Investors should enjoy relatively smooth sailing for the rest of 2018, according to Goldman Sachs analysts, but mind the clouds on the horizon.
U.S. market participants are probably best served staying the course, according to “(Un)Steady as She Goes,” a July 2018 report from Goldman Sachs Investment Management.
“The tug-of-war between the steady factors supporting financial markets and the unsteady undertow threatening to undermine them has continued unabated,” said the report. “When market participants focus on the steady factors, such as growth in world economies and corporate earnings, the equity markets appreciate; when investors’ focus shifts to the unsteady undertow, such as global geopolitical tensions and increasing populism, volatility rises and equity markets depreciate.”
The report is an unexpected mid-year update of GSIM’s annual outlook report, which presented a “steady as she goes” view that the bull market and economic growth would continue in the face of several unsteadying factors.
The probability of a recession in the U.S. during the rest of 2018 remains “close to zero” in GSIM’s view, but the potential causes of recession have changed. While many leading indicators show a decreased risk of recession, cyclical factors like a strong labor market and improving wages are reducing slack in the economy and suggesting that the country is entering the late stages of the business cycle.
A flattening or inverted yield curve, normally a reliable harbinger of a recession, is not necessarily a meaningful indicator in the current environment, write the report’s authors.
“While a tightening cycle may not foretell a recession, the difference in the yield levels between one- and 10-year Treasuries ahs been a harbinger of recessions when it is near zero or negative…” said the report. “That difference now lies at 0.58 percent. This level is far from near zero or negative, especially in a low inflation regime.”
The report’s authors recommend overweighting U.S. equities and maintaining allocations to other U.S. assets while underweighting EAFE and emerging markets equities.
In the U.S., where second quarter GDP growth reached 4.1 percent, the 10-year economic expansion has been buoyed by fiscal stimulus. The Tax Cuts and Jobs Act of 2017 and the Bipartisan Budget Act and the Consolidated Appropriations Act of 2018 and other forms of additional spending are augmenting employment, wage and business investment growth.
At the beginning of the year, GSIM anticipated a 7 percent return for the S&P 500 for 2018. According to the authors, the S&P 500 returned 5.9 percent through July 20. In 2019, GSIM anticipates a 5 percent total return, based on interest rates that remain low, valuations that remain steady and ongoing economic growth.