The continued economic expansion, the fluidity of global politics, and the shifting tectonics of monetary policy: All are reasons we think staying invested, but staying focused on alpha and on risk, is the appropriate path. Markets strike us as lacking extremes on either end of the valuation continuum, though they are subject to rising risks, including the potential for recession, flareups of volatility, and political shocks. Easy Does It, in our view, is the appropriate mindset in a climate that calls for a risk-aware adherence to strategic investment allocations.
We see current conditions as largely benign as long as investors understand that risk may no longer be linear. Political shocks and policy-related risks are the variables to watch, whereas we see recession risk as still moderate.
Investors who believe in risk assets but think they offer limited upside from this point forward may revisit strategies with the potential to offer equity-like returns, but with less equity-like beta. In our view this means examining a range of possibilities in income-oriented investing and alternatives. It may, in short, mean adopting an Easy Does It philosophy—seeking to optimize risk in the tenth year of an equity bull market.
Consequently we would emphasize:
The recent slowdown in activity and growth has had at least two remarkable features: 1) its protracted length, and 2) the manufacturing sector's weakness, whose signal should not be over-emphasized as its share of US GDP is only 10%. Other parts of the global economy—notably the services sector—have been much more resilient in the face of uncertainty over trade policy and the associated disruption to supply chains.
On the surface, exceptionally strong 1H 2019 equity market returns appear to contrast with the cautious signal of falling fixed income yields. The message may not be so mixed. Part of equities' strength reflected a rebound from 4Q 2018 oversold conditions, while low to negative rates reflect expectations for continued loose monetary policy.
Top Section Notes: As of July 31, 2019. 'Global manufacturing PMI' refers to Purchasing Managers' Index, an index measuring prevailing direction of economic trends in the manufacturing sector. Bottom Section Notes: As of July 31, 2019.
Harness time-tested sources of return in a transparent, rules-based manner.
We think these four factors are some of the most economically intuitive and commonly supported factors over the course of decades. They have proven robust in a variety of market environments and are “active” in the sense that they do more than merely deliver market beta. In our view, a cost-effective and transparent rules-based strategy can provide higher risk-adjusted returns compared to a traditional cap-weighted index.
Diversify across smart beta strategies to tap into a range of differentiated return sources.
A range of smart beta strategies have delivered attractive risk-adjusted returns over the last decade, but leaders and laggards have varied. In our view, allocating across the four above-described factors may provide smoother returns with a limited deviation from a traditional cap-weighted index. Since 2000, a smart beta equal-weight blend would have outperformed a cap-weighted index in nearly three-quarters of calendar years.
Source: Bloomberg and GSAM.
Top Section Notes: As of July 31, 2019. For illustrative purposes only. Bottom Section Notes: As of July 31, 2019. ‘Smart beta’ refers to transparent rules-based strategies. Analysis is based on net total returns in USD from December 31, 2000 to December 31, 2018. The traditional (cap-weighted) portfolio refers to the MSCI World Index. The Smart Beta Blend represents a hypothetical equal-weight blend of the MSCI Momentum, MSCI Value, MSCI Quality, and MSCI Low Volatility indices, rebalanced monthly. The Smart Beta Blend provided herein has certain limitations as these results are based on hypothetical past performance. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under-or overcompensated for the impact, if any, of certain market factors, such as lack of liquidity. Hypothetical returns in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown. Diversification does not protect an investor from market risk and does not ensure a profit. Past performance does not guarantee future results, which may vary.
Millennials’ lifestyle priorities are reshaping traditional economic arrangements.
Priorities born either of the financial crisis or pronounced generational differences have given rise to a “sharing economy.” These new business models may soon match the traditional economy in terms of economic value. Technology has enabled an “asset-light” business model where asset ownership is no longer imperative. Instead, cost-effectiveness, experiences, service, and sustainability become the modus operandi. Millennials have been the drivers of these platforms, but everyone is now a passenger.
Source: Bloomberg, PWC, and GSAM.
Companies need to adapt and evolve in order to survive.
The global corporate landscape has changed dramatically over the last 20 years. We believe this change has been largely driven by the millennial generation as early adopters of technology with different spending priorities. As this generation becomes increasing wealthy, millennials’ consumption will have a greater disruptive impact on global markets. By looking at the world through a “Millennial lens,” investors may identify tomorrow’s winners.
