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Q2 2017





More uncertainty, more growth, more record highs, and more risk: the reigning market theme today seemingly is one of quantity—more of virtually everything.

Investors in recent months have faced a blitz of new US policy initiatives whose contours are largely unknown but reflect the power of populism now gripping the globe. Voters in France and Germany will be offering their own verdicts on populism in coming months. Meanwhile, economic growth has been advancing in the US and has showed modest improvement in Europe and Japan.

We do expect one exception to the trend of “more”—returns. We foresee modest returns from major asset classes due to valuation and political realities. Consequently, we see even more need for intelligent portfolio construction and investor discipline.

Our key views:

  • A heavy 2017 political calendar heightens global risk
  • Greater equity market return dispersion cultivates a target-rich environment for skilled active managers
  • Elevated US equity valuations create a rationale for moving beyond beta and beyond borders




The 8-year US expansion may get a nudge in late 2017 from fiscal policy, though US trade, immigration, and European electoral risk may be noticeable counterweights.


Global inflationary impulses have picked up, particularly in the US amid firmer wage and healthcare costs, rising energy costs, and a shrinking output gap.

Monetary Policy

Despite three US rate hikes in 2017, we envision accommodative global central banks. Policy refinements could replace further open-ended purchase commitments.


From President Trump’s agenda to upcoming European elections, we expect unpredictable political outcomes to amplify macro risk. Populism has proven difficult to size and price.


Besides global politics, investors should be mindful of other sources of disruption, including the pace of US tightening, the sustainability of Chinese debt levels, and rarified valuations.

Global Economic Indicators Point to Acceleration

Top Chart Notes: GIR and GSAM as of February 28, 2017. Chart shows the Goldman Sachs Current Activity Indicator (CAI), an alternative monthly measure of economic growth, designed to reduce data reporting lags. The CAI is shown over the last 6 months with most recent readings highlighted. Readings of CAI's 5 subcomponents are scaled to their individual values. The aggregate economy is represented by the CAI, which is the sum of the 5 subcomponent values. Bottom Chart Notes: Goldman Sachs Global Investment Research (GIR) and GSAM as of February 28, 2017. Global Manufacturing Purchasing Managers’ Index (PMI) monthly data is from January 2010 to present, the largest available dataset. Global PMI is calculated by GIR by creating a Gross Domestic Product (GDP)-weighted composite of 33 countries’ PMI data. A reading above 50 implies an expanding global manufacturing sector, while a reading below 50 implies a contracting global manufacturing sector. The implied global GDP growth rate of 4.6% is based on analysis from GIR that regresses quarterly real GDP growth for the 33 countries against the Global Manufacturing PMI data. 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.

Key Takeaway

We expect the global expansion to gain strength with broadening contributions from manufacturing, the consumer, and policy stimulus. Inflationary impulses vary in their drivers and effects across geographies and influence on global central bank policy.





Global stocks may offer an attractive mixture of earnings, valuation, and security selection opportunities. Full US valuations may limit upside gains until the political landscape is clarified.


Higher rates may be underpinned by evolving monetary policy, accelerating global growth, shrinking excess capacity, and reflationary policy.


Tighter US credit spreads and higher leverage reflect late-cycle conditions, leaving us cautious on investment-grade and highyield beta, but constructive on idiosyncratic deployment.


After a period of consolidation, potentially sizable global rate differentials lead us to renew our stronger Dollar view, while Sterling could trade in concert with Brexit developments.


Markets may remain buoyed by pro-growth policy and macro data, but these tailwinds face growing pressures from higher rates, full valuations, and a prolonged legislative process.

Valuation: A Condition, Not A Catalyst

Source: Bloomberg, Barclays Live, and GSAM. As of February 28, 2017. Valuation Percentile of equity asset classes refers to the forward Price-to-Earnings Ratio of each asset class as a percentile of the asset class’ historical Price-to-Earnings ratio on a monthly basis. Forward Price-to-Earnings ratio is a common valuation metric representing the current price as a multiple of the next twelve months of earnings per share of that asset class. For fixed income asset classes, global valuation percentile refers to spreads as a percentile of historical spreads for each asset class. Global refers to the MSCI World Index. US refers to the S&P 500 Index. Euro area refers to the Eurostoxx 50 Index. UK refers to the FTSE 100 Index. Japan refers to the TOPIX Index. Global Investment Grade refers to Global Investment Grade Corporate Credit measured by the Barclays Global Aggregate Corporate Index. Global High Yield refers to the Barclays Global High Yield Index. Emerging Market Debt refers to the Barclays EM USD Aggregate Index. China refers to the MSCI China Index. Emerging Market refers to the MSCI Emerging Market Index. Past performance does not guarantee future results, which may vary.

Key Takeaway

We believe the macro backdrop remains supportive of moderately positive returns from risk assets, although policy and valuation have intensified tail risk. We favor equities over credit, credit over sovereign debt, and emerging markets over developed markets. We are cautious on beta and emphasize selectivity.

The Know
Political risk remains elevated

The 2017 calendar is packed with catalysts for potential market volatility.

More political surprises are possible even after Brexit and the election of US President Trump.

