Higher for even longer rates, geopolitics & changing markets shaping global investment themes moving into H2/24 | Goldman Sachs AM

by | Jul 10, 2024

A complex environment of opportunities and risks is evolving for investors to navigate, according to the Goldman Sachs Asset Management Mid-Year Outlook 2024. They outline three major global investing themes which they believe provide the focus for the remainder of 2024 as follows:

  • Macroeconomy: A Longer Path to Normalization
  • Geopolitics and Elections: Roadmaps for Resilience
  • Tailwinds and Headwinds: Investing in Megatrends

Putting some flesh on the bones of this strategy, commentators from Goldman Sachs AM said:

“Expectations of US rate cuts were repeatedly pushed back in 2024’s first half due to inflation pressures, while other central banks signaled the intent to or began to cut rates. This has created a complex and challenging environment for managing fixed income portfolios,” said Ashish Shah, Chief Investment Officer of Public Investing at Goldman Sachs Asset Management.

“Geopolitical fragmentation and potential conflict escalation in the Middle East and Ukraine remain risks, and the US elections add uncertainty, underscoring the need for balanced portfolios and hedging strategies. Opportunities in disruptive technology, led by artificial intelligence (AI) and sustainability, remain major targets for investors globally,” Mr. Shah continued.

Macroeconomy: Where to Invest with a Longer Road to Rate Normalization

The US economy should continue to a soft landing and continued disinflation, but central banks and investors are contending with last mile complexities. Resilience in the economy, corporate earnings, and labor markets coincided with upside surprises in inflation. This raised the bar for US Federal Reserve (Fed) policy easing, boosting prospects of prolonged elevated interest rates.

In contrast, the European Central Bank (ECB) lowered rates in June, motivated by inflation progress since its last hike in September 2023. Rate reductions are expected to be gradual, and we remain watchful of wage trends and services inflation, as well as any tightening in financial conditions caused by political uncertainty. In the UK, the Bank of England (BoE) appears on course to potentially ease policy this summer, absent significant upside data surprises.

In Japan, expect further, albeit limited, rate hikes, with longer-run inflation expectations rising to more sustainable levels. Emerging market (EM) cutting cycles have been underway for almost a year, with disinflation allowing an earlier start to policy easing. More recently, EM cutting cycles have become vulnerable to shifting US rate expectations, as well as EM election-related sentiment. This has created an environment that is more driven by country-specific factors as opposed to a synchronized easing cycle. China’s policymakers maintain an easing bias.

Public Markets

“With credit spreads near their tightest levels in decades, investors are not demanding too much compensation for credit risk. Corporate balance sheets are generally healthy. US companies are better able than in 2019 to service their debt, have more cash on hand, and are generating more profits. Yields on IG bonds in the US, Europe and UK are also close to their highest levels in a decade – but active bond selection is essential,” said Lindsay Rosner, Global Head of Multi-Asset Fixed Income.

“We anticipate the forward US Treasury yield curve to steepen, mindful that the Fed’s next action is a cut rather than a hike. Investors should adopt a dynamic strategy to manage duration and allocate to high-quality fixed income as part of well-diversified portfolios. We favor issuers in sectors that can demonstrate resilience through the economic cycle, including IG bonds of large banks and high-yield credit in industrials and energy. AAA-rated collateralized loan obligations (CLOs) are appealing for their attractive carry, supported by strong fundamentals and favorable technical conditions,” Ms. Rosner continued.

“In public equity markets, the strongest business models have demonstrated margin resilience, with recent US earnings seasons better than expected. Performance has widened beyond the ‘Magnificent 7.’ The second half of 2024 may present opportunities for investors to broaden their horizons beyond the largest names, with US small caps poised to rebound, offering attractive absolute and relative valuations. Small cap companies can provide access to the higher growth potential of future mid- and large- cap leaders. Certainty around rate cuts should provide added tailwinds,” said Mr. Shah.

“Europe’s improving growth and inflation mix, combined with better corporate earnings dynamics and modest valuations, bodes well for European equities. There continue to be vibrant opportunities in Japan, where structural changes are driving strong market performance after decades of deflation,” Mr. Shah continued.

