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2020: Edition 2

MARKET KNOW-HOW | 2020: Edition 2

Riding the Storm Out

Stepping aside from economic and investment insight for a moment, our thoughts today are with you, your family, and our communities directly affected by these unprecedented events. Globally, the severe economic and health consequences of COVID-19 will not be equally distributed, but we trust that this moment too shall pass, creating increased awareness of our environment and each other.

At the time of this writing, our baseline economic forecast is for the sudden deceleration in economic activity to be most acute in the second quarter, followed by a resurgence in growth during the second half of 2020 and into 2021. Still, developments are fluid. To be sure, we are not including decimal points in our forecasts at this time.

The remainder of this edition of the Market Know-How will focus on summarizing our macro expectations and providing a framework for riding the storm out. 

We emphasize ongoing strategic commitments to: 

  • Alpha-oriented, bottom-up strategies that can identify disruptions in the competitive landscape. We expect societal and consumer transitions that were underway prior to COVID-19 will be accelerated.
  • Income-oriented investing, with a move up-in-quality. Many securities may reflect challenges to market liquidity, not solvency or sustainability, providing excellent entry points to cash flow.
  • Diversified return streams that can buffer spikes in episodic volatility. This would include alternative and portfolio hedge investment strategies.
  • Being patient and positioned for recovery.

Macro & Market Views


Our latest global growth estimates reflect a combination of high-frequency anecdotes as well as the traditional flow of economic reporting. Aggressive physical distancing and shelter-in-place policies to “flatten the curve” have slammed the door on global activity, spiked unemployment rates, and, in only one quarter, likely increased the output gap by more than that experienced in the entirety of every post-war recession. In terms of speed, breadth, and magnitude, we believe the COVID-19 crisis has no corollary.

Source: Goldman Sachs Global Investment Research and GSAM. As of April 23, 2020.
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The Know
Passively drifting landscape.

The composition of fixed income indices has shifted over time.

Changing Duration and Yield

With structurally contained inflation and central bank intervention, the landscape of the fixed income market has changed. Portfolios that passively follow the US Aggregate Bond Index would have extended duration, lowered yields, and been more exposed to Treasuries over time. As such, passive core fixed income investment strategies may be missing out on opportunities for higher income and risk-adjusted returns in other parts of the markets such as investment grade corporates and mortgage-backed securities.

Source: Bloomberg and GSAM.

The How
Getting active.

Active fixed income managers have outperformed average passive managers across asset classes.

Be Proactive

While the changing backdrop has made fixed income a riskier investment with lower yields, active managers have been able to generate alpha by exploiting opportunities across different sectors, credit qualities, and term structures. The flexibility of active managers to deviate from their benchmark has generally led to outperformance versus passive managers on a net-of-fee basis across fixed income asset classes. In fact, across various Morningstar fixed income categories, the median ETF return was lower than that of the bottom-quartile active mutual fund managers.

Source: Morningstar and GSAM.

The Know
Short-term dislocation may present opportunities.

Municipal bonds trade at attractive historic valuations.

Technical Dislocation

Short-term dislocation in the municipal (muni) market driven by the COVID-19 sell-off may present potential opportunities for muni investors. The muni-Treasury ratio normally trades below 100% across the curve. In March, we saw ratios hit a 15-year high, indicating that munis have been trading significantly cheaper than Treasuries. Resilient fundamentals and attractive yield pickup may make munis increasingly rewarding versus Treasuries in today’s low rate environment.

Source: Bloomberg and GSAM.

The How
A blend of options.

Diversification across geography and credit may boost yield or reduce volatility.

National Diversification May Add Ample Possibilities

Investors can unlock the power of diversification in muni portfolios through national and credit exposure. There are an abundance of opportunities to boost risk-adjusted tax-equivalent yield by broadening muni exposure, in our view. This holds true even in a portfolio specific to a high-tax state such as California, where there are plentiful ways to enhance yield or reduce volatility by diversifying nationally across geography, sector, and credit quality.

Source: Bloomberg Barclays and GSAM.

The Know
A land of opportunity.

Investor returns need not be limited to the US.

Top Performers Have Been Concentrated Outside of the US

Since the post-crisis era, US equities have outperformed global peers across a number of metrics. Historical drivers of exceptional returns reflect both the US macro advantage (domestic GDP outpaced developed market GDP) and sector differentials (US equities tended to be more growth-tilted). Yet on average each year roughly 78% of the top performing 50 public companies are domiciled outside of the US. In 2019 alone, international companies represented 90% of these top performers. By broadening the opportunity set globally, we believe investors could unleash attractive return potential in their portfolios.

