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:
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.
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.
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.
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.
Rising inflation can be “good,” “bad,” or “ugly.” We see a “good” variant in the US, where limited slack in the economy and wage inflation impulses are feeding through the supply chain. Europe’s “bad” inflation is driven in part by energy prices, whereas in the UK, the “ugly” combination of rising energy prices and the shock of rapid Sterling depreciation is still being felt.
Key central bank policy has been pulled forward by strength in economic data, led by manufacturing and the consumer. During peak Brexit uncertainty in 2016, both the European Central Bank and Bank of England were not expected to raise short-term rates for at least 5 years. Today, the expected timeframe has shortened meaningfully.
Top Chart Notes: Analysis is from January 2016–February 2017, latest available data, for each respective country. The 10-Year breakeven inflation rate is what market participants expect inflation to be in the next 10 years, on average, which is derived from each country's 10-Year sovereign yield and its respective 10-Year inflation-indexed security. Bottom Chart Notes: As of February 28, 2017. Euro area and UK are respectively based on the EUR and UK region “Morgan Stanley Months to 1st rate hike” indices. 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.
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.
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.
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.
We think interest rates have room to rise—sovereign yields in several major countries are below fair value by our estimates. At the same time, interest rate moves over the last six months have erased some of the deep discounts to fair value. We expect this trend to continue.
Global uncertainty and interest rate differentials have contributed to an uptick in unusually sharp market moves in the bond and currency markets. We expect volatility to broaden into equity markets, suggesting investors consider strategies that offer downside management.
Top Chart Notes: Current data is as of February 28, 2017 and "Fair Value" is as of February 24, 2017, latest available. "Fair Value" is derived from the Goldman Sachs Global Investment Research (GIR) Fair Value model. Fair Value is the yield based on GIR economists’ outlook for growth and inflation, and the expected stance of monetary policy. The "basis points below Fair Value" represents the difference between nominal interest rates on sovereign securities with maturities of 10 years and their respective Fair Value yield. Bottom Chart Notes: As of February 28, 2017. “Sharp Market Moves” refers to market moves that are 3 standard deviations or greater from its respective mean, calculated using the larger of the day-to-day change and the intra-day trading high/low (when available). Standard Deviation is defined as a measure of the dispersion of a set of data from its mean. The S&P 500 Price data was analyzed back to January 3, 1928, US 10-Year Treasury yield back to January 3, 1962, and US Dollar Index (DXY) back to January 5, 1971. 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 2017 calendar is packed with catalysts for potential market volatility.
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.
In the past, elevated policy uncertainty has pointed to higher equity volatility.
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.
Top Section Notes: “FY” stands for fiscal year. “Budget Resolutions Debate” refers to the fiscal year 2018 budget resolutions debated on the House and Senate floors. “EU” stands for the European Union. “NATO” stands for the North Atlantic Treaty Organization. “G20” is an international forum for the governments and central bank governors from 19 of the world’s largest economies plus the European Union. Bottom Section Notes: As of February 28, 2017. The Baker, Bloom & Davis Index is a non-financial metric that can be used to gauge the underlying level of economic policy uncertainty on a country level, by exploiting the informational content of national newspapers. The Global Policy Uncertainty Index has been constructed by weighting and rescaling the single-country indices by their share of global GDP and rebasing the series as of 2003. The VIX Index is a measure of S&P 500 implied volatility. Both measures are shown using 6 month moving averages. Past performance does not guarantee future results, which may vary.
After more than three decades of declining interest rates, sustainable gains may be upon us.
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.
Historically, alternative strategies have generated higher returns with lower risk when rates have risen.
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.
Top Section Notes: As of February 28, 2017. Rising rate periods are the longest trough to peak periods where the US 10-Year Treasury rate rose since 1990. The 5 rising rate periods are: September 30, 1993–December 30, 1994, September 30, 1998–January 31, 2000, May 30, 2003–June 30, 2006, December 31, 2008–January 29, 2010, August 31, 2012–December 31, 2013. Bottom Section Notes: As of December 31, 2016. Starting point selected given longest common index inception (HFRI Fund of Funds Index inception January 1, 1990). Historical returns refers to the S&P 500 Total Return Index for Equities, the Barclays US Aggregate Bond Index for Fixed Income, and the HFRI Fund of Funds Index (HFRIFOF) for Alternatives. HFRIFOF and related indices are trademarks and service marks of Hedge Fund Research, Inc. ("HFR") which has no affiliation with GSAM. Information regarding HFR indices was obtained from HFR’s website and other public sources and is provided for comparison purposes only. HFR does not endorse or approve any of the statements made herein. The Average Annualized Risk and Return figures “During Rising Rate Periods” are the average annualized standard deviation and total return figures during the 5 rising rate periods as defined above. Past performance does not guarantee future results, which may vary.
Elevated US equity multiples have often pointed to mid-single digit long-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.
Buy-Write strategies historically have outperformed in muted market environments, with lower volatility.
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.
