A stabilizing macro backdrop, convergent growth, and late-cycle opportunity: each is a reason we do not see winter coming for investors. We believe that strategy will be key—we remain pro-expansion, yet pro-reality, attuned to the evolution of late-cycle conditions.
Here are the knowns: the global economy has transitioned from above-trend to near-trend growth, the expansion has continued, and looking ahead we see activity stabilizing. The US expansion is on track to notch its 121st month in June, which would be the longest expansion in history. Accordingly, absent clearer signs of a long-lasting deterioration in fundamentals, we believe the evolving market environment remains supportive of risky assets. On the back of a solid operating environment, credit performance should remain stable.
The unknowns bear close watch, though as the season progresses we expect more conclusions on several key concerns: an uncertain Brexit process, turbulent trade policy, and the possibility of further populist
shocks in election outcomes. Investors, in our view, should prepare for emergent risks even as they seek to capitalize on opportunity.
Consequently, we would emphasize:
Geopolitical shifts, trade negotiations, evolving monetary and fiscal policies, volatile oil prices, and ubiquitous media coverage are all forces contributing to elevated global economic policy uncertainty. On the margin, we believe these uncertainties should moderate through 2019, though the political echo chamber is likely to mask progress.
The past 30 years have seen dramatic changes in the trading environment. In this evolution, algorithmic trading now dominates many asset classes. Speed has replaced capital, creating vast pools of liquidity during periods of stability and vacuums of liquidity during crises. This structural shift should create awareness among investors to differentiate between fundamentally and algorithmically driven markets.
Top Section Notes: As of March 31, 2019. Bottom Section Notes: As of March 31, 2019. Chart shows the ideological spectrum of Democrats (blue, left) and Republicans (orange, right) in Congress based on their voting history. The political ideology scores represent how economically liberal or conservative a party is on the scale of -1 (very liberal) to +1 (very conservative). For example, the median economic ideology is more liberal for Democrats and is more conservative for Republicans in 2018 compared to 1968. 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. Please see additional disclosures at the end of this page.
Voracious municipal bond demand has been met with limited supply growth.
The technical backdrop for the municipal (muni) market has solid long-term underpinnings. The size and supply of munis have remained relatively steady while Treasury and corporate debt markets have experienced dramatic expansions. Demand for municipal securities has increased and may continue to grow as select provisions of the Tax Cuts and Jobs Act, including limitation on SALT deductions, are realized.
Source: SIFMA and GSAM.
More security selection is possible within lower-rated muni bonds, which may also benefit from wider spreads.
In the wake of the global financial crisis, the collapse of monoline insurers resulted in structural changes, such as the realignment of municipal credit ratings. Just as the opportunity set broadened across muni credit, option-adjusted spreads became more dispersed, indicating that spreads were increasingly driven by CUSIP-specific fundamentals and covenants. We believe that investing across the muni spectrum may allow investors to more fully benefit from an increasingly idiosyncratic market.
Source: Barclays POINT and GSAM.
Top Section Notes: As of December 31, 2018, latest available data. Chart shows outstanding US debt at the corporate, federal, and state level from December 2006 through
December 2018. ‘Corporate’ refers to debt obligations of US financial and nonfinancial corporations including bonds, notes, debentures, mandatory convertible securities, long-term
debt, private mortgage-backed securities, and unsecured debt. It includes bonds issued both in the US and in foreign countries, but not bonds issued in foreign countries
by foreign subsidiaries of US corporations. ‘Treasuries’ refers to interest-bearing marketable coupon federal public debt. ‘Municipals’ refers to debt obligations issued by states,
cities, counties, and other government entities. ‘SALT deductions’ refers to federal deductions for state and local taxes. Bottom Section Notes: As of December 31, 2018. Analysis
does not include pre-refunded municipal bonds. ‘OAS’ refers to option-adjusted spreads for individual outstanding CUSIPs. ‘Max OAS Differential’ is calculated by subtracting the
maximum OAS of bonds for 2018 versus 2006, by credit quality. A positive OAS differential suggests that credit spread range is widening. A negative OAS differential suggests
that credit spread range is narrowing. For example, a max OAS differential of -6 basis points (bps) for AAA-rated bonds means that the credit spread range has narrowed by 6 bps
between 2006 to 2018. Past performance does not guarantee future results, which may vary.
