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November 17, 2022 | 3 Minute Read
Senior Market Strategist, Strategic Advisory Solutions
Market volatility has been a story of 2022, with sharp price swings seemingly becoming the norm. The S&P 500 saw 70 all-time highs in 2021, accompanied by just 55 days of greater than 1% moves. But so far this year, the S&P 500 has registered only one all-time high and has had 105 days with moves greater than 1%. In our view, the array of macro headwinds ranging from sticky inflation to geopolitical tensions are likely to persist. As such, we believe investors may benefit from deriving a greater proportion of forward returns through stable cash flow over the uncertainty of price risk.
Equity markets have tended to see valuations contract and earnings decline during past periods of macro weakness. We see a similar backdrop today, with US economic growth inextricably linked to the trajectory of tighter financial conditions. In our view, equity prices may continue to trade sideways until clear signs of inflation containment are present. Ultimately, we believe that so long as higher real interest rates remain a source of upside risk, equity prices may have a way to go before seeing a sustainable rally.
While equity prices have been challenged, equity dividend income has proven more resilient. Historically, recessions have featured sharp earnings pullbacks of -13%, on median. Meanwhile, S&P 500 dividends only declined by a median of -1% in such instances. With forward 12-month price targets on US and European stocks expected to remain flat relative to current levels, we believe the case for income is even more powerful today. As shown in Exhibit 1, expected dividend yield for the next year is estimated to comprise a significant share of total equity returns in each region, and a much greater share than was the case in the past decade. Pockets of the equity market with a value orientation may realize an even greater share of returns in dividends than their growth-tilted counterparts. In a world where equity prices may revisit recent lows, we think that equity dividend income can act as a buffer against price volatility.
Source: Bloomberg, Goldman Sachs Global Investment Research, and Goldman Sachs Asset Management. As of October 31, 2022. “GIR” refers to Goldman Sachs Global Investment Research. “NTM” refers to next twelve months. The economic and market forecasts presented herein have been generated by Goldman Sachs Asset Management for informational purposes as of the date of this presentation. They are based on proprietary models and there can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this presentation. Past performance does not guarantee future results, which may vary.
The equity market is not the only place to look for income. The recent headwind of rising future interest rates may finally be giving way to higher starting interest rates, with investors now able to benefit from greater coupons. In Exhibit 2, we show the magnitude of yield surges across different fixed income sectors on the year. With peak policy hawkishness in the US likely behind us, current yields across taxable and tax-exempt bonds have more than doubled in this year, potentially providing a buffer against additional duration risk.
Source: Bloomberg and Goldman Sachs Asset Management. As of October 31, 2022. “Treasuries” refer to the US Treasury component the Bloomberg US Aggregate Bond Index. “Agg” refers to the Bloomberg US Aggregate Bond Index. “MBS” refers to the Mortgage-Backed Securities component of the Bloomberg US Aggregate Bond Index. “ABS” refers to the Asset-Backed Securities component of the Bloomberg US Aggregate Bond Index. “IG Corporate” refers to the Bloomberg US Corporate Investment Grade Index. “HY Corporate” refers to the Bloomberg US High Yield Corporate Index. “IG Municipal” refers to the Bloomberg Municipal Bond Index. “HY Municipal” refers to the Bloomberg Municipal High Yield Index. “TEY” refers to tax-equivalent yield for municipal bonds. “Tax-equivalent yield” refers to yield divided by one minus the current tax rate. A 40.8% tax rate is used to calculate tax-equivalent yield for current period. Goldman Sachs does not provide accounting, tax, or legal advice. Please see additional disclosures at the end of this document.
Global central banks are unwavering in their efforts to tame inflation. Combined with myriad other known and unknown risks, the market backdrop is likely to remain challenged. Consequently, we favor income strategies, across both equity and fixed income markets, to smooth out near-term price swings and secure more durable returns going forward.
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