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:
This material is addressed to an audience familiar with macroeconomic data, market dynamics, industry trends and other broad-based economic and market conditions. For further information, please consult an authorized financial advisor. 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. Views and opinions are current as of December 2019, and may be subject to change, they should not be construed as investment advice.
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.
Valuation often normalizes through earnings power and time, not price corrections. Current US valuation, in our view, provides a few key takeaways: 1) low interest rates may actually strengthen the equity opportunity set, 2) free cash flow yield is an important evaluation metric as companies have increasingly moved to capital-light business models, and 3) we think investors should emphasize bottom-up positioning rather than pure beta.
Top Section Notes: As of November 30, 2019. ‘US Recessions’ refers to periods of two or more consecutive quarters of negative GDP growth. Bottom Section Notes: As of November 30, 2019.
If equities deliver mid-single digit returns over the next decade, the role of income should be reconsidered.
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.
Consider seeking to lock in more total return through cash flow.
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.
Top Section Notes: As of November 30, 2019. ‘US Large Cap Equity’ is represented by the S&P 500 Index. 'Average Total Return' shows the average annualized return over the past five decades: 1970–1979, 1980–1989, 1990–1999, 2000–2009, and 2010–2019. '2010s' refers to the annualized total return for the S&P 500 Index from 2010 - 2019. 'Next Decade Expectations' refers to the expected annualized total return for the S&P 500 Index from 2020 through 2029. Bottom Section Notes: As of November 30, 2019. Expected returns are estimates of hypothetical average returns of economic asset classes derived from statistical models. There can be no assurance that these returns can be achieved. Actual returns are likely to vary. Expected returns on both charts reflect GS Global Portfolio Solutions Group strategic assumptions as of September 2019. Strategic long-term assumptions are subject to high levels of uncertainty regarding future economic and market factors that may affect future performance. They are hypothetical indications of a broad range of possible returns. ‘US Large Cap Equity’ is represented by the S&P 500 Index. ‘US REITs’ is represented by the FTSE/NAREIT US Index. ‘Bank Loans’ is represented by the Credit Suisse Leveraged Loan Index. ‘Global Infrastructure and MLPs’ is represented by the S&P Global Infrastructure Index. ‘Global High Yield Bonds’ is represented by the Bloomberg Barclays Global High Yield Index. ‘Emerging Market Debt’ is represented by the JPM EMBI Global Diversified Index. ‘Beta’ is calculated based on the past 12 months of daily return data for each index relative to the S&P 500 Index. Betas for Bank Loans, Emerging Market Debt, and US REITs are calculated using returns from the S&P Leveraged Loan Index, the Bloomberg Barclays Emerging Markets USD Aggregate Index, and the Dow Jones US Select Real Estate Index, respectively, due to data availability. Past performance does not guarantee future results, which may vary. 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.
China is the third largest sovereign bond market in the world, with a high quality rating and low government debt-to-GDP.
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.
China is set to become a sizeable proportion of key 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.
Top Section Notes: As of November 30, 2019. Chart shows various characteristics of government debt for China and the G7 economies. ‘Debt-to-GDP Ratio’ is the ratio of government gross debt to Gross Domestic Product (GDP). ‘Credit Rating’ refers to Standard & Poor's ratings. Past performance does not guarantee future results, which may vary. Bottom Section Notes: As of November 30, 2019. For illustrative purposes only. Tracking error is one possible measurement of the dispersion of a portfolio’s returns from its stated benchmark. More specifically, it is the standard deviation of such excess returns. The economic and market forecasts presented herein are for informational purposes as of the date of this document. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this document.
High quality bonds have driven volatility reduction.
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.
Within investment grade, different characteristics may lend different benefits.
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.
Top Section Notes: As of November 30, 2019. ‘US Agg’ refers to the Bloomberg Barclays US Aggregate Bond Index. ‘US High Yield’ refers to the Bloomberg Barclays US High Yield Index. Correlation is calculated using rolling ten-year periods of monthly total returns. Bottom Section Notes: As of November 30, 2019. The chart shows correlations of subcomponents of the Bloomberg Barclays US Aggregate Bond Index to the S&P 500 Index using the last ten years of monthly total returns. ‘US Treasury’ is represented by the Bloomberg Barclays US Treasury Index. ‘IG Corporate’ is represented by the Bloomberg Barclays US Corporate Investment Grade Index. ‘AAA’ is represented by the Bloomberg Barclays US Aggregate: AAA Index. ‘BBB’ is represented by the Bloomberg Barclays US Aggregate: BBB Index. ‘Short (1-3)’ is represented by the Bloomberg Barclays US Aggregate 1-3 Years Index. ‘Long (10+)’ is represented by the Bloomberg Barclays US Aggregate 10 Years or Higher Index. Past correlations are not indicative of future correlations, which may vary. Diversification does not protect an investor from market risk and does not ensure a profit. For illustrative purposes only. Past performance does not guarantee future results, which may vary.
Avoiding losses can also mean missing gains.
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.
In painful markets, liquid alternatives have proven resilient and outperformed equities.
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.
Top Section Notes: As of November 2019. Chart shows the average 5-year total return of the MSCI World Index from the last three economic cycles’ market bottoms (March 9, 2009, October 9, 2002, and September 28, 1990). ‘Stay Invested’ means remaining invested in the MSCI World Index at the market trough and on average the total return equaled 139% from the market bottom. The ‘gained’ proportion of total return represents the proportion of the full potential return of staying invested. The ‘missed’ proportion of total return represents the average amount of return that an investor missed out on by being uninvested for the given period versus staying invested through the market trough. ‘Invest 2 Days After Bottom’ means being uninvested for the first two days after the market trough, then being fully invested in the MSCI World Index. ‘Invest 1 Month After Bottom’ means being uninvested for the 21 trading days following the market trough, then being fully invested in the MSCI World Index. Bottom Section Notes: As of November 2018. Chart shows the average monthly growth of a $100 investment made one year before an average economic cycle market bottom (March 2009, October 2002, and September 1990) in both the MSCI World Index and the HFRI Fund of Funds Index (HFRIFOF), a common index for liquid alternatives. The analysis uses data from October 1988 to March 2011 for the MSCI World Index and from January 1990 to March 2011 for the HFRIFOF, the earliest available data through 24 months after the most recent recession. GROWTH OF $100: A graphical measurement of a portfolio's gross return that simulates the performance of an initial investment of $100 over the given time period. The example provided does not reflect the deduction of investment advisory fees and expenses which would reduce an investor's return. 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.
From hope, to reality, to sustainable advantage.
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.
New solutions and technologies for a brighter future.
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.
Top Section Notes: As of November 30, 2019. Chart shows the importance of Environmental, Social and Governance (ESG) criteria for individuals as consumers and investors. Data are from the Morgan Stanley white paper ‘Sustainable Signals,’ published in 2019. Data were collected online with a sample size of 1,000 US individuals. Millennials were aged 18-37 at the time of the survey. For illustrative purposes only. Bottom Section Notes: As of November 30, 2019. Chart show five critical areas that can support greater global environmental sustainability. For illustrative purposes only. Past correlations are not indicative of future correlations, which may vary. 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.
17 of the 18 hottest years on record have occurred in the last two decades.
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.
Climate change threatens economies globally and may also impact portfolios.
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.
Top Section Notes: As of November 30, 2019. The chart shows the difference between the annual global temperature and the annual historical average from 1910 to 2000. ‘Global Temperature’ refers to global land and ocean temperature. Bottom Section Notes: As of November 30, 2019. For illustrative purposes only. Past performance does not guarantee future results, which may vary.
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