Yields across a range of asset classes today may provide a significant buffer against potential price losses.
In the current benign rate environment, the coupon income from credit asset classes is looking particularly attractive. We estimate that yields could rise by a further ~1% before the offsetting price reduction would reduce returns in various credit sectors to breakeven. For example, rates or spreads would need to rise more than 197 basis points to generate negative returns in US High Yield.
Source: Bloomberg Barclays and GSAM.
The large rate moves that would be required to offset this substantial income have been exceedingly rare.
The present difference between the current and breakeven yields for several sectors is so wide that it has historically been breached just a handful of times. For example, the 197 basis point move in US HY yields has occurred in just 2% of 12-month periods. Given our expectation for stabilizing global growth, contained inflation, and dovish central bank policy, we consider the likelihood of such moves to be particularly slim.
Source: Bloomberg Barclays and GSAM.
Top Section Notes: As of March 31, 2019. ‘Current Yield’ refers to the current stated yield to maturity. ‘Breakeven Yield’ refers to the estimated yield at which total returns
would be negative based on current yield to maturity and current modified duration. ‘US 10-Year Treasury' refers to the Bloomberg US Generic Government 10-Year Yield Index.
‘Euro HY’ refers to the Bloomberg Barclays Pan-European High Yield Index. ‘EM Debt Local’ refers to the Bloomberg Barclays Emerging Market Local Currency Government Index.
‘EM Debt USD’ refers to the Bloomberg Barclays Emerging Market USD Aggregate Index. ‘US HY’ refers to the Bloomberg Barclays US High Yield Index. Bottom Section Notes:
As of March 31, 2019. Analysis is from June 2008, earliest common inception, to March 2019 on a rolling monthly basis. High-yield, lower-rated securities involve greater
price volatility and present greater credit risks than higher-rated fixed income securities. 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. Past performance does not guarantee
future results, which may vary.
The impact of sector composition on growth-versus-value return differentials can be quite large.
The sector composition of large-cap growth indices has been famously dominated by the information technology sector, while value has historically tilted toward financials. Each of those sectors today represents more than 25% of the respective index. In our view, a tactical bias to either growth or value should be informed by underlying sector views. In fact, roughly 70% of the growth-versus-value return differential is attributable to the sector allocation effect.
Source: Bloomberg and GSAM.
Style investors have often benefited from taking stock of Federal Reserve interest rate moves.
We believe that today’s late-cycle conditions may benefit the sectors contained in value-tilted positions. Value sectors have historically outperformed the S&P 500 in the 12-month period immediately following a cycle’s last Federal Reserve (Fed) rate increase by at least two percentage points. If markets are correct that the data-dependent, increasingly dovish Fed has concluded its rate hikes, investors may benefit from revisiting large-cap value and its key underlying sectors.
Source: Goldman Sachs Global Investment Research and GSAM.
Top Section Notes: As of March 31, 2019. ‘Growth’ style refers to the S&P 500 Growth Index. ‘Value’ style refers to the S&P 500 Value Index. S&P 500 sectors follow GICS
categorization. *The Real Estate sector was previously grouped within the Financials sector. ‘Growth Tilted’ refers to a sector having a higher allocation in the S&P 500 Growth
Index than in the S&P 500 Value Index. ‘Value Tilted’ refers to a sector having a higher allocation in the S&P 500 Value Index than in the S&P 500 Growth Index. Bottom Section
Notes: As of March 31, 2019. Federal Reserve (Fed) rate hike cycles include: November 1986–February 1989, February 1994–February 1995, June 1999–May 2000, and July
2004–June 2006. 'Sector Excess Return' refers to the excess return above the S&P 500 Index over the 12-month period after the conclusion of each Fed rate hike cycle, for each
GICS sector. ‘Hit Rate’ refers to the frequency in which sector returns exceeded the S&P 500 Index. A hit rate of 75% indicates that the sector outperformed the S&P 500 Index by
three out of four times. ‘Median’ refers to the 50th percentile of excess return across the four rate hike periods. Past performance does not guarantee future results, which
We see emerging markets poised for a comeback as global macro conditions converge.