Source: Bloomberg and GSAM.
Top Section Notes: As of July 31, 2019. The chart is based on a PwC study (https://www.pwc.com/hu/en/kiadvanyok/assets/pdf/sharing-economy-en.pdf) that shows that in 2013, sharing economy companies represented the “new business model” with the most prevalent earned sales revenue of 15 billion USD. Chart shows that by 2025, sales will have risen to 335 billion USD, with half of the revenues in these markets going to companies with a sharing-based model. ‘c2c’ represents a market environment where one customer purchases goods from another customer using a third-party business or platform to facilitate the transaction. ‘c2c’ companies are a new type of model that has emerged with e-commerce technology and the sharing economy. Bottom Section Notes: Chart shows the largest listed companies by market capitalization in USD as of July 26, 1999 and as of July 26, 2019. For illustrative purposes only.
Liquidity is an essential part of investment strategy, yet the opportunity for cash to work is often underappreciated.
Identifying goals for cash can enable investors to better align short-term investments with particular liquidity needs. We think that a differentiation between daily liquidity and on-demand liquidity is important. Both allow for preservation of capital, but strategic investments for on-demand liquidity may further unlock incremental return without sacrificing access to cash.
Late-cycle flattening makes the front end of the curve attractive on an absolute and risk-adjusted basis.
The front end of the yield curve offers a sweet spot for investors from a yield and duration perspective, in our view. We see advantages for investors residing on both ends of the maturity spectrum. In light of a more accommodative central bank posture, portfolios with longer durations may find more attractive yield towards the shorter end of the curve. At the same time, the US average savings account rate of 1.2% may have daily liquidity investors leaving money on the table.
Source: Bloomberg and GSAM.
Top Section Notes: As of July 31, 2019. 'Liquidity' refers to short duration securities that can be quickly bought or sold in the market at a price reflecting its intrinsic value. 'Primary liquidity' refers to investments with an investment horizon of less than 12 months, an objective of preservation of capital and liquidity, and that uses traditional money market or short-term conservative income strategies. 'Secondary liquidity' refers to investments with an investment horizon on 12 months or longer, an objective of enhanced return and preservation of capital, and that uses short duration strategies. 'Tertiary liquidity' refers to investments with an indefinite investment horizon, an objective with greater emphasis on maximizing return potential, and that uses broad fixed income strategies. 'Daily liquidity' refers to a subset of primary liquidity with an investment horizon of less than 6 months. 'On-demand liquidity' refers to a subset of primary liquidity with an investment horizon of 6–12 months. For illustrative purposes only. Bottom Section Notes: As of July 31, 2019. 'US average savings account rate' is from the Bankrate survey of large lenders in all 50 states. Chart shows the current yield and risk-adjusted yield for different tenors of on-the-run US Treasuries. 'On-the-run' refers to the most recently issued Treasuries of a particular maturity. 'Risk-adjusted yield' is measured by the yield per unit of risk, where risk is defined as the standard deviation of monthly total returns over the last 10 years. 'Yield' refers to the end of day yield to maturity. Past performance does not guarantee future results, which may vary.
Idiosyncratic factors have grown in importance as drivers of European equity returns.
European equity returns have dislocated from traditional growth drivers; political uncertainty and weak corporate profitability explain virtually all of Europe's under-performance. Europe's highly cyclical and mature sector composition amplifies these issues. While we expect episodic out-performance during periods of growth acceleration, rising rates, higher US inflation, aggressive US tech regulation, and/or favorable political momentum, we believe the best opportunities in Europe are micro, not macro.
Source: Bloomberg, Goldman Sachs Global Investment Research, Haver, and GSAM.
High-performing European firms have seen higher returns.
Since 2009, European companies with outperforming stocks have exhibited significantly greater earnings growth, profit margins, and annual returns than those with weak share-price returns. These fundamental differences are particularly large relative to the US, which is why we see a strong case for active management in European equities. While European beta may have diminished macro momentum, we see alpha opportunities as plentiful—and may be best captured through bottoms-up analysis and more concentrated positioning.
Source: Bloomberg and GSAM.
