In 2020, we believe markets are likely to interpret good news as good news, and bad news as bad news. Risk asset returns should reflect fundamental realities rather than monetary expectations. Ultimately, we think solid fundamentals will prevail.
EQUITIES
Equities remain our favored risk asset, though valuation and slower economic growth may limit multiple expansion. We think 2020 may be an inflection point for more neutral allocations as recent flashes of US value, US small cap, international DM, and EM outperformance may become more sustainable. As the cycle matures and dispersion rises, we favor idiosyncratic positioning across all sectors and geographies.
RATES
We believe that global sovereign rates have approached the lower end of their range, but are unlikely to move meaningfully higher without a more globalized inflationary push. Additionally, while US core inflation is firmer than other economies, low rates on German Bunds et al. could limit US rates from moving significantly higher.
CREDIT
Rising US corporate leverage is surfacing as a potential source of risk. However, low rates, tight credit spreads, localized defaults, and solid market access should sustain the credit markets in 2020. Beta-caution is warranted, as we highly prefer idiosyncratic deployment at this stage of the credit cycle.
CURRENCY
Most of our 2020 FX views are marginal in magnitude as central banks adopt more neutral postures through the course of the year. We favor the euro to US dollar as monetary policy differentials stabilize and global risk tolerance improves. Implications of declining “no deal” Brexit risk raise the potential for sterling appreciation.
VOLATILITY
The overall level of volatility should remain relatively stable as a generally supportive macro backdrop sustains further global expansion. However, the risk of flare-ups appears elevated, spurred by the binary outcomes of trade, tweets, and elections. We also believe monetary policy’s backstop to the market—the famed central bank “put”—is less effective today in alleviating uncertainty.
Source: GSAM. As of December 2019. 'DM' refers to developed markets. 'EM' refers to emerging markets. 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. 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.
Stock CAPEability
Valuation often normalizes through earnings power and time, not price corrections. Current US valuation, in our view, provides a few key takeaways: 1) low interest rates may actually strengthen the equity opportunity set, 2) free cash flow yield is an important evaluation metric as companies have increasingly moved to capital-light business models, and 3) we think investors should emphasize bottomup positioning rather than pure beta.
Source: Goldman Sachs Global Investment Research and GSAM.
Time is on Your Side
Valuations have virtually no predictive utility for short-term performance. In the long-run, however, valuation has been a useful tool in estimating subsequent returns. Based on this statistically significant long-term relationship, we think today’s elevated valuations presage lower returns in the next ten years relative to the past ten. This insight should inform strategic portfolio design.
Source: Bloomberg and GSAM.
Yield Curve Ball
Like thunder after lightning, recessions following yield curve inversions are often afforded the same degree of predictive reliability. However, 2–10 year inversions in G7 economies have preceded downturns anywhere between 3 months and 3 years. At their best, inversions lack depth perception. Rather than the inversion itself, a sharp re-steepening following an inversion has provided much closer recessionary proximity.
Source: Bloomberg and GSAM.
Top Section Notes: As of November 30, 2019. Please see page 16 for additional definitions. Middle Section Notes: As of November 30, 2019. ‘Valuation’ refers to Cyclically Adjusted Price-to-Earnings (CAPE) ratio. Strength of relationship between S&P 500 CAPE ratios and S&P 500 returns is measured by the R-squared statistic, which ranges from 0 to 1, or from weakest to strongest explanatory power. Bottom Section Notes: As of November 30, 2019. The chart shows the historical number of days until the beginning of a recession based on two comparison points: the date of a first 2-10 year US Treasury yield curve inversion, and the subsequent steepening of the 2-10 year US Treasury yield curve by 100 bps or more. ‘G7’ refers to a bloc of industrialized countries: Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. For illustrative purposes only.
