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2019: Edition 3

MARKET KNOW-HOW | 2019: Edition 3

Easy Does It

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:

  • Sticking to the plan, by maintaining strategic asset allocation weights
  • Alpha-oriented, bottoms-up strategies over pure equity beta
  • Income-oriented investing and alternatives as a response to moderating returns

Macro & Market Views

Uneven global deceleration…

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.

Source: Haver and GSAM.
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The Know
Rethink passive and active.

Harness time-tested sources of return in a transparent, rules-based manner.

Four Key Common Factors

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.

Source: GSAM.

The How
Stronger together.

Diversify across smart beta strategies to tap into a range of differentiated return sources.

Smart Beta and Cap-Weighted Index Return Comparison

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.

The Know
Sharing is caring.

Millennials’ lifestyle priorities are reshaping traditional economic arrangements.

The Rise of The Sharing Economy

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.

The How
Millennials may define the winners of tomorrow.

Companies need to adapt and evolve in order to survive.

Leaders Come And Go

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.

The Know
Liquid tension.

Liquidity is an essential part of investment strategy, yet the opportunity for cash to work is often underappreciated.

Don't Let Your Cash Drag

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.

Source: GSAM.

The How
Get short.

Late-cycle flattening makes the front end of the curve attractive on an absolute and risk-adjusted basis.

Find Your Sweet Spot

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.

The Know
Less macro.

Idiosyncratic factors have grown in importance as drivers of European equity returns.

Fading Factors

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.

The How
More micro.

High-performing European firms have seen higher returns.

Bigger Needles in Smaller Haystacks

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.

The Know
Fundamentals over FX.

Buying Japanese equities based on a currency view worked well in the past but may not in the future.

The Japanese Equities-Yen Relationship Has Broken Down

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.

The How
Sectors matter.

Certain sectors are more favorably positioned against any possible appreciation in the Yen.

Some Sectors Are Better Positioned Than Others

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.

The Know
At the cutting edge.

Investment managers' information advantages are hard to sustain as data analysis is constantly evolving.

The Competitive Value of Data

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.

The How
Human and machine.

Artificial intelligence may help innovative managers stay ahead of the pack.

Continuous Evolution of Artificial Intelligence

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.

Source: GSAM.


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