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2019: Edition 1


Pressure Points

Investors today face a market of pressure points. These markers of sensitivity include the pace of economic growth, the ongoing withdrawal of monetary policy accommodation, escalating trade tensions, and geopolitical risk. Each of these can drive episodic volatility. While markets may come under pressure in 2019, we are both confident in the continued global expansion and cautiously optimistic of late-cycle conditions.

Among the reasons we remain constructive despite these pressure points: none appears to possess the muscle to initiate a recession on its own. Together, they magnify sensitivities emerging in the system, which is why they bear close watch. As the year unfolds, we believe that macroeconomic fundamentals and the evolving market environment will remain supportive of risk assets. Now is the time for investors to stay focused on a commitment to risk management and strategic portfolio design.

Consequently, we would emphasize:

  • Revisiting the balance between growth and value style weights
  • Emerging markets strike us as poised for a comeback
  • Deploying alternatives to manage a riskier market landscape.

Macro & Market Views

Financial Excess... or Lack Thereof

The current US economic recovery is likely to become the longest in history in 2019. Yet a smörgåsbord of leverage- and valuation-based indicators still points to few current imbalances in the economy. While the economy is probably closer to the end of this cycle than the beginning, financial excesses appear to be contained.

Source: Goldman Sachs Global Investment Research and GSAM.
The Know
Growth spurt

The outperformance of US large-cap growth stocks versus value has been unprecedented by some metrics.

Peak Growth

The length of growth or value outperformance can vary across periods, making it difficult to time investment decisions for the two styles. The current length of growth outperformance has exceeded its long-term median length by a factor of four. At 21 months, growth dominance today is twice as long as the period during the dot-com bubble. At the same time, growth valuation continues to be stretched at its highest level ever.

Source: Bloomberg and GSAM.

The How
Balancing act

Growth’s remarkable run may have created an unintended overweight.

Growth Drift

Over recent years, rolling returns for US large-cap growth stocks have surpassed value stocks by a wide enough margin that an equally-weighted starting allocation to growth and value would have drifted to a markedly imbalanced allocation today. In our view, investors should be aware of any such imbalances, and should prepare their portfolios in the event of a regime change in growth-versus-value performance trends.

Source: Bloomberg and GSAM.

The Know
Navigating EM headwinds

A stronger dollar, country crises, and geopolitical headlines help explain challenged 2018 performance.

A Series of Unfortunate Events

We believe that 2018 EM underperformance has been driven primarily by the trifecta of a stronger US dollar, idiosyncratic country risk, and Sino-US trade tensions. Performance may make a comeback as these conditions, which are likely temporary, start to unwind. Additionally, EM companies have limited revenue exposure to the US, which suggests that this headwind may not represent long-term structural risk.

Source: Bloomberg, FactSet, and GSAM.

The How
Leaning against the wind

Earnings growth in emerging markets remains stronger than in developed markets.

Growing Up Cheap

History tells us that over the long term, earnings growth is the predominant driver of returns in EM economies. We estimate that 2019 EM earnings growth will beat developed markets. In addition, EM valuations are lower than in developed markets. We believe this backdrop of attractive valuations and higher earnings growth may be supportive for EM market performance.

Source: Bloomberg, FactSet, and GSAM.

The Know
Comfort in the crowd

Individual stocks’ vulnerability can be reduced by diversifying across a basket of equities.

Going it Alone Versus Sticking Together

Single stocks have greater exposure to both outsized gains and outsized losses. Sometimes they win big, but historically investors have faced losses in single stocks one-third of the time. We believe that diversification through an index can help investors reduce exposure to potentially punitive company-specific risk while still participating in the market.

Source: Morningstar Direct and GSAM.

The How
Know when to fold ‘em (into an index)

Disruption across equity markets has accelerated over recent decades.

Accelerating Disruption in the Index

Technology and globalization have made competition fiercer, faster, and disruption more commonplace. Accordingly, the staying power of companies has diminished. For example, the lifespan of the average company in the Dow Jones Industrial Average has shrunk by a third—from 46 years in 1984 to 30 years today. Companies no longer dominate their industries for long timespans the way that they used to. We would caution investors against overconcentration in any single equity.

Source: Bloomberg and GSAM.

The Know
A two-way street

Sitting on the sidelines can mean missing out on gains even if investors succeed at the task of avoiding losses.

Missing the Bottom, Missing the Bounce

Some of the strongest equity market returns have come within days of a market bottom. We are wary of investors' tendency toward loss aversion, which may lead to missing out on gains while trying to time the market. Investors are rarely able to achieve perfect timing—even if they miss drawdowns, they may still fail to benefit from rebounds. We advocate for a risk-aware approach and maintaining a strategic allocation.

Source: Bloomberg and GSAM.

The How
Gearing up for a bumpy ride

Long-term strategic market exposure has often beaten market timing strategies.

Know Your Alternatives

Liquid alternatives, in our view, can be a valuable late-cycle diversifier and counterbalancing asset for periods of heightened episodic volatility. Historically, as the economic cycle turns, investors who have held liquid alternatives have seen smaller losses than those who held only equities, while still participating in the subsequent recovery. In our view, alternatives offer an efficient solution for investors to de-risk yet remain invested.

Source: Bloomberg and GSAM.

The Know
Credit where it’s due

Municipal bond managers who diversify across the credit spectrum have outperformed over time.

BBBroadening Out Conventional Muni Investing

Top-quartile muni managers have broadly positioned their portfolios with an overweight to credit—as measured by their exposure to muni bonds rated BBB and below—relative to the Bloomberg Barclays Municipal Aggregate Index. Bottom-quartile performers have been consistently overweight quality, meaning AAA-rated bonds. We read these data points as evidence that full participation in the broader municipal landscape represents an effective long-term strategy.

Source: Morningstar Direct, Bloomberg Barclays, and GSAM.

The How
Mutually advantageous

Muni mutual funds have consistently generated higher net returns than similarly benchmarked SMAs.

Mutual Funds' Long-Term Outperformance Versus SMAs

We view mutual funds as structurally better designed to express credit preferences in municipal bonds than SMAs. Consistent with that view, muni mutual funds outperformed similarly benchmarked SMAs for the last 20 years. In a universe of 50,000+ securities, the median muni SMA held 30 positions, compared to 217 for the median mutual fund.

Source: Morningstar Direct, eVestment, and GSAM.

The Know
A taxing situation

Investors consistently experience a contrast between pre- and post-tax returns.

Returns Withheld

Following an extended run of equity gains, being thoughtful about taxation is more important now than ever. On average, investors have lost roughly 2% of their returns to tax liabilities across 1-, 3- and 5-year investment horizons. This tax gap widens further in asset classes for which taxable distributions are larger and/or more common. Being tax-conscious, in our view, is one of the most important methods of enhancing potential returns.

Source: Morningstar Direct and GSAM.

The How
Managing up

Investors do not have to take their tax bills lying down.

Pick Your Position

Investors can deploy a range of strategies designed to manage the impact of taxes on their investment returns: tax loss harvesting, asset location, and tax-efficient vehicles. Tax loss harvesting utilizes market volatility to bolster returns by offsetting capital gains with realized losses. Asset location strategically places assets into tax-advantaged accounts in an effort to maximize after-tax returns. Tax-efficient vehicles by nature typically have little to no tax obligations.

Source: GSAM.


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