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In the Spotlight
In the Spotlight
In The Spotlight
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It was exactly fifty years ago that Monty Python’s Flying Circus proclaimed “And now for something completely different.” It was also precisely fifty years ago that the US withdrew from the gold standard, thus ushering in a “completely different” era of monetary policy arrangements, inflation dynamics, and market relationships. Paradigm shifts may be infrequent but, when they occur, they can have profound consequences.
This edition of the Market Know-How coincides with another moment where the future could potentially look “completely different” from the recent past. As the global economy begins to reopen we will discover over the next few months what the new post-COVID-19 “normal” looks like: will inflation prove to be sticky in a way we haven’t seen for decades, and will central banks have an increased tolerance for that? Will taxes have to rise to recoup the costs of the fiscal largesse? Should we be recalibrating valuation models to reflect structural changes to crossmarket relationships?
The next phase of the recovery may prove to be a paradigm shift: a move into a world of “completely different” macro and market relationships to those which we have been accustomed to in recent years. Hence, the last decade’s successful portfolio allocation may require adjustments for the years ahead. In this Market Know-How we explore how some of those factors may shape the investment landscape.
The combination of strongly pro-cyclical fiscal and monetary policies in most major economies, in conjunction with households’ pent-up consumption, means that the global economy is currently enjoying its strongest period of growth in decades. Although momentum should inevitably fade as the reopening restores some semblance of normality, the global outlook for 2022 is one of continued above-potential activity. Thereafter, we expect 2023 will return to a lower but more sustainable and historically normal pace of expansion.
Following an impressive policy-fueled, vaccine-led recovery, we believe the US equity cycle is transitioning back to fundamentals. While full valuations and a moderating forward-return environment may temper our optimism, equities remain our preferred asset class. As we enter the longest phase of the equity cycle – the growth phase - corporate earnings, positive investor sentiment, and increased confidence around the sustainability of the recovery may continue to drive returns.
Intro Section Notes: Source: Goldman Sachs Asset Management. Views and opinions expressed are for informational purposes only and do not constitute are recommendation by Goldman Sachs Asset Management to buy, sell, or hold any security. Views and opinions are current as of August 2021 and may be subject to change, they should not be construed as investment advice. 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 page.
Top Section Notes: As of September 15, 2021. “Real GDP” refers to Gross Domestic Product adjusted for inflation. Estimates reflect year-over-year (YoY) changes. The economic and market forecasts presented herein are for informational purposes as of the date of this page. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this page. Bottom Section Notes: As of July 31, 2021. Data from 1973 onward, non-annualized. Excludes the current equity cycle. Chart shows the S&P 500 averages across each phase of the equity cycle: Despair, Hope, Growth, and Optimism. “Despair” refers to the first period where the market moves from peak to trough. “Hope” refers to the following period where the market rebounds from its trough through P/E expansion. “Growth” refers to the following period when earnings growth drives returns. “Optimism” refers to the final period where returns are driven more by P/E multiple expansion than earnings growth. The number of months in parentheses is the average historical duration of each phase of the cycle. Past performance does not guarantee future results, which may vary.
Low Yields Across G7 Economies
We anticipate improving macro fundamentals will drive global rates higher, with some choppiness likely in the path forward. The economic rebound should push long-end rates higher while key dynamics such as unemployment and inflation may shift central bank reaction functions on front-end curves. Still, we expect risk assets to grind higher should rate increases remain measured and gradual, enriching the alpha opportunities across markets.
Source: Bloomberg, Goldman Sachs Global Investment Research, and Goldman Sachs Asset Management.
Rising Rate Investment Preferences
Investment solutions emphasizing 1) sensitivity to global growth, 2) lower duration, and 3) income have traditionally outperformed in rising rate environments.
Source: Goldman Sachs Asset Management.
Top Section Notes: As of July 31, 2021. “10-Year Government Yield” refers to yield to worst of the Bloomberg Global G7 Total Return Index Value Unhedged USD. “Forecast” reflects year-end market-cap weighted 10-year yield estimates by Goldman Sachs Global Investment Research for the US, Germany, Japan, UK, Canada, and Bloomberg consensus estimates for France and Italy. Bottom Section Notes: “Small- and mid-cap” equities refer to global firms with a maximum market cap of 48.4 million as of July 31, 2021. “Active selection” refers to the selection of securities expected to outperform a broad index.
Inflation Expectations Are Elevated
Higher inflation prints have raised concern over how long price pressures will last, despite the Federal Reserve’s assertion that this surge in inflation is transitory, driven by base effects and COVID-19 disruptions. Although we believe these temporary pressures will soon roll off, investors may see benefit in owning assets that display strong performance during periods of rapidly rising inflation expectations.
Source: Bloomberg and Goldman Sachs Asset Management.