US economic growth may converge with the rest of the world, "catching down.” We expect exceptional 2018 US earnings growth to normalize closer to the global trend, and EM earnings to catch up. Additionally, we expect a weakening US dollar, which would also be supportive of EM assets.
Source: International Monetary Fund (IMF), FactSet, Goldman Sachs Global Investment Research, and GSAM.
Many investors are structurally underweight EM, and thus may not fully benefit from EM growth prospects.
Portfolios we’ve examined through GSAM PRISM™ are systematically underweight EM equity, debt in US dollar and in local currency by an average of 3.8 percentage points (pp), 1.7pp, and 2.7pp, respectively, relative to our strategic asset allocation. We think that portfolios with higher EM allocations could enjoy enhanced risk-adjusted returns, particularly at a time of softening developed market fundamentals and US convergence.
Top Section Notes: As of March 31, 2019. ‘Change in Gross Domestic Product (GDP) Growth’ is represented by the difference in GDP growth (%, YoY) from the previous year’s GDP
growth. For example, a 0.6 percentage point (pp) change means that the pace of GDP growth was 0.6pp faster than its prior year. ‘Earnings Growth’ refers to top-down consensus
earnings per share (EPS) growth. Bottom Section Notes: As of March 31, 2019. GSAM PRISM™ is a registered trademark of GSAM. ‘Client Portfolio’ is represented by the average
allocation of a GSAM PRISM™ client portfolio with core fixed income between 20% and 40%. ‘Client Portfolio Underallocation' refers to the difference between a respective GSAM
PRISM™ Illustrative Strategic Asset Allocation and the average allocation of the respective asset class across 2,600 financial advisors. ‘GSAM PRISM™ Illustrative Strategic Asset
Allocation’ refers to the 70:30 GSAM PRISM™ Strategic Asset Allocation Portfolio, composed of 70% core equity and diversifiers and 30% core fixed income. Core equity includes
US equity and international developed equity. Core fixed income includes US aggregate fixed income and global ex-US aggregate fixed income. Diversifiers include emerging market
debt (USD), emerging market debt (local currency), global high yield, bank loans, emerging market equity, international small cap equity, international real estate, US real estate,
and global infrastructure and master limited partnerships. These allocations are based on the asset class views of GSAM Portfolio Strategy. Please see glossary for additional
definitions. 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 document. Past performance does not guarantee future results, which may vary.
Private equity has been generating more value, attracting more interest, and becoming more accessible to investors.
The private equity (PE) universe has expanded rapidly in recent decades, and is creating more value for companies and their investors. A favorable funding environment has enabled companies to strategically delay public offerings. Individual investors’ barriers to entry have shrunk as asset managers have lowered minimum net worth and investment requirements. We believe this evolution has enhanced the asset class’ attractiveness.
Source: Preqin, CB Insights, and GSAM.
Investing across managers, funds, and vintages in our view is key to improving client outcomes.
Diversifying vintage years enables exposure to different stages of the PE investment cycle. Diversifying across strategies enables access to buyout, distressed, growth, and venture investments. Each strategy comes with unique risk and return tradeoffs; single-strategy performance may be highly variable. A diversified approach, in our view, may mitigate risk and help transform PE into a core allocation.
Source: Preqin and GSAM.
Top Section Notes: As of March 31, 2019. ‘Unicorn’ refers to a private company with a valuation of $1 billion or greater. Bottom Section Notes: As of December 31, 2018, latest
available data. 'Average Net IRR' and 'Standard Deviation of Net IRR' are calculated from reported Net IRR of over 3,000 PE funds in the Preqin database with a vintage year
between 1997 and 2017 (inclusive). ‘Standard deviation’ is a measure of volatility. The ‘Illustrative Diversified Strategy’ is an equal-weight illustrative portfolio of the four private
equity strategies shown in the chart. 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 private equity strategies used. The result will vary
based on market conditions and your allocation. An investment in a PE fund is speculative with a substantial risk of loss. An investment in a PE fund is only suitable
for investors who have no need for liquidity in the investment. Investors generally are not able to redeem their units or withdraw from a PE fund for the life of
the investment. This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.
Diversification does not protect an investor from market risk and does not ensure profits. Please see end notes for important disclosures. This information discusses general
market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. Please see
glossary for additional definitions. Past performance does not guarantee future results, which may vary.
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