We hope that you, your family, and your community are mending from the disruption of COVID-19. Our thoughts continue to be with you during this period.
As we look into 2021 and beyond, it is increasingly evident
to us that global policymaking, while important, will be less governed by the latest political victory than by the realities
of massive sovereign deficits, shifting demographics, and environmental conditions. COVID-19 has only accelerated
this climate of change and the need for prescriptive solutions and investment.
Furthermore, as we enter a hopefully long and sturdy global recovery, we should keep in mind a few important lessons from 2020, including: 1) the value of addressing tactical uncertainty with strategic discipline, risk management, and quality, 2) most investment horizons are much longer than election cycles, and 3) the opportunity set is becoming more idiosyncratic and global.
The remainder of this edition of the Market Know-How
will focus on summarizing our macro expectations and providing a framework for positioning in 2021.
We estimate that global real GDP will rise 6.1% in 2021. Barring major policy errors or health-related setbacks, this should keep growth far stronger than in previous recoveries. However, 2021 will likely be characterized by flatter growth as economies transition from the sharp rebound in Q3 2020, to a period of deceleration until we see the vaccine-contingent strength we expect in 2021. Moreover, we expect the fiscal bridge to be sizeable across advanced economies as many sectors struggle to normalize under physical distancing and occupancy limitations.
The speed of the 2020 equity plunge and near instantaneous reversal was unparalleled. Lacking the early warning signs of some emergent cyclical or financial disequilibrium, markets were whipsawed between the medically-induced shuttering of global economies and the deluge of monetary and fiscal support. Notwithstanding full valuations, we believe global equities remain attractive, supported in 2021 by low real yields, contained inflation, easy financial conditions, peak earnings, and a substantial equity risk premium.
Top Section Notes: Goldman Sachs Global Investment Research and GSAM. As of November 30, 2020. ‘Real GDP’ refers to gross domestic product adjusted for inflation. 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. Past performance does not guarantee future results, which may vary. Bottom Section Notes: Bloomberg and GSAM. As of November 30, 2020. Chart shows the MSCI ACWI Index levels from 1998 to 2020. For illustrative purposes only. ‘Peak-to-trough’ refers to the period from the market high to the subsequent market bottom. ‘Peak-to-recovery’ refers to the period from the market high to when prices fully recover to reach a new market high. ‘Easy financial conditions’ refers to an environment supportive of economic growth. The performance results are based on historical performance of the indices used. The results will vary based on market conditions. If any assumptions used do not prove to be true, results may vary substantially. Past performance does not guarantee future results, which may vary.
Five companies have driven a majority of US equity returns
The record degree of concentration in the US equity market has continued to rise as mega-cap tech companies have led the 2020 rally. The five largest US companies (Facebook, Apple, Amazon, Microsoft, and Google—or FAAMG) now comprise nearly a quarter of the S&P 500 Index market capitalization. The fundamental landscape today gives us reasons to be both constructive in the long-term growth trends supporting these names, but also cautious on their continued momentum. We think a good response to the potential risks of narrow market breadth may be geographically expanding the opportunity set.
Source: Bloomberg and GSAM.
Investors may find outperformers by expanding their horizons
There are hundreds of companies around the world that outperform the basket of the FAAMG stocks from year to year, including 323 names in 2020 YTD. Many of these outperformers have been in the technology sector, but increasingly we believe the market’s willingness to pay a premium for innovation and earnings may extend to areas such as Med-tech, Fin-tech, Ed-tech, Green-tech, and Environmental, Social, and Governance (ESG) investments. These features are evident in some US companies, but are also prominently represented globally. Investors who can identify high-quality companies with strong earnings potential may benefit from expanding their horizons.
Source: Bloomberg and GSAM.
Top Section Notes: As of November 30, 2020. ‘YTD’ refers to year-to-date. Chart shows the year-to-date performance of the S&P 500 Index, the 5 largest companies in the S&P 500 on a market capitalization weighted basis (Facebook, Apple, Amazon, Microsoft, and Google), and the rest of the index. Any reference to a specific security does not constitute a recommendation to buy, sell, hold or directly invest in these securities. Bottom Section Notes: As of November 30, 2020. Chart shows the proportion of companies in the MSCI ACWI Index that outperformed the FAAMG basket on a calendar-year basis, grouped by company domicile. ‘Median’ refers to the 50th percentile. International securities entail special risks such as currency, political, economic, and market risks. The performance results are based on historical performance of the indices used. The results will vary based on market conditions. If any assumptions used do not prove to be true, results may vary substantially. Past performance does not guarantee future results, which may vary.