Equities and real assets have historically delivered solid performance in periods of rising breakevens, with the potential to provide reliable protection when most needed.
Source: Goldman Sachs Asset Management.
Top Section Notes: As of July 31, 2021. “10-Year Breakeven” is the difference between the nominal yield on the 10-Year Treasury and the real yield on the 10-Year Treasury Inflation-Protected Security (TIPS). A “>1 Std. Dev. Increase” occurs when breakeven inflation exceeds 17.4 basis points month-over-month. "Std. Dev." is Standard Deviation. Bottom Section Notes: As of July 31, 2021. For illustrative purposes only.
US Equity Valuations
Today’s elevated equity valuations may diminish return potential in the longer term, even if they do not portend a correction per se. We do not expect any imminent re-pricing of risk assets, absent renewed recessionary factors, and would be buyers of any short-term weakness.
Source: Robert Shiller, Bloomberg, and Goldman Sachs Asset Management.
Even so, we see greater opportunities in more affordable pockets of the global equity market, particularly in a security-specific approach. Additionally, diversifying assets, or those that can secure returns through dividend income rather than capital appreciation, may benefit portfolios in a lower return environment.
Source: Goldman Sachs Asset Management.
Top Section Notes: As of July 31, 2021. “CAPE” refers to the Cyclically-Adjusted Price-to-Earnings ratio. Chart shows historical percentile of the CAPE ratio and the 10-year average subsequent return. Bottom Section Notes: As of July 31, 2021. For illustrative purposes only.
From Strong Economic Growth to Strong Earnings Growth
India’s macro outlook remains one of the strongest globally, in our view. The country experienced a COVID-19 set-back earlier in the year, but since then a significant part of the population has either been vaccinated against the virus or exposed to it. In addition, we think recent reforms have improved India’s growth prospects.
Source: Bloomberg, IMF, Goldman Sachs Global Investment Research, and Goldman Sachs Asset Management.
Given Indian corporates’ ability to translate economic growth into strong earnings, and the high concentration of cyclical and consumer-sensitive stocks in India’s stock market, we believe that Indian equities are well-positioned to benefit from the ongoing recovery. While high valuations have often been a concern, we believe that current prices and growth outlook offer attractive return potential.
Source: MSCI and Goldman Sachs Asset Management.
Top Section Notes: As of July 31, 2021. Annual data as of fiscal year (FY) ending March. “Indian equities” refers to the S&P BSE Sensex Index. Goldman Sachs Global Investment Research forecasts used for GDP estimates beyond FY 2021. Bottom Section Notes: As of July 31, 2021. Consumer-sensitive sectors are Consumer Discretionary and Consumer Staples. Non-consumer cyclical sectors are Financials, Materials, and Industrials. 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.
The Good, the Bad, and the Volatility
Since the creation of Bitcoin in 2009, over 11,000 cryptocurrencies have been established and the market has grown to more than $1.6tn. Interest has been driven by speculative sentiment, potential equity and inflation hedging capabilities, and the development of blockchain applications and digital assets. However, given extreme volatility, our analysis suggests a 1% portfolio allocation to Bitcoin would require a 165% long-term annualized return. As such, while the high idiosyncratic risk may be appealing to risk-seeking traders such as hedge funds, they do not merit a strategic allocation in our view.
Source: Bloomberg, Goldman Sachs Investment Strategy Group, and Goldman Sachs Asset Management.
Stats and Facts
1) Portfolio Construction, 2) Alt-Coins, 3) Regulatory Risk, 4) ESG, 5) CBDCs, and 6) Blockchain.
Source: Goldman Sachs Investment Strategy Group, Coinmetrics, Cambridge Center for Alternative Finance (CCAF), and Goldman Sachs Asset Management.
Top Section Notes: Size of crypto market is as of July 31, 2021. Realized Return based on Bitcoin spot price from since its inception (July 2010) through July 2021. Top chart’s annualized volatility refers to standard deviation of Bitcoin price movements compared with those of several major asset classes. Bottom chart’s theoretical return required for 1% and 2% allocation to Bitcoin shows the expected long-term annualized Bitcoin return required for a 1% or 2% allocation within a moderate-risk portfolio using Goldman Sachs Investment Strategy Group’s robust optimization model. Please see additional disclosures at the end of this page. Past performance does not guarantee future results, which may vary. Bottom Section Notes: The probability of a 60% more drawdown per year is calculated based on Bitcoin price data since its inception (July 2010) through July 2021. “Alt-coins” refer to any cryptocurrency that is not Bitcoin. Bitcoin mining energy consumption data is from Cambridge Center for Alternative Finance (CCAF) as of May 2021, latest available. Percent of global central banks experimenting with CBDCs is as of June 2021, latest available.
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