Some market prognosticators have sounded warning signs about possible recession risks, but Goldman Sachs Asset Management is telling investors it’s too soon to take risk off the table.
“After six months of strong equity returns — and facing popular concerns about the cycle being stretched and valuations high — it appears tempting to de-risk portfolios in preparation for the eventual downturn,” the report’s authors write in the firm’s third-quarter investment outlook, released on Monday. The authors add that in their view it is “much too early” to reduce risk in portfolios aimed at generating returns, as “the data is consistent with an expansion that could continue for another two years rather than one facing a more immediate turnaround.”
Still, the firm says, high asset prices and expectations for growth could lead to volatility. The firm tells clients that at the very least, the current economic expansion and low unemployment can continue through the end of the year, but that “risks around growth data are moderately to the downside.”
GSAM is recommending equities over credit and credit over rates. “In equities, we are particularly positive on emerging markets and Europe,” the report states. GSAM cautions, however, that unlike the first half of the year, investors’ expectations have increased, and there may be few surprises on the upside from now until the end of the year.
GSAM thinks Europe and Japan will do well, with the asset manager saying these regions will benefit now that the economic expansion in the U.S. is widening out to a broader set of countries than at any time since 2010. A recovery in the global manufacturing sector and in emerging market economies will also help, the firm says.
The asset manager is bearish on government bonds, saying the market is underpricing how quickly the Federal Reserve may raise rates. GSAM also is cautious on credit, even though it says it’s too early to adjust portfolios in anticipation of significant spread widening. It expects the U.S. dollar to outperform other major currencies and emerging markets currencies to benefit from growth and low inflation.
As for the prospect of higher inflation, the asset manager notes that historically, falling unemployment has translated to higher wages and inflation, but this hasn’t materialized. The asset manager says this is partly because the global labor market is not as tight as unemployment rates in the best-performing economies would suggest, because while the U.S., Germany, and Japan account for much of the global growth, labor markets are much broader and more dispersed. While growth is improving in many economies, significant dispersion in global unemployment rates remains.
The firm adds that “persistent low inflation is self-reinforcing,” as workers are more concerned about job security than rapid wage growth, which is preventing them from pressing for higher wages despite low levels of unemployment. GSAM expects inflation in the U.S. to rise only gradually and to remain “very low” in Europe and Japan.
Political uncertainty has also declined strongly, according to GSAM. Despite the Russia investigation engulfing the Trump administration, the firm is optimistic that growth-oriented policy changes by Trump have become more realistic. GSAM’s researchers write, “If anything, we see some upside risks relative to low expectations for growth policies in the U.S.”
GSAM hasn’t yet seen a big impact from the wind-down of central bank asset purchases —quantitative easing — but it says the lack of a historic model for the policy is a clear source of uncertainty for the markets.
