Episodic volatility has picked up. Markets are abuzz with trade tensions, geopolitical missteps, populism, and pockets of stressed liquidity. Much of it amounts to noise. The operating environment remains on solid footing. Fully 97%
of global economies are expanding, central banks are slowly removing policy accommodation, financial imbalances are limited, and the current US fiscal boost is strong.
We believe the backstretch of 2018 should remain supportive of risk assets, particularly equities, though the rapid speed at which sentiment can change calls for a strategic commitment to risk management. Equally, we accept the signaling power of a flattening US yield curve, but would caution not to over-interpret curve implications at this point. In short, market conditions are highly consistent with late-cycle characteristics.
Consequently, we would emphasize:
If markets bring the noise, a focus on idiosyncratic positioning can differentiate portfolios from pure market beta.
Global growth may have peaked amid policy transitioning, tighter financial conditions, and trade uncertainty. Even so, data as they stand are healthy, with low global recession risk.
The global inflation pickup remains gradual and country-specific. While excess capacity has generally contained global prices, tariffs may introduce a statistical wrinkle in the data.
Transitioning central bank policy will be top of mind as markets discount reaction functions and terminal levels. We expect a gradual data-centric approach towards normalization.
Markets appear to be trading with a higher beta to policy. Consequently, trade policy and Brexit negotiations may intensify swings in market sentiment and investment activity.
Late-cycle factors such as higher rates and earnings growth deceleration may be amplified by limited fiscal/monetary options. Trade, politics, and populism also feature prominently.
Source: GSAM. As of August 2018. S&P 500 Average Return is the path of the S&P 500 Index before and after historical midterm elections (i.e. the midterm elections are the
starting point of the analysis to determine the average pre- and post-election S&P 500 path), using the averages of weekly returns in order to generate that path. The midterm
elections analyzed were: 1994, 1998, 2002, 2006, 2010, and 2014. Average VIX refers to the average weekly absolute value of the CBOE Volatility Index (VIX) to generate a path
before and after those same midterm elections. The analysis uses S&P 500 and VIX data from May 27, 1994 to April 24, 2015. For example, the S&P 500 average return four weeks
before the midterm elections was 5.2% lower than that of the midterm week. The average VIX level four weeks before the midterm elections was 24.0. Past performance does
not guarantee future results, which may vary.
Although global growth may have peaked, conditions for continued global expansion remain intact, offsetting trade, policy and related macro uncertainties.
Global growth may have decelerated, but generally remains above trend in key economies. More broadly, 97% of world economies currently register expansionary conditions, consistent with the International Monetary Fund’s expectation that 2018 will experience the fewest recessions on record.
We view trade disputes in the context of an economy’s overall exposure to external commerce, where the US ranks lower than many other major economies. Trade also introduces peripheral
uncertainties, potentially including:
1) financial markets and risk sentiment, 2) reduced investment, and 3) retaliation escalating policy from
bi-lateral to multi-lateral.
Top Section Notes: As of August 2018, latest available. PMI stands for the Purchasing Managers’ Index, which is based on monthly surveys (January 2014 to July 2018) of select
companies operating within the manufacturing and services sectors in 20 developed and developing economies worldwide. Using composite PMIs, the chart shows economies
expanding and contracting, with results weighted by Gross Domestic Product (GDP). GDP data used is as of 2017. Expanding composite PMIs refers to readings above 50.
Contracting composite PMIs refers to readings below 50. 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. Bottom Section Notes: As of August 2018. Data as of July 2018, latest available. The chart shows the total exports
and imports as a percent of GDP for G7 (Canada, France, US, United Kingdom (UK), Germany, Japan, and Italy), BRIC (Brazil, Russia, India, and China), and Mexico.
Improving valuation reflects a persistently strong earnings cycle. We expect earnings growth to support equities but taper down from the policy-induced gains of 2018.
We believe the technical impact from quantitative tightening should drive global rates higher, potentially reducing the effectiveness of government debt as a hedge.
Fundamentals look good-to-very-good, though tight spreads, higher duration, and higher leverage temper our return expectations. Idiosyncratic positioning remains key.
Dollar pressure may ease, as above-trend global growth differentials narrow, and the pace of higher relative US interest rates slows.
