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2020: Edition 1

MARKET KNOW-HOW | 2020: Edition 1

One Mississippi, Two Mississippi...

Folk wisdom holds that the counting of “Mississippis” can help estimate a storm’s distance by judging the time between the flash of lightning and thunder. Similarly, many market observers in 2019 believe they have witnessed cyclical warning signs which start the countdown to the next recession. Last August brought a surge of Google searches for the term “recession” in the same week that the 2–10 year portion of the US Treasury curve inverted. In our view, the inversion was no telltale flash of lightning.

We believe recession is not a foregone conclusion. Recent lightning flashes include sluggish global growth, mired manufacturing, and the just-mentioned inverted curve. We expect a modest global expansion to be sustained in 2020 by the stability of the consumer, committed central banks, financial condition tailwinds, and improved visibility on persistent geopolitical issues such as Brexit, trade, US impeachment, and elections.

Consequently we would emphasize in this Market Know-How:

  • Sticking to the plan, by maintaining strategic asset allocation
  • Alpha-oriented, bottom-up strategies over pure beta
  • Income-oriented investing and alternatives in light of moderating returns and occasional bouts of volatility.

Macro & Market Views

Split Decision

Elevated economic policy uncertainty (EPU) has become standard across the globe, though implied volatility (VIX) has not followed suit. Many investors expect volatility to rise as it converges to higher EPU, but in our view this trend may persist. Broad expectations for contained global inflation and central bank responsiveness appear to be holding volatility down, while the unrelenting volume of headline risk elevates EPU. In other words, few signals, plenty of noise.

Source: Bloomberg and GSAM.
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The Know
New era, new expectations.

If equities deliver mid-single digit returns over the next decade, the role of income should be reconsidered.

The Great Moderation

Equity markets have delivered strong returns in the decade since the Global Financial Crisis. Going forward, investors may face a decade of more modest returns given a starting point of elevated valuations, low interest rates, and moderate economic growth. We see a case for less reliance on capital appreciation and a greater effort to “lock in” total return through income potential.

Source: Bloomberg and GSAM.

The How
Appreciating income.

Consider seeking to lock in more total return through cash flow.

In Search of Cash Flow Enhancers

Cash flow diversifiers could be one potential solution for lower returns going forward. A range of these asset classes—which include Emerging Market Debt and Global Infrastructure—have more than double the yield of US equities, while also providing diversification potential. With low historical betas, these asset classes may serve to offset some portfolio volatility while seeking to lock in a greater proportion of total return through income.

Source: Bloomberg and GSAM.

The Know
Too big to ignore.

China is the third largest sovereign bond market in the world, with a high quality rating and low government debt-to-GDP.

China Sovereign Debt Appears Attractive Relative to G7 Economies

China’s government bond market has grown from $1Tr in 2009 to over $5Tr, and has become the third largest after the US and Japan. The country is too significant for well-diversified investors to ignore. Additionally, China offers an attractive yield relative to major government bond markets for a comparably high credit rating and low government debt-to- GDP ratio. Finally, while foreign investor participation is currently low, Chinese policymakers are committed to financial market liberalization to improve market access, bond market depth and liquidity, which has led to global bond index inclusions.

Source: Bloomberg, Haver, and GSAM.

The How
A major investment opportunity.

China is set to become a sizeable proportion of key global bond indices.

Chinese Sovereign Bond Inclusion in Major Global Bond Indices

The inclusion of China Government Bonds (CGBs) in major global bond indices is a key milestone in the opening of the country’s capital market and a pivotal step toward China becoming a substantial component of a well-diversified fixed income portfolio. We anticipate potentially significant inflows from both active and passive investors benchmarked to these indices of c.$300bn if China is included in all three indices. We see China’s inclusion as a critical event. Excluding 6% of the Global Agg would be the equivalent of excluding a market of the size of France and could result in significant tracking error.

Source: Bloomberg, Goldman Sachs Global Investment Research, and GSAM.

The Know
Not all fixed income is created equal.