Private Markets

“General partners (GPs) in private markets must return capital to investors. Operational value creation levers, aligning with secular growth trends and prudence in deploying capital, are poised to become the main determinants of private equity success. As base rates start to come down, multiple exit strategies will emerge. When acquiring new assets GPs must consider who an asset may be attractive to in the future, ideally a strategic buyer, and what the next buyer might pay,” said Michael Bruun, Global Co-Head of Private Equity.

“Private credit should continue to see long-term secular growth, yet asset allocators are under-allocated to private credit relative to targets. Sentiment continues to be positive towards the space as investors look for diversification, and innovation is driving expansion of the private credit universe. We expect risk-adjusted returns to remain attractive for lenders who are disciplined in their underwriting. Lenders with scale and deep sourcing who can lend through the capital stack should be best positioned. Investors should look for companies with market leading positions in stable, defensive sectors that generate cashflow, regardless of the market cycle,” said James Reynolds, Global Head of Direct Lending.

“Limited partners (LPs) are seeking liquidity from existing holdings before making new investments. Many are making liquidity a condition for new investments, leading GPs to look at continuation vehicles or structured solutions to return capital to investors and buy more time to increase valuations. We continue to see strong interest in secondaries as investors seek liquidity and GPs extend hold times,” said Michael Brandmeyer, Global Head of the External Investing Group (XIG).

Geopolitics and Elections: Roadmaps for Resilience

When geopolitics is unstable, investors have historically gravitated to the most fundamental assets: commodities, which have historically exhibited hedging properties against geopolitical and financial shocks. Beyond commodity exposure, we believe elevated geopolitical risk and potential for conflict escalation underscore the importance of being proactive and preparing entire portfolios for unexpected events. Politics remain in focus moving further into a mega-election year globally, and investors should avoid trying to time markets or take calls based on binary policy outcomes.

“Hedge funds that have taken advantage of dispersion across asset classes, sectors, and regions are performing well. As private market activity recovers, identifying macro dislocations, relative value discrepancies between securities, and event-driven opportunities may help to capture upside and limit downside risk,” said Mr. Brandmeyer.

“Attractive opportunities in emerging markets can provide diversification to developed market equity allocations and enable alpha. Reforms enacted by many EM countries as part of an IMF program are not only helping to provide liquidity support through broader multilateral and bilateral funding, but also helping to provide a policy anchor for the medium term. Improved market access has acted as a tonic for many lower rated and frontier market sovereigns, allowing them to refinance their near-term maturities for longer dated financing. Some strong BB countries, although they appear fairly valued, can continue to be resilient carry stories given their positive trajectories to investment grade. The EM corporate bond market is diverse and underappreciated, with attractive yields and exposure to secular megatrends. EM corporates tend to exhibit lower sensitivity to political events compared to EM sovereign bonds, but a selective approach is essential,” said Anupam Damani, Co-Head of Emerging Market Debt Investing.

 “Investing across three security themes could offer a broad universe for stock ideas. Given advancements in AI, attempts by major economies to strengthen technology supply chains are likely to receive broad support. Developed markets are accelerating their transition to clean energy to increase energy independence and reduce reliance on fossil fuels. Geopolitics can be expected to drive increased defense spending in the years ahead, creating solid investment opportunities,” said Steve Barry, Global Head of Fundamental Equity.

Tailwinds and Headwinds: Investing in Megatrends

Five key structural forces – decarbonization, digitization, deglobalization, destabilization in geopolitics, and demographic aging – will drive investment megatrends, but many of these trends are in early stages. Active strategies and diversification can help deliver alpha opportunities, and investors who stay in silos and focus on one theme may miss opportunities and underestimate risks.

The decarbonization drive is unlocking opportunities in equities, fixed income, and alternatives. Clean-energy technologies continue to improve, driven by growing affordability and greater solar power and battery storage efficiency. Carbon emissions can be reduced by helping high emitters restructure their business models and reposition for a greener economy.

Digitization and technology advancements, notably generative AI, should drive long-term allocations due to the pace of disruption and potential wealth creation opportunities. Companies should focus on using generative AI for true strategic differentiation, not just efficiency gains.

Deglobalization and destabilization are forcing investors to combine macroeconomic and geopolitical expertise with thoughtful strategies to understand the profound interdependencies of these megatrends and their investment implications.

Demographic aging is influencing economic and social outcomes, shaping public policy and related spending, inflation, and private sector investment decisions over the long run.

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