We expect trend volatility to remain below normal, but the frequency and magnitude of episodic dislocations to increase as technology and speed replace capital in trading.
Source: Bloomberg, Barclays Live, and GSAM. As of July 31, 2018. 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 based on the past 10 years from June 2018. 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 Euro Stoxx 50 Index. UK refers to the FTSE 100 Index. Investment Grade refers to the Bloomberg Barclays Global Aggregate Corporate Index. High Yield refers to the Bloomberg Barclays Global High Yield Index. Emerging Market Debt ($) refers to the Bloomberg 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.
Late-cycle markets tend to be supportive of risk assets like equities and commodities, though volatility may increase as markets digest the level, speed, and shape of rates.
While US yield curve inversions have often preceded recessions, they have not caused recessions. Instead, inversions are indicative of the conditions that typically occur ahead of recessions. They should not be interpreted in isolation. Over the last 70 years, the lag time between curve inversions and recessions appears to be growing.
Market and macro volatility have diverged since central banks embarked on aggressive inflation targeting in the mid-1980s. While the reward for transparency has driven macro volatility lower, market volatility at times disconnects from fundamentals, reflecting concerns over technical conditions and challenged liquidity.
Top Section Notes: As of July 31, 2018. Yield curve refers to the curve that plots maturity versus yield using bonds with comparable credit quality. Yield curve inversion is
measured by the US 10-Year and 2-Year Treasury yields. US expansion is defined as the phase of the business cycle when the economy moves from a trough to a peak, as defined
by the National Bureau of Economic Research (NBER). The Treasury Yield Curve, which is also known as the term structure of interest rates, draws out a line chart to demonstrate
a relationship between yields and maturities of on-the-run Treasury fixed income securities. Past performance does not guarantee future results, which may vary. Bottom
Section Notes: As of July 31, 2018, latest available. Analysis is from January 1, 1947, common inception to July 31, 2018. Volatility is a measure of the amount of uncertainty or risk
related to the size of changes. Annualized volatility for US Consumer Price Index (CPI) is the annualized standard deviation of year-over-year changes in headline CPI. Annualized
volatility for US Gross Domestic Product (GDP) is the average 5-year standard deviation in annualized quarter-over-quarter nominal US GDP growth. Annualized volatility for the
S&P 500 refers to the annualized standard deviation of daily returns, gross of fees.
Realized duration has been historically lower than duration “on paper.”
In today’s rising rate environment, we believe that an understanding of muni rate sensitivity is critical. The difference between OAD and realized duration is also found among credit securities broadly. Munis, for example, trade at an average beta of 0.7 to OAD, implying that they are less sensitive to interest rates than is often assumed.
Source: Bloomberg Barclays and GSAM.
Rate sensitivity may be further reduced by rethinking muni term structure and credit exposure.
We believe that with munis’ features such as callability, credit profile and liquidity, realized duration is a more accurate and essential measure of interest rate sensitivity. By incorporating credit and term structure, investors may amplify the reduction in realized duration and improve tax-equivalent yields relative to the Bloomberg Barclays Municipal Bond Index.
Source: Bloomberg Barclays and GSAM.
Top Section Notes: As of July 31, 2018. Option-Adjusted Duration (OAD) is a measure of the sensitivity of bond price to interest rate changes, assuming that the expected cash
flows of the bond may change with interest rates. Realized duration refers to the actual price sensitivity of a bond based on historical market-based data. Bottom Section Notes:
Top Chart Notes: As of July 31, 2018. For illustrative purposes only. Short Muni Index is represented by the Bloomberg Barclays 3 Year Municipal Bond Index. Municipal Bond Index
represented by the Bloomberg Barclays Municipal Bond Index. High Yield Muni Index is represented by the Bloomberg Barclays High Yield Municipal Bond Index. Bottom Chart
Notes: As of July 31, 2018. Tax-equivalent yield is the return required on a taxable investment to make it equal to the return on a tax-exempt investment. The tax rate assumption is
40.8%, representing a 37% federal rate and a 3.8% Affordable Health Care Tax. Tax-equivalent yield per unit of realized duration is a ratio of %/years. The Illustrative Muni Portfolio
is a hypothetical portfolio constructed from an equally weighted allocation of three indices: Short Muni Index, High Yield Muni Index, and the Municipal Bond Index. Treasury Bond
Index is represented by the Bloomberg Barclays US 3–5 Year Treasury Index, the index with the closest duration (OAD 3.86 years) to the Illustrative Muni Portfolio (Realized Duration
3.73 years). 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. The performance results are based on historical performance of the indices used. The result will vary based on market conditions and your allocation.