High quality bonds have driven volatility reduction.

High Quality, Low Correlation

Tighter credit spreads, a flatter yield curve, and the potential for equity volatility to remain elevated remind us of the importance of core fixed income’s potential diversification benefits in a portfolio. Over the past ten years, the correlation of the US Agg to US large cap equity has averaged around zero. High quality bonds have the potential to provide both current income and duration, two strong hedges against volatile markets.

Source: Bloomberg Barclays and GSAM.

The How
A wide-ranging asset class.

Within investment grade, different characteristics may lend different benefits.

Ends of the Spectrum

We think the “safer” corners of the market can provide superior hedging abilities to equities, which may be desirable as the economic expansion elongates. Yet high quality fixed income need not limit the opportunity set. Hedging characteristics could be preserved in a core fixed income portfolio without sacrificing exposure to alpha-generating scenarios such as sector selection, credit quality, and term structure.

Source: Bloomberg Barclays and GSAM.

The Know
“Time in” versus “timing” the market.

Avoiding losses can also mean missing gains.

No Pain, No Gain

Historically, equity markets have delivered strong returns right after a market bottom. Loss aversion may push investors to stay on the sidelines which may lead to missing out on gains. “Timing” markets is a difficult task even for professional investors, and while investors may be lucky enough to avoid drawdowns, they may still fail to benefit from rebounds. We view a long-term, strategic mindset as the bedrock of investment strategy.

Source: Bloomberg and GSAM.

The How
Alternatives to reduce risk.

In painful markets, liquid alternatives have proven resilient and outperformed equities.

Less Pain, More Gain

We believe liquid alternatives could be a valuable late-cycle diversifier and counterbalancing asset. In today’s market, where a countdown to the next recession may have already started, these strategies may be worth revisiting. Historically, as the economic cycle turns, liquid alternatives have suffered much smaller declines than equity markets, while still participating in the bounce. These characteristics may offer an efficient solution to de-risk yet remain invested.

Source: Bloomberg and GSAM.

The Know
Millennials care about sustainability.

From hope, to reality, to sustainable advantage.

As Consumers and Investors, Millennials Care About Sustainability

Millennials today are the world’s most powerful consumer force, and sustainability has become an important factor in their consumption decisions. Companies that fail to align to their preferences may be at a disadvantage. The same trend also influences their investment decisions—Millennial money is making sustainability matter.

Source: Morgan Stanley and GSAM.

The How
Greater responsibility for sustainability.

New solutions and technologies for a brighter future.

Five Critical Areas to Support Environmental Sustainability

The Millennial generation is playing a critical role in driving greater global environmental awareness. While in the past climate change has often been denied or dismissed, this phenomenon is receiving public recognition as its consequences progressively come to be understood. Clean energy, water sustainability, resource efficiency, waste management and recycling and sustainable consumption and production are all critical for a sustainable future.

Source: GSAM.

The Know
Did you know...

17 of the 18 hottest years on record have occurred in the last two decades.

It’s Getting Hot in Here

The impact of climate change is already being felt throughout the world. Record-breaking temperatures, more frequent flooding, dangerous wildfires, extended droughts, and destructive storms are just some of the intensifying patterns that countries and communities face. Global temperatures have risen by ~1°C since the 1880s. Although a 1°C change on any given day may seem to have little effect, a rise of 1°C globally has potentially massive effects—water at 0°C is solid ice, but at 1°C it is liquid.

Source: National Oceanic and Atmospheric Administration (NOAA) and GSAM.

The How

Climate change threatens economies globally and may also impact portfolios.

Impact of Climate Change on Investments

Global warming is more than an inconvenience. Temperatures and precipitation levels affect the performance of entire economic sectors, in addition to the amount of energy we consume and how much water we have to drink. Extreme weather events create environmental risks that impact industries such as agriculture, infrastructure, and consumers. Changes in climate are likely to accelerate with implications for the health and welfare of every community, and for the performance of economies and investments.

Source: GSAM.


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