Buy-Write strategies are represented by the CBOE S&P 500 2% OTM (Out of the Money) BuyWrite Index. A Buy-Write strategy refers to an investment that receives call premium on an underlying equity position to generate income. The CBOE S&P 500 2% OTM (Out of the Money) BuyWrite Index’s performance is not necessarily reflective of all Buy-Write strategies. Past performance does not guarantee futures results, which may vary.
Top Section Notes: The “long-term average” and percentile levels for the cyclically-adjusted price-to-earnings (CAPE) ratio are calculated from December 30, 1927, the inception of the S&P 500 Price Index. Subsequent returns analysis is from January 29, 1988, the inception of the S&P 500 Total Return Index, through February 28, 2017. Bottom Section Notes: Buy-Write strategies are represented by the CBOE S&P 500 2% OTM (Out of the Money) BuyWrite Index. Analysis uses total returns from January 2007 through December 30th 2016. “Global Financial Crisis” refers to 2008. “Moderately Positive” and “Very Positive” respectively refer to calendar years with returns between 0–10% and greater than 10%.
Greater variation in the returns of individual stocks may create security selection opportunities.
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.
Skilled active managers may be rewarded, especially in international stocks.
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.
Top Section Notes: Analysis from January 2014 to December 2016. "Global Ex-US" refers to the S&P Developed Ex US Large and Mid Cap Index. "US" refers to the S&P 500 Index, a proxy for the US Large Cap equity universe. Dispersion of returns is measured by the standard deviation of index returns around their mean, on a monthly basis. A higher level of return dispersion means there is more variation in returns and hence the environment is more conducive to active managers. Active managers refers to strategies that make investments with the goal of outperforming a benchmark. Bottom Section Notes: Analysis as of February 2017. "Global Ex-US" includes top quartile funds over 3, 5, and 10 years from the Morningstar Foreign Large Cap Developed Markets category, which include funds benchmarked to the MSCI ACWI ex US Index that are categorized by Morningstar as Foreign Large Cap Blend. "US” refers to US Large Cap Blend managers which are benchmarked to the S&P 500. Excess returns compare fund performance against the MSCI ACWI Ex US Index for "Global Ex-US" and fund performance against the S&P 500 Index for the "US." Managers for the different time periods are not necessarily the same. Please see end disclosures for additional definitions. Investments in foreign securities entail special risks such as currency, political, economic, and market risks. Past performance does not guarantee future results, which may vary.
Emerging markets may be entering a new period of growth.
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 trend of improving 2016 emerging market earnings revisions has carried over into 2017.
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.
Top Section Notes: Based on the MSCI Emerging Market index, from 2008–2017, using Datastream’s “total market indices,” which are indexed to 100 at the start date. 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. Please be advised that since this example is calculated gross of fees and expenses the compounding effect of an investment manager's fees are not taken into consideration and the deduction of such fees would have a significant impact on the returns the greater the time period and as such the value of the $100 if calculated on a net basis, would be significantly lower than shown in this example. Phases and phase descriptions for illustrative purposes only. Forward Earnings per Share (EPS) refers to consensus 12-month EPS forecasts. Forward Price/Earnings refers to the consensus next 12-month valuation forecast. Bottom Section Notes: As of February 28, 2017. The MSCI Emerging Market EPS growth forecast revisions represent analyst revisions to consensus earnings growth forecasts and the trajectory of revisions across time. Please see disclosures for definitions. EM securities may be less liquid and more volatile than developed markets and are subject to a number of additional risks, including but not limited to currency fluctuations and political instability. Past performance does not guarantee future results, which may vary. Please see additional disclosures at the end of this document.
Munis have continued to deliver strong tax-equivalent income for each year of duration.
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.
Variable returns in the municipal market make a case for flexibility.
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.
Top Section Notes: As of February 28, 2017. Municipal represents the Bloomberg Barclays Municipal Bond Index, Investment Grade Corporate represents the Bloomberg Barclays Investment Grade Corporate Index, Agency represents the Bloomberg Barclays US Aggregate: Agency Index, and Treasury represents the Bloomberg Barclays U.S. Treasury Index. Chart shows a line of best fit of Tax-Equivalent Yields for 3, 5, 10, and 20 year bonds versus their durations. Tax-Equivalent Yield adjusts for tax-free earnings of municipal bonds, to make muni yields comparable with taxable yields. Current tax rate is 43.4%, reflecting a 39.6% Federal Rate and a 3.8% Affordable Care Act Tax. The 33% tax rate reflects Trump administration tax proposals. Goldman Sachs does not provide accounting, tax, or legal advice. Lower interest rates may reduce the duration of callable securities. As a result, the municipal and corporate indices used in this analysis have significantly lower duration, though similar maturity, as the government indices. Bottom Section Notes: As of February 28, 2017. Chart rankings are relative to 5 year single A performance and are a reasonable representation of an intermediate, investment grade rated portfolio. Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold, or directly invest in the company or its securities. These illustrative results do not reflect any GSAM product and are being shown for informational purposes only. No representation is made that an investor will achieve results similar to those shown. Goldman Sachs does not provide accounting, tax or legal advice. Please see additional disclosures at the end of this document. Past performance does not guarantee future results, which may vary.
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