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Edition 2


Walking the Tightrope

Late-cycle expansions are often associated with elevated equity valuations, tight credit spreads, and financial excesses. These conditions can create vulnerability even when the operating environment is sound. History also demonstrates that late-cycle equity returns can be robust, rewarding a disciplined approach.

In our view, 2018 is unfolding much like a performer walking a tightrope. Risk is considerable, but manageable, and best addressed by balance, agility, and focus.

Our key views:

  • Balance: A balance pole lowers one’s center of gravity and increases rotational inertia, providing vastly improved stability. Similarly, we believe alternative investments may help stabilize portfolios, especially if equity and rate volatility move higher.
  • Agility: Crossing the chasm with skill recognizes the necessity of risk-taking. For equity investors, we believe higher risk-adjusted results may be achieved from an increased focus on idiosyncratic earnings opportunities rather than pure market beta.
  • Focus: Funambulists generally pay keen attention to the end of the line, not the uncertainty of each step. Similarly, if volatility increases, we believe a focus on strategic portfolio design and investment time horizon can help address market crosswinds.




Global growth should remain solid as the synchronized expansion continues, but the pace is likely to moderate amid tightening monetary policy and financial conditions.


A likely source of volatility, inflation remains highly regional, with US readings gradually firming, Europe subdued, and emerging markets mixed, but Chinese inflation likely to rise.

Monetary Policy

In 2018, we expect: four hikes by the Federal Reserve, two by the Bank of England, the end of quantitative easing by the European Central Bank, and the Bank of Japan to still be on hold.


US fiscal expansion may lower recession risk in the near-term, but emerging tariff rhetoric and the potential for targeted retaliation introduce new systemic risk.


Late-cycle factors such as higher rates and earnings growth deceleration may be amplified by limited fiscal/monetary options. The potential for a trade war also remains top of mind.

Recession Risk Remains Low

Source: Goldman Sachs Global Investment Research, National Bureau of Economic Research, and GSAM. As of March 2018. The chart shows quarterly data from January 1984 to March 2018, the latest available data, of the unconditional probability of a US and Euro area recession over the next 8 quarters. 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 further global expansion with relatively low recession risk, contained financial imbalances, and a gradual firming of inflation. Central banks are likely to remain patient as monetary policy normalizes.

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The current operating environment remains favorable for earnings. Equities are our preferred asset class, particularly those in ex-US markets that are more levered to global expansion.


US rates appear vulnerable to transitioning monetary policy, a pick-up in term premium, and increased Treasury supply. Forward pricing appears to lag Federal Reserve communications.


Tax reform was a tailwind for credit, potentially elongating the cycle. Still, we remain cautious on credit beta as tight spreads and higher leverage moderate our return expectations.


Euro and USD markets are likely to be dominated by differentials in interest rates, economic growth, and current accounts, with trade policy also joining the mix.


Elevated valuation, rising rates, and policy uncertainty may heighten equity sensitivity to exogenous shocks and shifts in the operating environment.

More Earnings Growth, Less Multiple Expansion

Source: Bloomberg, Goldman Sachs Global Investment Research, and GSAM. Data as of March 31, 2018. ‘Multiple expansion’ refers to the change in the ratio of price to the next 12 months of forecasted earnings per share, and is a measure of how expensive an asset class is. The chart shows a decomposition of each year’s total return contributors. 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.

Key Takeaway

We believe the synchronized global macro backdrop provides an attractive operating environment for risk assets, though the market appears increasingly vulnerable to bouts of volatility and adjustment.

The Know
Earning better valuations

Rising corporate earnings may normalize expensive markets—lower prices are not a requirement.

Don’t forget the ‘E’ in the ‘P/E’ (price-to-earnings) ratio.

Near the 90th percentile of historical valuation, US equities may seem primed for lower forward valuations. But investors who sell expecting a better entry point may miss out on strong earnings momentum. We believe that rising earnings, rather than price declines, can be the primary driver of normalizing valuation.

Source: Bloomberg and GSAM.

The How
A time to 'Buy-Write'

Should equity returns moderate, Buy-Write strategies may benefit.

Buy-write strategies have outperformed the broader equity market as valuation has normalized.

As valuation contracts from elevated levels (our base case over the next few years), markets may see moderate, but positive returns. This is potentially an ideal backdrop for buy-write strategies in which investors maintain broad equity exposure, but forego a portion of potential equity upside in exchange for additional returns in the form of distributions from call option premiums.

Source: Bloomberg and GSAM.

The Know
Cycle the globe

Major countries around the world find themselves in varying stages of economic, credit, and monetary policy cycles.

