The continued economic expansion, the fluidity of global politics, and the shifting tectonics of monetary policy: All are reasons we think staying invested, but staying focused on alpha and on risk, is the appropriate path. Markets strike us as lacking extremes on either end of the valuation continuum, though they are subject to rising risks, including the potential for recession, flareups of volatility, and political shocks. Easy Does It, in our view, is the appropriate mindset in a climate that calls for a risk-aware adherence to strategic investment allocations.
We see current conditions as largely benign as long as investors understand that risk may no longer be linear. Political shocks and policy-related risks are the variables to watch, whereas we see recession risk as still moderate.
Investors who believe in risk assets but think they offer limited upside from this point forward may revisit strategies with the potential to offer equity-like returns, but with less equity-like beta. In our view this means examining a range of possibilities in income-oriented investing and alternatives. It may, in short, mean adopting an Easy Does It philosophy—seeking to optimize risk in the tenth year of an equity bull market.
Consequently we would emphasize:
The recent slowdown in activity and growth has had at least two remarkable features: 1) its protracted length, and 2) the manufacturing sector's weakness, whose signal should not be over-emphasized as its share of US GDP is only 10%. Other parts of the global economy—notably the services sector—have been much more resilient in the face of uncertainty over trade policy and the associated disruption to supply chains.
On the surface, exceptionally strong 1H 2019 equity market returns appear to contrast with the cautious signal of falling fixed income yields. The message may not be so mixed. Part of equities' strength reflected a rebound from 4Q 2018 oversold conditions, while low to negative rates reflect expectations for continued loose monetary policy.
Top Section Notes: As of July 31, 2019. 'Global manufacturing PMI' refers to Purchasing Managers' Index, an index measuring prevailing direction of economic trends in the manufacturing sector. Bottom Section Notes: As of July 31, 2019.
The first half of 2019 saw especially high inflows into municipal bonds, which we expect to persist.
The first six months of 2019 saw municipal bond inflows of almost $21 billion, surpassing the average five-year same-period figure by 2.4x. We believe that this voracious demand will persist for the remainder of the year and likely beyond, as the impact of the Tax Cut and Jobs Act continues to drive demand for tax-free income.
Source: Simfund and GSAM.
A diversified muni portfolio may match benchmark returns and may offer higher yield or lower duration.
While the municipal bond aggregate benchmark makes for a solid starting point, diversification is key in muni portfolios. An illustrative portfolio that matches the Muni Agg benchmark duration may yield nearly 100 basis points more, while one that matches the yield may offer lower interest rate risk. In an environment of low interest rates, broadening term structure and credit quality may provide additional yield or less rate risk.
Source: Bloomberg Barclays and GSAM.
Top Section Notes: As of June 30, 2019, latest available. Chart shows the municipal fund inflows averaged over the past five years (2014–2018) and for 2019 year-to-date.'Municipal fund inflows' are based on 'net new flows' as defined by Morningstar's 'Muni National Intermediate' category group. Bottom Section Notes: As of July 31, 2019. 'Muni Short' refers to the Bloomberg Barclays 3-Year Municipal Bond Index. 'Muni HY' refers to the Bloomberg Barclays High Yield Municipal Bond Index. 'Muni Agg' refers to the Bloomberg Barclays Municipal Bond Index. Chart shows several illustrative municipal bond portfolios that match the historical tax-equivalent yield and duration of the Bloomberg Barclays Muni Index respectively. 'Tax-equivalent yield' is used to compare the yield of a taxable bond to that of a tax-exempt bond. 'Duration' is a measure of the sensitivity of the price of a fixed income investment to a change in interest rates. 'Average credit rating' refers to ratings provided through Bloomberg Barclays. Tax-equivalent yield, duration, and average credit rating are portfolio-weighted averages of index data. These illustrative results do not reflect any GSAM product and are being shown for informational purposes only. No representation made that an investor will achieve results similar to those shown. The performance results are based on historical performance of the indices used. The results will vary based on market conditions and your allocation. Diversification does not protect an investor from market risk and does not ensure a profit. Please see glossary for additional definitions on both the top and bottom chart. Past performance does not guarantee future results, which may vary.
Liquidity is an essential part of investment strategy, yet the opportunity for cash to work is often underappreciated.
Identifying goals for cash can enable investors to better align short-term investments with particular liquidity needs. We think that a differentiation between daily liquidity and on-demand liquidity is important. Both allow for preservation of capital, but strategic investments for on-demand liquidity may further unlock incremental return without sacrificing access to cash.
Late-cycle flattening makes the front end of the curve attractive on an absolute and risk-adjusted basis.