Top Section Notes: As of July 31, 2019. 'Relative strength ratio' refers to the relationship between Europe and the US based on equity and economic ratios. The equity ratio is calculated by taking the ratio of the Euro Stoxx 600 Index cumulative daily performance over a denominator of S&P 500 Index cumulative daily performance. The economic ratio is calculated by taking the ratio of monthly Euro area Markit Manufacturing Purchasing Managers Index (PMI) over a denominator of monthly US ISM manufacturing PMI. 'Info Tech' refers to Information Technology. 'Fin.' refers to Financials. 'Comm. Service' refers to Communication Services. 'Cons. Disc.' refers to Consumer Discretionary. 'Indus.' refers to Industrials. 'Cons. Stap.' refers to Consumer Staples. 'Util.' refers to Utilities. Bottom Section Notes: As of December 31, 2018, latest available. Analysis is done on an annual basis from 2009 to 2018. Each data point represents the 10-year average difference between the median of outperforming and underperforming stocks for each respective measure. 'Outperforming stocks' refers to securities with an annual return that exceeds the index, and 'underperforming stocks' refers to securities with an annual return less than the index. 'EPS growth' refers to earnings per share growth. 'Profit margin' refers to profit as a percentage of revenue. 'Return dispersion' refers to the difference between annual returns of outperforming and underperforming securities. Past performance does not guarantee future results, which may vary.
Buying Japanese equities based on a currency view worked well in the past but may not in the future.
Japanese equities are more than a pure FX strategy. The correlation between equity returns and FX plummeted over the last few years. In our view, drivers such as steady profit growth for domestic oriented companies, lower sensitivity of exporters’ profits to the Yen, an increase in ROE and net margins, and stronger corporate fundamentals today matter more than FX dynamics.
Source: Bloomberg and GSAM.
Certain sectors are more favorably positioned against any possible appreciation in the Yen.
According to Japan’s Cabinet Office, the average exchange rate to maintain profitability currently stands at 99.8 Yen per USD, a much stronger level versus this year’s average rate of 110.9. In addition, some sectors such as pharmaceuticals and chemicals are better positioned than others. In our view, rather than an FX-based strategy, fundamentally driven bottom-up security selection is key in reducing risk and unlocking value in Japanese equities.
Source: Bloomberg, Cabinet Office of Japan, and GSAM.
Top Section Notes: As of July 31, 2019. Analysis based on monthly data from July 2009 to July 2019. TOPIX refers to the Tokyo Stock Price Index denominated in JPY. JPY refers to the Japanese Yen. Past correlations are not indicative of future correlations, which may vary. Past performance does not guarantee future returns which may vary. Bottom Section Notes: As of July 31, 2019. Based on the Annual Survey of Corporate Behavior, published in March 2019 by the Cabinet Office of Japan. The breakeven USD/JPY rate of listed exporting companies (all industries, actual value average) was 99.8 USD/JPY. The breakeven USD/JPY rate is a sector specific survey-based level of exchange rate to maintain profitability, beyond which corporates balance sheets can start to be impaired by currency strengths. 'Pharma.' refers to Pharmaceutical. 'Chem.' refers to Chemicals. 'Electric App.' refers to Electric Appliances. 'Mach.' refers to Machinery. 'Trans. Equip.' refers to Transportation Equipment. 'Info. Comm.' refers to Information & Communication.
Investment managers' information advantages are hard to sustain as data analysis is constantly evolving.
The value of data-derived insight varies according to the amount and quality of information. In the initial stage (Zone 1), not enough data is available and the incremental value of data-derived insight remains small. Once sufficient data is available (Zone 2), managers with interpretive processing capabilities have an edge, which may provide an opportunity for alpha generation. However, as data becomes broadly accessible to the public (Zone 3), there is declining incremental value in acquiring “more.” On the whole, managers must consistently evolve and adapt to maintain their information advantage.
Source: Goldman Sachs Global Markets Institute (GMI) and GSAM.
Artificial intelligence may help innovative managers stay ahead of the pack.
Artificial intelligence can be defined as a set of computer algorithms performing tasks once perceived to require human intelligence, but which can now be done rapidly, independent of human intervention. Machines can now consistently learn and improve their knowledge and performance at a speed well beyond human cognition, potentially empowering investors with informational advantages.
Top Section Notes: As of July 31, 2019. For illustrative purposes only. 'Information advantage' refers to unique knowledge that gives a firm or an individual a competitive advantage. Bottom Section Notes: As of July 31, 2019. For illustrative purposes only. 'Algorithm' refers to a step-by-step procedure designed to perform an operation.
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