International markets offer solid growth potential as they remain in the earlier stages of the cycle.

The global economy, credit, and central banks are all subject to cycles. Currently, the cycle in the US is farther along from an economic, credit and central bank perspective. Other major markets remain in earlier, more expansionary stages, providing support for earnings growth absent a US slowdown.

Source: GSAM

The How
Earnings beyond borders

Global economic growth provides a supportive backdrop for international profit margins.

Net profit margins have improved globally, with more upside potential ex-US.

Global growth may remain abovetrend, which historically has supported earnings growth outside the US. For every dollar of sales growth, the earnings benefit has been greater internationally. These markets are more levered to global growth, via higher operational leverage, a broader revenue mix, and a significant financial sector representation.

Source: Datastream, MSCI, and GSAM.

The Know
Emerging at a faster pace.

When growth in emerging markets outstrips developed markets, equity returns have tended to follow suit.

We expect continued expansion in emerging markets (EM) and persistent earnings momentum.

A widening growth differential between EM and developed markets (DM) has been conducive to historical EM equity outperformance. Today, IMF forecasts suggest a widening growth differential which may be more than temporary. We believe EM equities stand near the beginning of a cyclical performance uptick relative to DM.

Source: Haver, Bloomberg, Factset, International Monetary Fund (IMF), and GSAM.

The How
Emerging returns during rate hikes

A trend higher in interest rates has often favored EM assets.

Substantial improvements to EM fundamentals have made EM assets more resilient to US rate pressure.

During the last three US rate-hike cycles, EM equities have not only withstood the increases, but also delivered strong performance. With the backing of strong macro conditions, EM equities may exhibit similar resilience in this cycle.

Source: Bloomberg, Federal Reserve, and GSAM.

The Know
Between a rock and a hard place

Interest rate risk is at historic highs and equity volatility’s unexpected spikes may persist.

Rate risk has risen and equity volatility has returned.

The Bloomberg Barclays US Aggregate Bond Index’s duration has trended to an all-time high, indicating that sensitivity to rising interest rates has increased. In addition, equity volatility, as measured by the VIX index, has recently begun to surge.

Source: Barclays Live, Bloomberg, and GSAM.

The How
There are alternatives

Diversified liquid alternatives have historically exhibited favorable features relative to stocks and bonds.

During recent US equity drawdowns and interest rate spikes, diversified liquid alternative investments have functioned as effective hedges.

The last two equity drawdowns highlighted the low beta benefits of alternative investments, which fell less than half as much as equities. Similarly, the last two large rate increases demonstrated the benefits of the low correlation of alternative investments, which posted positive returns while bond returns were in negative territory.

Source: Bloomberg and GSAM.

The Know
Measured munis

The municipal bond market has delivered less volatility than US government bonds.

Across most maturities, municipal bonds have delivered less volatility than similar duration Treasuries.

With the onset of higher longer-term interest rates unfolding since September 2017, we find that diversified municipal bond portfolios, including those with broad allocations to credit and term structure, have produced less volatility than similar duration US Treasuries.

Source: Barclays Live and GSAM.

The How
Vehicle of choice

The power of muni diversification can be unlocked in a mutual fund structure.

We believe a mutual fund structure may be well suited for gaining broad municipal bond exposure.

In a universe of 50,000+ securities, the median number of holdings in separately managed muni accounts is only 30, compared to 217 for the median mutual fund. Historically, the more diverse portfolios have outperformed identically benchmarked SMAs, particularly during rate tightening cycles.

Source: Federal Reserve, Barclays Live, Morningstar, eVestment, and GSAM.

The Know
Big data is revolutionizing investing

Managers who can find signals in the noise may enjoy a competitive advantage.

As much as 90% of all data has been created in the last 2 years, but less than 2% of this data is being analyzed.

Big data is about more than computers and zettabytes. Extracting actionable insights requires skilled managers to harness advanced analytics and processing technologies. As the rate of data generated increases exponentially, we believe a judicious blend of human judgment and computer-led analytics will become an essential tool in uncovering investment insight.

Source: International Data Corporation (IDC), IBM, and GSAM

The How
Bridge the gap

Technology plus human expertise can lead to more informed investment decisions.

Data proliferation may translate into new opportunities.

Natural language processing (NLP) technologies use computers to boil down vast amounts of text into themes and insights that humans could not otherwise discover on their own. Subtle relationships between companies or trends can be uncovered. While data-driven technologies can convey timely and informed inputs, it is the successful pairing of technology with human judgment that will be key.

Source: GSAM.


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