Diversification does not protect an investor from market risk and does not ensure a profit. Past performance does not guarantee future results, which may vary.
Today, stocks and bonds are less useful diversifiers of one another than they have been in the past.
The forty year decline in long-term interest rates coincided with several multi-year equity bull markets, during which returns were simultaneously positive for both asset classes. Going forward we believe that rising rates could pressure bond and equity returns alike, potentially necessitating broader and more effective sources of diversification.
Liquid alternatives could potentially be an offset for stocks and bonds.
We believe that macro fundamentals support rising rates over time-a direct headwind to fixed income returns. Additionally, the speed and slope of rate increases may create a headwind for equities. As a result, stock and bond returns could be potentially challenged,
simultaneously-strengthening the case for alternatives.
Top Section Notes: As of July 2018. Analysis is from July 1988 to July 2018, based on earliest available data through most recent month end. The correlation shown uses
6-month, rolling daily returns. Correlation measures the extent to which two sets of data move in relation to each other. Bottom Section Notes: As of July 2018. Analysis is
from January 1993 to July 2018, based on earliest available data through most recent month end. Stocks refers to the S&P 500 Index. Bonds refers to the US 10-Year Treasury.
Liquid Alternatives refers to the HFRI Fund of Funds Composite Index. Historical frequency measures what percent of the time the referenced scenarios have historically taken
place. Past performance does not guarantee future returns, which may vary. Diversification does not protect an investor from market risk and does not ensure a profit.
Investments in Liquid Alternative Funds expose investors to risks that have the potential to result in losses. These strategies involve risks that may not be present
in more traditional (e.g., equity or fixed income) mutual funds.
More growth-oriented companies are delaying their entry into public markets compared to the past.
Supportive economic growth, plentiful private funding, strong end-investor demand, and regulatory shifts have made it easier for EGCs to stay private longer, with greater flexibility in timing their IPOs. Consequently, the private equity cohort has many established companies with outstanding management, solid revenue growth and profitability.
Source: Dow Jones VentureSource and GSAM.
As the number of US listed companies drops, the private marketplace has expanded rapidly.
Investors are increasingly adopting private markets as a strategic portfolio component for the potential diversification and total return benefits across equities, credit, real estate, special situations, and geographies. Environmental, Social and Governance (ESG) and impact investing is also seeing development as investors align their portfolios with social and environmental objectives.
Source: World Bank, PitchBook, and GSAM.
Top Section Notes: As of August 2018. The chart shows median time for a US company to go public. Initial Public Offering (IPO) refers to when a company sells shares of stock
to the public, usually to raise additional capital. Corporate lifecycle refers to the progression of a business and its phases over time, and is most commonly divided into five stages:
launch, growth, shake-out, maturity, and decline. Bottom Section Notes: As of August 2018. Private markets refers to investments that are not traded on a public exchange.
Private equity (PE) refers to investment funds organized as limited partnerships that are not publicly traded, which make investments in startup or operating companies. The
number of PE-backed company data is as of December 2017. The number of listed US domestic companies is as of June 28, 2018. Private equity investments are speculative,
highly illiquid, involve a high degree of risk, have high fees and expenses that could reduce returns, and subject to the possibility of partial or total loss of fund
capital; they are, therefore, intended for experienced and sophisticated long-term investors who can accept such risks.
The ESG and impact investing spectrum has broadened and evolved over time.
Popular misconceptions about Environmental, Social and Governance (ESG) and impact investing include: 1) the space is a niche investment subsector, and 2) ESG investment principles may come at the expense of returns. In our view, these premises are fundamentally not true.
Impact investing requires the same discipline and rigor as traditional investing.
An effective ESG investing program, in our view, requires a focus on material, data-driven metrics. When executed with the same discipline and rigor as traditional investing, ESG data can drive analysis, insights, and potential returns.
Source: Bloomberg, Goldman Sachs Global Investment Research, and GSAM.