From French and German elections to US trade and fiscal policy, 2017’s political calendar is full. Rising populism and policy making obstacles have the potential to impact Europe’s governing structure and induce market volatility.

Source: GSAM.

The How
Something has to give

In the past, elevated policy uncertainty has pointed to higher equity volatility.

Prevailing policy uncertainty levels have been consistent with a VIX at twice today’s levels.

The historical link between equity volatility and global policy uncertainty (GPU) suggests that the equity market today is somewhat dismissive of policy unknowns. In our view, the policy uncertainty reflected in volatile bond and currency markets is likely to spill over into equities should GPU remain elevated.

Source: Bloomberg; Baker, Bloom & Davis; and GSAM.

The Know
US rates transition higher

After more than three decades of declining interest rates, sustainable gains may be upon us.

The trend of falling interest rates cannot last forever—we think it has already begun to reverse.

We see a transition toward a rising interest rate environment driven by accelerating global economic growth, the evolving composition of monetary policy, and a sustainable shift towards higher US inflation. Tighter Federal Reserve policy and greater fiscal stimulus may add to the trend.

Source: Bloomberg and GSAM.

The How
Know your alternatives

Historically, alternative strategies have generated higher returns with lower risk when rates have risen.

We consider alternative strategies to be a core portfolio allocation.

Although equities and alternatives have each experienced higher returns and lower volatility in rising rate environments compared to their long-term performance, we see more notable risk/return improvement for alternative strategies. In five rising rate periods since 1990, although fixed income risk did edge lower, returns fell sharply.

Source: HFR, Bloomberg, and GSAM.

The Know
Higher valuations, lower expectations

Elevated US equity multiples have often pointed to mid-single digit long-term returns.

Any given year’s total return is difficult to predict, but equity valuations have been more predictive of longer-term returns.

Relative to the long-term average cyclically-adjusted price-to-earnings (CAPE) ratio (18x), current valuations (29x) point to a more muted return outlook over the next 3, 5, and 10 years. For core equity allocations, we believe a transition in strategy may be warranted as returns moderate.

Source: Bloomberg, Robert Shiller, and GSAM.

The How
Buying the ‘write’ strategy

Buy-Write strategies historically have outperformed in muted market environments, with lower volatility.

Buy-Write strategies have often outperformed when equity returns are in the single digits.

Over the last 10 years, Buy-Write strategies have lagged the S&P 500 in strong return environments but outperformed when broad equity returns were negative or moderately positive. These strategies have also offered a less volatile investment experience because their losses have been smaller during periods of market pressure.

Source: Bloomberg and GSAM.

The Know
Dispersion returns

Greater variation in the returns of individual stocks may create security selection opportunities.

The gap between winning stocks and losing stocks has widened.

We believe that precise security selection may be critical as dispersion in equities has trended higher. This is particularly true in international markets, where individual stock performance has demonstrated an even wider range of outcomes than in the US.

Source: S&P Capital IQ and GSAM.

The How
A target-rich environment

Skilled active managers may be rewarded, especially in international stocks.

Historically, higher dispersion in international equities has translated to top-quartile manager outperformance.

In markets of higher return dispersion, security selection outcomes are more pronounced, with clearer winners and losers. Since international markets are structurally more dispersed than the US, these markets have helped the best active managers realize significant alpha over the benchmark.

Source: Morningstar and GSAM.

The Know
An emerging growth phase

Emerging markets may be entering a new period of growth.

Equity markets have cycled between periods we would label despair, hope, growth and optimism—EM may shift into growth mode.

2015’s declining EM earnings and challenged equity performance gave way to an earnings and market rebound in 2016. We expect this recovery to continue. However, earnings may dominate equity returns as we enter the growth phase.

Source: IBES, Datastream, Goldman Sachs Global Investment Research, and GSAM.

The How
Earnings in focus

The trend of improving 2016 emerging market earnings revisions has carried over into 2017.

Earnings per share (EPS) forecasts are trending higher to a degree not seen in years.

We see encouraging signs that EM earnings bottomed in 2016. While we continue to closely monitor political risk and trade policy, we anticipate earnings to be the primary driver of equity returns.

Source: Datastream, MSCI, and GSAM.

The Know
Municipal bonds have endured

Munis have continued to deliver strong tax-equivalent income for each year of duration.

In our view, munis remain an effective fixed income investment.

The impact of potential US tax code legislation and reflationary pressures have drawn focus on tradeoffs between interest rate sensitivity and net cash flow. After adjusting the current highest tax bracket from 43.4% to a hypothetical 33%, municipal bonds remain attractive compared to other investment grade fixed income.

Source: Barclays Live and GSAM.

The How
Stay dynamic

Variable returns in the municipal market make a case for flexibility.

Each year, municipal top performers vary across the credit spectrum and yield curve.

Municipal bond investing has often been characterized by a static commitment to buy-and-hold “ladder” portfolios. However, we believe structural shifts in insurance, issuance, inventory, and the variable nature of returns are best addressed by a flexible approach that includes the capacity to shift duration, term structure, and credit quality.

Source: Barclays Point and GSAM.


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