities. Emerging markets securities may be less liquid and more volatile and are subject to a number of additional risks, including but not limited to currency fluctuations and political instability. Past performance does not guarantee future results, which may vary.
Global central banks’ dovish turn potentially elongates the cycle.
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 credit cycle is maturing, not nearing an end.
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.
Top Section Notes: As of March 31, 2019. 'Current' is as of April 2, 2019. Chart shows market-implied pricing for G7 central bank rates as of April 2, 2019 and as of January 1, 2019. The Group of Seven (G7) is a group consisting of Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. A market-implied rate is the difference between the spot interest rate and the interest rate for the forward or futures delivery date. Bottom Section Notes: As of March 31, 2019. Moody’s default rates are calculated from data drawn from its proprietary database. Moody’s calculates its par-weighted or dollar volume-weighted default rates using the same cohorts-based methodology as its issuer-weighted default rates. Default rates are calculated as a fraction where the numerator represents the total dollar amount of defaulted corporate bonds over a 12-month period and the denominator represents the total face value of corporate bonds outstanding that could have defaulted at the beginning of the period. Past performance does not guarantee future results, which may vary.
Alternative Risk Premia strategies represent a rules-based, systematic approach to investing.
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.
Accessing ARPs across different styles and asset classes.
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.
Top Section Notes: As of April 30, 2019. For illustrative purposes only. ‘Alternative risk premia’ refers to rules-based, multi-asset, long/short investment strategies which have historically been employed by hedge funds. Examples of strategies employed for alternative risk premia include momentum, value, carry, quality, low volatility, and structural. Bottom Section Notes: As of April 30, 2019. For illustrative purposes only. Diversification does not protect an investor from market risk and does not ensure a profit.Investments in Liquid Alternative Funds expose investors to risks that have the potential to result in losses. These strategies involve risks that may not be present in more traditional (e.g., equity or fixed income) mutual funds. Past performance does not guarantee future results, which may vary.
Private equity has been generating more value, attracting more interest, and becoming more accessible to investors.
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.
Investing across managers, funds, and vintages in our view is key to improving client outcomes.
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.
Top Section Notes: As of March 31, 2019. ‘Unicorn’ refers to a private company with a valuation of $1 billion or greater. Bottom Section Notes: As of December 31, 2018, latest available data. 'Average Net IRR' and 'Standard Deviation of Net IRR' are calculated from reported Net IRR of over 3,000 PE funds in the Preqin database with a vintage year between 1997 and 2017 (inclusive). 'Standard Deviation' is a measure of volatility. The ‘Illustrative Diversified Strategy’ is an equal-weight illustrative portfolio of the four private equity strategies shown in the chart. 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. The performance results are based on historical performance of the private equity strategies used. The result will vary based on market conditions and your allocation. An investment in a PE fund is speculative with a substantial risk of loss. An investment in a PE fund is only suitable for investors who have no need for liquidity in the investment. Investors generally are not able to redeem their units or withdraw from a PE fund for the life of the investment. This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. Diversification does not protect an investor from market risk and does not ensure profits. Please see end notes for important disclosures. This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. Please see glossary for additional definitions. Past performance does not guarantee future results, which may vary.
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