Corporate governance, earnings, and profitability all improving
The Suga administration, newly elected in September 2020, is likely to accelerate market-friendly corporate reform measures laid out by the Abe government since 2012. Those reforms have significantly improved the interests of minority shareholders and made Japanese equities a potential sweet spot for investors. Boosted by this Suga rush, corporate governance, earnings growth drivers, and profitability are set to improve even further. However, this improvement has not been uniform across industries, creating a lot of dispersion. Furthermore, the rationale for being active has been further strengthened this year due to the COVID-19 pandemic which has had a varied impact on businesses and their profits.
GSAM, Factset, and Goldman Sachs Global Investment Research.
Alpha has become more important than before
In Japan, markets have undergone a radical change over the last few years and the best active managers have increasingly been able to generate alpha. Between 2012 and 2015, Japan was a “beta market,” with Abenomics and the BoJ’s policies acting as the key determinants of equity prices. Since 2015, the impact of macroeconomic policies on the market has subsided. In our view, the key driver of equity prices is now business fundamentals, resulting in renewed dispersion in returns across companies. Consequently, the ability of managers to generate alpha has increased and we expect this trend to amplify under the new Suga administration.
Source: Morningstar and GSAM.
Top Section Notes: As of October 31, 2020. ‘Japanese Equities’ refers to he TOPIX Index. Year-end 2021 forecasts are GS Global Investment Research forecasts. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this presentation. Past performance does not guarantee future results, which may vary. Bottom Section Notes: As of October 31, 2020. Charts shows fund performances ranked by quartile for the Japan Equity Morningstar category. Past performance does not guarantee future results, which may vary.
Higher-weighted emerging market equity countries have sustained the least economic damage
When investors approach emerging markets, it is important to remember that EM GDP is not the same as EM Equity. The country composition and weightings between the two can vary significantly. As such, views on the EM aggregate macro are less critical than the outlooks for highly-weighted, investment-relevant countries such as Taiwan, China, South Korea, India, and Brazil, which make up 80% of the index. In East Asia, where virus containment has been early and effective, there has been limited impact to aggregate GDP estimates and the recovery may continue to see equity returns pulled forward. In India and Brazil, where there has been more sustained economic damage, markets may have even more room to run.
Source: IMF, MSCI and GSAM.
EPS growth in these investment-relevant EM countries is set to be strong
EM earnings are expected to outperform their DM peers with shallower declines in 2020 and stronger recoveries in 2021. The result is cumulative earnings growth of 19% over this period, with the strength broad-based across countries. The combined tailwinds of cyclicality, commodity exposure, China sensitivity, and pockets of deep value may lead EM outperformance beyond the occasional bursts and become more sustained. Even so, we believe that repeatable alpha generation in emerging markets comes from investing in companies rather than countries as the opportunity set remains highly diverse.
Source: Goldman Sachs Global Investment Research and GSAM.
Top Chart Notes: As of October 31, 2020. Chart shows the difference between IMF estimates for 2021 GDP levels from October 2019 to October 2020, measured in percentage terms. Bottom Chart Notes: As of October 31, 2020. ‘EPS’ refers to consensus estimates of Earnings Per Share. ‘EM’ refers to the MSCI Emerging Markets Index. ‘US’ refers to the S&P 500 Index. ‘Europe’ refers to the Euro Stoxx 600 Index. ‘2020-2021 Cumulative’ refers to the aggregate EPS growth from 2020 and 2021 combined. ‘Investment-relevant’ refers to the emerging market companies in the MSCI Emerging Market Index. 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.
Emerging Asia has weathered the COVID-19 storm better than many other regions
As prolonged COVID-related turmoil triggered aggressive rate cuts and large-scale asset purchases by most major DM central banks in 2020, yields across the industrialized world plummeted. By contrast, large parts of Emerging Asia have long since begun to return to some semblance of economic normality and—absent that distortionary influence—there has been much less policy-induced spread compression in Asian fixed income markets. With the US and much of Europe potentially facing years of ultra-low policy rates, Asian High Yield (HY) markets offer relatively attractive yields and an underlying average credit quality that is superior to US peers.
Source: Bloomberg, J.P. Morgan, and GSAM.
Asian HY has delivered strong risk-adjusted returns relative to other fixed income assets
With Asia leading the global recovery, the regional macro backdrop is conducive to further declines in underlying credit risk. In our view, Asian HY default rates are likely to be lower than in the US and recovery rates are likely to be higher. With volatility broadly comparable to a number of other fixed income spread products, the returns per unit of risk in Asian HY have historically delivered strong Sharpe ratios and, we think, have the potential to continue to do so.
Source: Bloomberg, J.P. Morgan, and GSAM.