Top Section Notes: As of August 2018. For illustrative purposes only. Bottom Section Notes: As of April 2018, latest available. The chart shows that an aggregation of the amount
of ESG data available through Bloomberg has increased between 2007 and 2015, in order to provide more transparency on ESG values. ESG strategies may take risks or eliminate
exposures found in other strategies or broad market benchmarks that may cause performance to diverge from the performance of these other strategies or market benchmarks.
ESG strategies will be subject to the risks associated with their underlying investments’ asset classes. Further, the demand within certain markets or sectors that an ESG strategy
targets may not develop as forecasted or may develop more slowly than anticipated.
Trade concerns have sparked a flight from emerging market assets despite their solid fundamentals.
EM fundamentals remain strong, and the favorable economic growth differential versus developed markets remains intact. Investors have nevertheless sold EM first and asked questions later amid volleys between the US and China.
Source: National Sources, Bloomberg, the Institute of International Finance (IIF), and GSAM.
EM economic activity is largely regional in nature, which is an important context for trade concerns.
Despite the emergence of globally relevant companies and brands, EM revenues remain largely among EM countries. We believe market volatility may reveal the periodic disconnect between sentiment or fund flows, and fundamentals.
Source: FactSet and GSAM.
Top Section Notes: As of June 30, 2018. Portfolio flows refer to net non-resident purchases of emerging market (EM) equities ("equity flows") and bonds ("debt flows") in USD.
These measures are developed by the Institute of International Finance (IIF) and can be referred to as a proxy for portfolio flows as measured by a country's balance of payments.
Portfolio flows for May and June are IIF preliminary estimates for emerging market debt (EMD) and emerging market equity (EME) portfolio flows. Emerging markets refers to
25 countries: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland,
Russia, Qatar, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates. Bottom Section Notes: As of July 6, 2018. For illustrative purposes only. The economic and market
forecasts presented herein are for informational purposes as of the date of this presentation. Investments in foreign securities entail special risks such as currency,
political, economic, and market risks. Emerging markets securities may be less liquid and more volatile and are subject to a number of additional risks, including
but not limited to currency fluctuations and political instability. All indices are defined in the end notes for both charts. Please see end for additional chart
disclosures. Past performance does not guarantee future results, which may vary.
Investing is a journey and a destination—there are many paths to pursuing investment objectives.
A manager’s deviation from a specified benchmark can be quantified as tracking error, which differs widely even among the top performers. The magnitude of this variation has important implications for selecting managers. Diversifying among your managers may help to reduce risk relative to the benchmark—sizing matters.
Source: Morningstar Direct and GSAM.
Sizing risk over capital means matching risk allocation to investment conviction.
As an example, in our view, a 50/50 capital blend rarely reflects a 50/50 balance of risk. This approach may inadvertently overweight one manager’s risk-taking over another’s. The approach we favor is sizing according to risk by allocating according to tracking error.
Source: Morningstar Direct and GSAM.
Top Section Notes: As of June 2018, latest available. Top Quartile Performing Active Managers represents the top quartile of US-domiciled funds based on their 5-year return.
US Equity represents the US Large Cap Growth, Value, and Blend universe in Morningstar Direct. US Equity funds are benchmarked to the S&P 500 Index. Developed ex-US Equity
represents the Foreign Large Growth, Value, and Blend universe in Morningstar Direct. Developed ex-US Equity funds are benchmarked to the MSCI EAFE Index. Emerging Market
Equity represents the Diversified Emerging Market universe in Morningstar. Bottom Section Notes: As of June 2018, latest available. Emerging Market Equity funds are benchmarked
to the MSCI Emerging Markets Index. For illustrative purposes only. Low Tracking Error Fund is represented by the lowest 10th percentile tracking error (2.7%) fund in the emerging
market active funds universe as defined by Morningstar Direct. High Tracking Error Fund is represented by the highest 10th percentile tracking error (7.1%) fund in the emerging market
active funds universe as defined by Morningstar Direct. The correlation of excess returns of these two funds is -0.32. Diversification does not protect an investor from market risk and
does not ensure a profit. 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. The performance results are based on historical performance of the indices used. The result will vary based on market conditions and your
allocation. Past performance does not guarantee future results, which may vary.
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