The front end of the yield curve offers a sweet spot for investors from a yield and duration perspective, in our view. We see advantages for investors residing on both ends of the maturity spectrum. In light of a more accommodative central bank posture, portfolios with longer durations may find more attractive yield towards the shorter end of the curve. At the same time, the US average savings account rate of 1.2% may have daily liquidity investors leaving money on the table.
Source: Bloomberg and GSAM.
Top Section Notes: As of July 31, 2019. 'Liquidity' refers to short duration securities that can be quickly bought or sold in the market at a price reflecting its intrinsic value. 'Primary liquidity' refers to investments with an investment horizon of less than 12 months, an objective of preservation of capital and liquidity, and that uses traditional money market or short-term conservative income strategies. 'Secondary liquidity' refers to investments with an investment horizon on 12 months or longer, an objective of enhanced return and preservation of capital, and that uses short duration strategies. 'Tertiary liquidity' refers to investments with an indefinite investment horizon, an objective with greater emphasis on maximizing return potential, and that uses broad fixed income strategies. 'Daily liquidity' refers to a subset of primary liquidity with an investment horizon of less than 6 months. 'On-demand liquidity' refers to a subset of primary liquidity with an investment horizon of 6–12 months. For illustrative purposes only. Bottom Section Notes: As of July 31, 2019. 'US average savings account rate' is from the Bankrate survey of large lenders in all 50 states. Chart shows the current yield and risk-adjusted yield for different tenors of on-the-run US Treasuries. 'On-the-run' refers to the most recently issued Treasuries of a particular maturity. 'Risk-adjusted yield' is measured by the yield per unit of risk, where risk is defined as the standard deviation of monthly total returns over the last 10 years. 'Yield' refers to the end of day yield to maturity. Past performance does not guarantee future results, which may vary.
Low rates and high equity valuations have presaged lower long-term returns.
Current equity valuations have historically corresponded to mid-single-digit returns in the subsequent decade. At the same time, the aging proportion of the population has steadily marched higher, and by 2020 we expect the number of people aged 65 and older to exceed those aged five and younger. Both developments suggest that in an environment of normalizing equity returns and lower interest rates, investors must look beyond traditional asset classes in pursuit of sustainable cash flow.
Source: Bloomberg, Robert Shiller, and GSAM.
Cash flow enhancers may help generate income.
In today's environment, we believe income generation will be an increasingly important consideration in portfolio construction. With US equities yielding just under 2%, investors may need to look outside of traditional core assets to achieve a 4% or greater annual distribution. Additionally, incorporating cash flow enhancers may help investors capture the majority of equity returns through income rather than relying upon capital appreciation, which is more risky in nature.
Source: Bloomberg Barclays, Morningstar, and GSAM.
Top Section Notes: As of July 31, 2019. 'CAPE ratio' refers to the cyclically adjusted price-to-earnings ratio, which is a valuation measure using real earnings per share (EPS). '10-year Avg. Sub. Return' references monthly returns of the S&P 500 Total Return Index. Table shows the CAPE ratio in deciles, from lowest to highest, and its respective average returns over the next 10 years. Past performance does not guarantee future results, which may vary. 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 page. Bottom Section Notes: As of July 31, 2019. 'Global Infra. and MLPs' refers to Global Infrastructure and MLPs. With the exception of the US 10-Year Treasury, distribution yield assumptions represent the asset-weighted median 12-month distribution of Institutional or No-Load Shares of mutual funds in the representative Morningstar category, excluding those funds with 12-b(1) fees greater than 0.25%. In an effort to distinguish funds by what they own, as well as by their prospectus objectives and styles, Morningstar developed the Morningstar Categories. While the prospectus objective identifies a fund's investment goals based on the wording in the fund prospectus, the Morningstar Category identifies funds based on their actual investment styles as measured by their underlying portfolio holdings (portfolio and other statistics over the past three years). Please see additional disclosures at the end of the page.
Idiosyncratic factors have grown in importance as drivers of European equity returns.
European equity returns have dislocated from traditional growth drivers; political uncertainty and weak corporate profitability explain virtually all of Europe's underperformance. Europe's highly cyclical and mature sector composition amplifies these issues. While we expect episodic outperformance during periods of growth acceleration, rising rates, higher US inflation, aggressive US tech regulation, and/or favorable political momentum, we believe the best opportunities in Europe are micro, not macro.
Source: Bloomberg, Goldman Sachs Global Investment Research, Haver, and GSAM.
High-performing European firms have seen higher returns.
