With investors eyes fixed on central banks’ monetary policy, Goldman Sachs Asset Management (GSAM) has taken an overweight position on European rates while it remains bearish on US rates.
The firm said in its mid-year outlook report that US rates will struggle to move higher in the short term after a steady climb that pushed ten-year Treasury yields above 3% in April for the first time since 2014.
GSAM expects upward pressure on US rates to continue in the longer term.
In the Eurozone, the recovery is moderating but ongoing. Despite expansionary activity, upward inflationary pressure is scarce, so GSAM’s inflation and monetary policy outlook is more dovish than consensus and than that of the European Central Bank.
Downside risks circle the Eurozone, the firm said. While the region has enjoyed strong growth over the last 18 months, there have been clear signs of moderation. Support is fading due to the strengthening euro, rising interest rates and a likely moderation in global industrial activity.
As for markets, the firm said equities could absorb a ten-year US treasury yield of approximately 3.5% before a sustained sell-off, but GSAM cautioned that rising rates alone are a poor indicator of subsequent equity returns.
The US dollar’s detachment from interest rate differentials earlier in the year underlines the need to look beyond traditional market relationships and drivers. The asset manager said it sees value in strategies focused on capturing spreads in short-term credit, which are pushed higher by supply pressures.
Rate normalisation and the rising cost of capital reinforce a “Darwinist framework where strong companies thrive and the weak perish”, GSAM said.
In the current environment GSAM finds US small caps attractive. Small caps have performed well in rising interest-rate regimes as they are more levered to growth prospects and less sensitive to rates due to paying, on average, small dividends.
Also currently attractive in GSAM’s eyes are emerging market equities. Accelerating economic growth in emerging markets is expected to outpace developed markets in the next few years. Supportive macro fundamentals have revived emerging markets’ earnings growth - exceeding developed markets - while valuations are at a 20-25% discount.
GSAM also sees scope for gains in emerging market bonds as the global economic expansion continues.
A dynamic approach to investing is necessary, the firm said, with a spike in equity volatility after a calm 2017. GSAM expects more frequent drawdowns but said it thinks volatility will be episodic and related to temporary drawdowns.
©2018 funds europe