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2022: Edition 2

MARKET KNOW-HOW | 2022: Edition 2

Catch Me If You Can

Catch Me If You Can

Central banks and inflation are the two main actors in a play not seen in decades. After many unexpected twists and turns, inflation has continued to be a dominant theme, fueled by tight labor markets, supply chain dynamics, and geopolitical tensions. In the US, the Fed has credibly embarked on policy tightening to rein in price pressures. Elsewhere, other major central banks also stand ready to “catch” inflation, though with different policy paths relative to the US.


We believe the transition back to “normal” may not only invite continued market volatility but also potentially broaden investment opportunities, especially after valuation contraction in 1H 2022. We believe markets now offer a more compelling value proposition for long-term investors.


In this edition of the Market Know-How, we explore how investors may navigate the economic normalization, with emphasis on:

  • Looking toward the destination, not the journey. While uncertainty may persist, strong fundamentals have strengthened the investment case within and across markets.
  • Positioning for accelerated disruption. Consequently, we believe alpha may be better found in idiosyncratic, focused, and global portfolios.
  • Elevating the importance of income to potentially better manage episodic volatility.
  • Diversifying existing exposure with alternative investments to potentially access unique sources of returns and to reduce concentrated risks.

Macro & Market Views

Global Growth

We recognize growth risks are skewed to the downside while inflation remains elevated. But, we think the deceleration in growth reflects a move into a more sustainable expansion in both developed and emerging markets. A well-liquefied banking system, robust private sector balances, strong consumer demand, and relatively limited financial imbalances provide sources of economic stability in the midst of global uncertainty.

Goldman Sachs Global Investment Research and Goldman Sachs Asset Management.
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Geopolitics: Short-Lived Shocks

Political Noise, Geopolitical Shocks, and Recessionary Bears

Geopolitics has become top of mind this year, with the Federal Reserve’s geopolitical risk index surging on the back of the Russia-Ukraine war. Still, we believe that not all sources of volatility are created equally. Global equity markets have historically been more resilient through these unexpected geopolitical shocks than they have been in recessions.

Source: Bloomberg and Goldman Sachs Asset Management.


Balancing Results During Geopolitical Shocks

While we do not expect current geopolitical risks to cause a recession, the wide array of potential spillover effects may lend to greater left-tail risks to growth. Investors may consider staying invested and diversifying portfolios with core fixed income, liquid alternatives, income strategies, and real assets.

Source: Bloomberg and Goldman Sachs Asset Management.

Valuations: Pricey, but Not Costly

Expensive is Relative

Equities have traded expensively for most of recent history, but fair value is rarely known at the time of purchase. In recent decades, investors paid a greater premium for expected earnings amid lower tax rates, enhanced global integration, and declining real bond yields. The operating environment may be evolving, but we believe the median and absolute S&P 500 CAPE ratios can stay elevated because valuations, and the factors driving them, have demonstrated themselves to be adaptive, not mean-reverting.

Source: Robert Shiller, Bloomberg, and Goldman Sachs Asset Management.


Multiple Contraction Doesn’t Mean Negative Returns

Still, we expect a period of multiple contraction from earnings catching up rather than prices catching down, with such periods having delivered positive equity returns in the past.

Source: Robert Shiller, Bloomberg, and Goldman Sachs Asset Management.

Rates: Over the Hump

Yield Benefits of Staying Short

Rates have repriced at the fastest speed in years. But, we believe the worst may be behind us as markets now embrace Fed policy guidance and its inflation-fighting priorities. With today’s higher rates, the short- and long-end of the yield curve look appealing again, offering higher income and potentially improved hedging capabilities, respectively. For long-term investors, we believe duration risk will be counterbalanced by attractive coupons available through credit.

Source: Bloomberg and Goldman Sachs Asset Management.


Fed Reception

Beyond bonds, we believe risk assets may deliver positive, though moderating, returns even amid a tightening cycle as long as the expansion endures and private sector balance remains intact.

Source: Bloomberg, Goldman Sachs Global Investment Research, and Goldman Sachs Asset Management.

Inflation: Hot Inflation, Time to Cool Down

We Expect Hot Inflation to Cool

Price pressures have strengthened globally. Such a sudden, synchronized jump in inflation hasn’t been seen in decades. The causes vary across countries but the persistence of some factors such as global supply chain issues and energy trade disruptions are likely to keep inflation elevated for longer. However, the direction may turn due to base effects and normalizing supply-demand imbalances, with implications for asset prices.

Source: Bloomberg, Goldman Sachs Global Investment Research, and Goldman Sachs Asset Management.


Asset Class Performance in Different Inflation Environments

While recognizing nuances that are present today, cooling inflation from a high level has historically been associated with positive real returns for both equities and bonds.

Source: Bloomberg, Robert Shiller, and Goldman Sachs Asset Management.

Alpha: IDEA: Innovate, Disrupt, Enable, Adapt

Potential Wealth Creators of the Future

Decelerating GDP growth, rising interest rates, and peaking profit margins suggest returns may be lower in the new market cycle. Looking ahead, we think the companies contributing to alpha will innovate, disrupt, enable, and adapt, and be diverse across global markets. We believe investors will need to be precise in identifying these wealth creators, especially in a world of narrow wealth creation.

Source: Bloomberg, FactSet, Goldman Sachs Global Investment Research, and Goldman Sachs Asset Management.


The Wealth Creators of the Past

To put the past two decades in perspective, just 27% of Russell 3000 companies accounted for 140% of the market cap gain, and only 48% of S&P 500 companies outperformed US Treasury bills. Directionally, we think active management in ex-US equities and liquid alternatives can potentially navigate the new cycle skillfully.

Source: Bloomberg and Goldman Sachs Asset Management.


Stay Informed and Be Ahead of the Curve


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