Since 2009, European companies with outperforming stocks have exhibited significantly greater earnings growth, profit margins, and annual returns than those with weak share-price returns. These fundamental differences are particularly large relative to the US, which is why we see a strong case for active management in European equities. While European beta may have diminished macro momentum, we see alpha opportunities as plentiful—and may be best captured through bottoms-up analysis and more concentrated positioning.
Source: Bloomberg and GSAM.
Top Section Notes: As of July 31, 2019. 'Relative strength ratio' refers to the relationship between Europe and the US based on equity and economic ratios. The equity ratio is calculated by taking the ratio of the Euro Stoxx 600 Index cumulative daily performance over a denominator of S&P 500 Index cumulative daily performance. The economic ratio is calculated by taking the ratio of monthly Euro area Markit Manufacturing Purchasing Managers Index (PMI) over a denominator of monthly US ISM manufacturing PMI. 'Info Tech' refers to Information Technology. 'Fin.' refers to Financials. 'Comm. Service' refers to Communication Services. 'Cons. Disc.' refers to Consumer Discretionary. 'Indus.' refers to Industrials. 'Cons. Stap.' refers to Consumer Staples. 'Util.' refers to Utilities. Bottom Section Notes: As of December 31, 2018, latest available. Analysis is done on an annual basis from 2009 to 2018. Each data point represents the 10-year average difference between the median of outperforming and underperforming stocks for each respective measure. 'Outperforming stocks' refers to securities with an annual return that exceeds the index, and 'underperforming stocks' refers to securities with an annual return less than the index. 'EPS growth' refers to earnings per share growth. 'Profit margin' refers to profit as a percentage of revenue. 'Return dispersion' refers to the difference between annual returns of outperforming and underperforming securities. Past performance does not guarantee future results, which may vary.
Investment managers' information advantages are hard to sustain as data analysis is constantly evolving.
The value of data-derived insight varies according to the amount and quality of information. In the initial stage (Zone 1), not enough data is available and the incremental value of data-derived insight remains small. Once sufficient data is available (Zone 2), managers with interpretive processing capabilities have an edge, which may provide an opportunity for alpha generation. However, as data becomes broadly accessible to the public (Zone 3), there is declining incremental value in acquiring “more.” On the whole, managers must consistently evolve and adapt to maintain their information advantage.
Source: Goldman Sachs Global Markets Institute (GMI) and GSAM.
Artificial intelligence may help innovative managers stay ahead of the pack.
Artificial intelligence can be defined as a set of computer algorithms performing tasks once perceived to require human intelligence, but which can now be done rapidly, independent of human intervention. Machines can now consistently learn and improve their knowledge and performance at a speed well beyond human cognition, potentially empowering investors with informational advantages.
Top Section Notes: As of July 31, 2019. For illustrative purposes only. 'Information advantage' refers to unique knowledge that gives a firm or an individual a competitive advantage. Bottom Section Notes: As of July 31, 2019. For illustrative purposes only. 'Algorithm' refers to a step-by-step procedure designed to perform an operation.
Transportation is poised to change more in the next decade than any time since the invention of the automobile.
The next 10 years of mobility will revolutionize the way people and products move. Emergent technologies such as ride-hailing, autonomous vehicles, micro-mobility, and even eVTOL (electric vertical takeoff and landing, a.k.a. flying cars), stand to disrupt a $7 trillion global mobility market, impacting more than $700 billion of profits in the space. The new mobility market will create opportunities for investments as new businesses are established, existing transportation concepts disrupted, and cities transformed.
Source: Goldman Sachs Global Investment Research and GSAM.
The global mobility market is about to change as pay-as-you-go models disentangle usage and ownership.
The evolution of ride-hailing stands to spawn broader technological and social transformation. Cloud mobility is utilizing data to alter how cities move, through transportation services including smart shuttle buses and various types of car-sharing. This pay-as-you-go mobility market could potentially expand four-fold to $409 billion by 2030. In the US, we expect vehicles per licensed driver to begin declining in 2028, while in Japan, cars in operation are expected to begin declining as early as 2024.
Source: AAA, EPA, Experian, FHWA, Goldman Sachs Global Investment Research, and GSAM.
Top Section Notes: As of July 31, 2019. For illustrative purposes only. Bottom Section Notes: As of July 31, 2019. For illustrative purposes only. The chart is based on an average American driver's cost and benefit of car ownership and ride-sharing. The analysis is based on assumptions that the average American incurs the following monthly expenses: $456 car payment, $99 insurance, $62 registration and taxes, $72 gas cost ($2.86 per gallon, 25.4 mileage), and $300 parking cost. The cost of ride-sharing is assumed to be $2 per mile. The assumptions in the analysis were derived from latest third party survey, research, or public documents. 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 page.
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