Source: Bloomberg and GSAM.

The How
Concentrate on selectivity.

International markets are less top heavy.

2019’s Top Performing Stocks Comprised <2% of the MSCI ACWI Index

Taking advantage of the full global equity opportunity set requires investors to consider securities more actively. Top performing stocks in the MSCI ACWI made up less than 2% of the index in aggregate, but on average generated over four times the return of the index’s largest stocks by market capitalization. This strong performance equated to an average return of 132% in 2019, even surpassing returns of top US technology names. In our view, investors should focus on identifying outperforming companies through careful stock selection.

Source: Bloomberg and GSAM.

The Know
Volatility erupting.

Tail risk has increased over the last ten years, even as average volatility has been subdued.

Increased Risk of Left-Tail Risk Events

Volatility has recently been elevated as markets digest the COVID-19 downturn. Yet since the financial crisis, the odds of seeing left-tail risk events—defined as where the VIX closes up by five standard deviations or more in one day—has increased substantially. From 1993–2007, there were left-tail risk events approximately once every two years. From 2008 onwards, left-tail risk events occurred twice every year, amounting to a four-fold increase. In light of this trend, we believe investors should focus on reducing left-tail risk.

Source: Bloomberg and GSAM.

The How
Win by not losing.

Alternatives may act as a buffer in volatile markets.

Down but not Out

When left-tail risks are realized, it is important to have shock absorbers built into portfolios. Liquid alternative strategies may serve this purpose by reducing beta to equity markets. When equity volatility spikes, historically liquid alternatives have avoided 75% of US equity losses and outperformed equities by 2.4 percentage points (pp). In our view, alternatives may offer an effective and efficient solution for investors to lower portfolio risk while remaining invested.

Source: Bloomberg and GSAM.

The Know
Losses exist in all markets.

The majority of stock prices may fall in good times and in bad.

Most Everybody Hurts

More than 50% of stocks in the S&P 500 have had some level of negative returns in the last 15 years. In down years nearly every stock has experienced losses, but years of strong performance have offered ample loss-harvesting opportunities as well. On average, 75% of companies in the S&P 500 have seen their shares fall at least 5% at some point in any given year. Investors can exploit these moments of market volatility by strategically realizing losses to offset capital gains and reduce annual 1099 shock.

Source: Bloomberg and GSAM.

The How
Take advantage.

Tax-aware equity strategies can bolster after-tax returns.

It’s What you Keep that Counts

The after-tax experience of equity investors often underwhelms headline index returns, even when indexes are down. We believe the equity market volatility that investors have experienced this year provides an opportunity to improve after-tax returns through tax-loss harvesting: offsetting capital gains with realized losses. In down markets, tax savings from loss harvesting may add 6 percentage points (pp) to investor returns. In strong markets, loss harvesting may bolster returns by 2.3 pp on average. In an environment where investors are fighting for income across markets, keeping more in their pocket may be especially attractive.

Source: Bloomberg and GSAM.

The Know
Did you know...

Mind the gap. Ideological separation and thin party margins underscore legislative complexities.

Eyes on the Senate

The Presidential race remains a toss-up at this point. What seems certain is that the President-elect will inherit an ideologically disparate Congress challenged to advance major legislation outside of the reconciliation process. There are 35 Senate seats up for election in November with only 10 considered competitive. These seats will most likely split between parties, but even in the event of a hypothetical blue or red wave, the party in power would be operating without a filibuster-proof majority of 60 seats. As a result, policy making may be dominated by reconciliation or executive order.

Source: Cook Political Report and GSAM.

The How

Order from the executive. Policy implementation will likely be dominated by executive authority.

Executive Action is Less Challenging than Congressional Action

There are three paths to policy change in Washington: legislation, reconciliation, and executive action. Legislative risk would most likely be limited given the structure of the Senate. Reconciliation, which requires a simple majority, can only affect one aspect of 1) revenue, 2) spending, and 3) deficit each year. To be sure, the rules of reconciliation can be broadened. Consequently, while the legislative process remains challenged, policy risk is real in the form of potential reconciliation and executive action.

Source: GSAM.


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