Top Section Notes: As of October 31, 2020. ‘Yield’ refers to Yield to Worst. Credit rating refers to the credit rating from the respective index providers. Bottom Section Notes: As of October 31, 2020. Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates. Sharpe ratio is defined as the annualized return earned in excess of the risk-free rate (here 0%) per unit of annualized volatility. ‘EMD Local’ refers to the JPM GBI-EM Global Diversified Index, ‘EM IG’ refers to the JPM CEMBI Broad Diversified Index, ‘Euro HY’ refers to the ICE BofA European Currency High Yield Constrained Index, ‘EMD$’ refers to the JPM EMBI Global Diversified Index, ‘Asia HY’ refers to the ICE BofAML Asian Dollar High Yield Corporate Constrained Index, ‘EMD HY’ refers to the JPM CEMBI Broad Diversified High Yield Index, and ‘US HY’ refers to the ICE BofAML US High Yield BB Constrained Index. Past performance does not guarantee future results, which may vary.
Private credit has rapidly gone from niche to mainstream
Private credit has grown three-fold over the past decade, and is now the third-largest private asset class following private equity and real estate. Private credit has attracted investors globally, and continues to show healthy supply and demand dynamics in our view. Additionally, as companies increasingly decide to stay private for longer, private credit demand has expanded as the asset class benefits from positive spillovers from private equity. Supply has simultaneously been on the rise: as of April 2020, there were 457 private credit funds in the market, up from 261 in 2015. As investors familiarize themselves with the asset class, its role in client portfolios is set to grow accordingly in our view.
Source: Preqin, Goldman Sachs Global Investment Research, and GSAM.
Liquidity premiums make private credit a desirable source of yield
Propelled by investors’ search for yield, direct lending has grown to represent over a third of the private credit universe by AUM. Its yield has remained higher than that of both high yield credit and leveraged loans. While part of the gap can be attributed to differences in firm size and default rates, investors are increasingly attracted to the asset class for its liquidity premiums. Private credit offers potential compensation for illiquidity over time, while its public counterparts may not retain their liquidity all the time—for example, under stressed market conditions. We believe a long-term focus allows investors to better capitalize on liquidity premiums.
Source: Bloomberg, Cliffwater, and GSAM.
Top Section Notes: As of June 30, 2020, latest available data. ‘Dry powder’ refers to committed, but unallocated capital. ‘Global financial crisis’ refers to the financial crisis from 2007-2008. An investment in private equities is not suitable for all investors. Investors should carefully review and consider their potential investments, risks, charges and expenses before investing. Bottom Section Notes: As of June 30, 2020, latest available data. Yields are measured by yield to maturity. ‘AUM’ refers to assets under management. ‘Liquidity’ refers to an asset’s ability to be bought and sold easily and quickly. ‘Liquidity premium’ refers to the increase in the price of an illiquid asset required by investors in return for holding an investment that cannot easily be sold. The performance results are based on historical performance of the indices used. The results will vary based on market conditions. If any assumptions used do not prove to be true, results may vary substantially. Past performance does not guarantee future results, which may vary. Investments in fixed income securities are subject to credit, liquidity, and interest rate risk. Please see additional disclosures on page 20 of the document.
COVID-19 has amplified the importance of environmentally, socially, and economically aware portfolios
Investors in 2020 were reminded of the investment importance of environmental, social, and governance (ESG) factors. The Coronavirus pandemic has made social issues—such as the health and safety of employees, customer support, and production decisions—key operational factors, and has elevated their significance in investors’ due diligence. During the stress of COVID-19, ESG industry leaders outperformed their peers during drawdown and recovery. We believe that ESG investing is a lasting trend supported by demographic shifts, the Great Wealth Transfer, and the potential to generate sustainable returns and manage risk.
Source: JUST Capital, Factset, Cerulli Associates, Goldman Sachs Global Investment Research, and GSAM.
We believe ESG is here to stay as a fundamental process of portfolio construction
ESG is not a separate asset class or a carve out in a portfolio. Rather, it is a part of integrated asset allocation. Investors can invest sustainably across a variety of investment options and asset classes from traditional equity to fixed income to private equity. Sustainable investing is not a singular act, but one that may continue to enhance portfolio durability in any macro climate. In our view, ESG and Impact investing will be increasingly relevant for years to come.
Top section Notes: As of September 30, 2020, latest available data. ‘Drawdown’ refers to a market decline. ‘The Great Wealth Transfer’ refers to intergenerational wealth passed from the Baby Boomer generation to beneficiaries. Past performance does not guarantee future results, which may vary. Bottom Section Notes: As of November 30, 2020. For illustrative purposes only. ‘MLP’ refers to master limited partnership.
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