Better, Stronger and Faster for 2018 – The Goldman Sachs Perspective

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Published by Taylor Financial Group

Last week, I attended Goldman Sachs 2018 Global Outlook Year End Reception, where we heard from Candace Tse, Market Strategist, and Katherine Bordlemay, Portfolio Manager for Emerging Markets. Goldman’s theme for 2018 is “better, stronger and faster.” The presentation highlighted Goldman’s views on domestic equities and emerging markets.  Candace Tse, Goldman’s Market Strategist, discussed synchronized GDP growth and stronger economies worldwide year over year. Ninety-eight percent of the economies are growing positively and 94% are growing faster year over year, hence Goldman’s theme of better, strong and faster. As a result, Goldman is pro-growth and pro-equity (over fixed income).

Tse acknowledged concerns regarding valuations and the potential for volatility in the domestic markets. In addition, she pointed out that there hasn’t been a 5 or 10% drawdown in over one year, and therefore, they are “pro-reality.”

From a macro side, their top six views are:

  • GDP Growth. Globally Synchronized. And US GDP will grow at above trend (excess of 2+%), and India and China will be mid-to-high single digits.
  • Unemployment numbers will continue to improve and therefore wage inflation will move higher, which should increase inflation.
  • Rates will increase in December and Goldman is predicting three hikes in 2018. ECB is also considering normalization of balance sheets, because they have run out of German Bunds to buy.  When the German Bund rate increases, that will indirectly affect domestic rates on US Treasuries, which have felt downward pressure as a result of lower Bund yields.
  • Tax bill reconciliation will likely occur and the market is placing an 80% chance of passing a bill.
  • Biggest risk and question is whether the Fed will move too fast. There is also concern about geopolitical issues, but not the base case. And they don’t believe that we will enter into a recession, with a prediction of only a 33% chance of entering into a recession within the next two years.
  • When considering commodities, which have entered into a stealth bull market, there are great opportunities with energy and MLPs (Master Limited Partnerships) and infrastructure companies. They see oil rangebound between $45-65 during 2018, and they believe we are at the floor. Most MLPs are the cheapest that they have been in years.

Market Views

Goldman likes equities over fixed income and prefers to take credit risk over interest rate risk when delving into fixed income markets. When reviewing equities, they prefer foreign over US equities.

Although they are predicting mid-single digit returns, at a minimum, Goldman favors equities because returns could be higher depending on the reaction to tax reform. Looking at fixed income, rates will trend higher as rates are currently anchored so low. Therefore, Goldman is cautious with sovereign debt and is a little nervous about high yield, as there have been lots of recent returns.  So, they say to be careful with security selection.

Regarding currency, Goldman sees potential upside risk to the US dollar, which could move higher with tax reform.

Finally, regarding volatility, the VIX average is 10 as compared to a historical average of 19, and there is concern due to geopolitical issues which cause a spike 50% of the time. So, Goldman advises that investors should build their portfolio so it is prepared for the spike. According to Goldman, volatility will return.  It is just a matter of how and when, and no one warns you in advance.

One final note on crypto currencies (a.k.a. bitcoin) – Goldman is starting to do research in this area, noting that it is the most volatile asset class in the market this year. Goldman has tested out the swap market in connection with bitcoin, so it appears as if they are looking at it more from a trading perspective. They are not interested in the actual bitcoin, but they are interested in the technology behind bitcoin, as it permits certain types of trading. And, they reminded us that there is no store of value in connection with bitcoin, which is something that Jamie Dimon has also recently mentioned. They are most interested in blockchain, which is the technology behind it. Goldman did not appear to be recommending bitcoin to us or their other clients.

Catherine Bordlemay, Emerging Market Portfolio Manager, also spoke to us. Bordlemay reminded us that 86% of all millennials live in emerging markets, which means that the growth drivers for today’s economy are different than ten years ago. The primary driver of emerging market growth is consumption, not commodities and energy, as it was in the past. Bordlemay mentioned that they favor service companies, such as Tencent and Alibaba, for example.

Bordlemay also reminded us that a typical house in India is likelier to have a cell phone over a toilet, with almost 100% penetration of cell phones (many of which are smart phones), which enables leap frogging development. As an example of the types of companies they prefer, Bordlemay explained that there are matrimonial websites in India that combine tradition with technology and services.

What are Goldman’s high-level thoughts for 2018 in emerging markets?

Three things to consider:

  • Have a long-term plan. Historically, emerging markets has been a strong diversifier in a portfolio, with only a 30bp correlation. So, if you are worried about domestic volatility or underperformance, emerging markets can help there.
  • It is a good time to build the emerging markets allocation. There is accelerating growth in emerging markets, at about 4-5%, so it is very attractive. Goldman recommends small and mid-cap emerging markets companies, as they are typically more service oriented whereas large-cap is more commodity oriented. There has been lots of reform in the emerging markets, and it is a very heterogenous asset class, but Goldman is very bullish thinking that it is a recovery through 1,000 stitches. Goldman also believes that many of the BRIC currencies (acronym for five major emerging national economies: Brazil, Russia, India, China and South Africa) are undervalued in comparison to the dollar, but they don’t focus on currencies anyway, as most of the returns are driven by earnings. They also believe that emerging markets valuations look attractive, which are trading at a 30% discount to the SP500, where historically it has been a 15% discount.
  • Be highly selective and go active as the Benchmark is broken. Emerging markets are not efficient, so ETFs don’t make sense here. There are over 6,000 emerging market companies, but the Index has 800, chopping off a lot of the opportunity set. For example, the Index has 25% state owned companies, which Goldman avoids as their shareholder returns lag. As a result, Goldman doesn’t like state owned Chinese banks, but they do like stock exchanges. In addition, Goldman points out that the Index is comprised of over 85% larger companies, but Goldman has a larger exposure to small and mid-cap, companies which are more oriented towards consumption.

In short, Goldman is preferring equities, particularly developed and emerging markets equities. We have been favoring international equities for the last year, and will likely continue favoring those allocations. Feel free to call or contact us with any questions about your portfolio.

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