Goldman Sachs Asset Management: A Better Balance of Risks

A Better Balance of Risks

We think the outlook for risk asset returns has improved. Interest rates have risen, equities have sold off and the bar for growth is lower after the recent moderation. We are strategically pro-risk, but continue to emphasize a dynamic approach to investment as volatility re-emerges.

We think three developments since the start of 2018 suggest a better balance of risks:

• The pace of global growth has moderated somewhat from 2017 and we think the risks to growth are now more balanced.
• Interest rates have adjusted higher and are more consistent with the outlook for inflation and Federal Reserve (Fed) policy. 
• Market volatility has re-emerged and we expect further drawdowns, but we do not anticipate a shift to a persistently high-volatility regime. 

Economic data has softened this year, lowering the bar for positive news on growth going forward.

1. US fiscal stimulus is the main development on the economic front, and should boost near-term growth while raising longer-term risks of overheating.
2. Risks for growth in the Euro area and China have become tilted somewhat to the downside as policy support declines.
3. Equities remain our preferred asset class, as the global expansion is likely to continue and the risks to growth are more balanced.

A reset of interest rate risk

US interest rates have adjusted higher and we are less concerned about the near-term potential for rate-driven volatility in other asset classes.

1. Rising US interest rates have not translated into substantially tighter financial conditions, and we see few near-term catalysts for another sharp increase in rates.
2. We think the bond market continues to underestimate the likely path of Fed rate hikes, but interest rates are now more consistent with Fed guidance.
3. The Inflation data clearly suggests last year’s weakness was temporary and we expect low unemployment to drive wages higher, but only gradually.

Higher volatility, but not a high-volatility regime

We think we are too early in the cycle for a shift to a regime of persistently high volatility, despite the increase from extraordinarily low levels in 2017.

1. The S&P 500 experienced a record stretch without at least a 5% drawdown until the equity sell-off in late January.
2. We expect episodic bouts of volatility related to temporary drawdowns, rather than a persistently high-volatility regime, which normally occurs much later in the cycle.
3. We think volatility could trend higher later this year as it becomes increasingly evident that the US needs tighter financial conditions to avoid overheating.

For more on GSAM’s mid-year outlook, visit GSAM.com.