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The following article comes from Goldman Sachs, probably “the best of the best” of all investment advisors. We pick only their best articles, not everything they write. The following article includes very good advice and insight into the future of investing.
Weathering Heights: How to Invest in 2018
Can equities continue to rise from their current heights? Investors ask us this question more than any other and our answer remains yes. Valuations are high relative to history but the macro environment is remarkably benign for financial markets and valuations should be judged in that context.
We think equity markets will be carried to new highs by a supportive macro environment in 2018. Headwinds are present though. The US economy is at risk of overheating, tighter financial conditions could slow the European recovery and Chinese growth stimulus seems likely to moderate following the 2017 Party Congress. Geopolitical risks related to North Korea or US trade relations could flare up at any time.
How can investors weather the heights in asset valuations and the potential risks in 2018? We think this environment calls for a dynamic approach to asset allocation, an equity strategy that looks beyond the major developed market benchmarks and a fixed income approach that seeks returns outside of developed market government and corporate bonds.
Six Questions for 2018
- Can the global economic expansion continue?
- Are equities overvalued?
- Is 2018 the year central bank policy tightening starts to matter?
- What gets disrupted next?
- What market trends are we seeing through the lens of Big Data?
- How to invest in 2018?
1. Can the global economic expansion continue?
Yes. We expect the global expansion to continue, carrying global equity markets to new highs in 2018.
- We think the economic and market cycle is well supported and has yet to fully mature.
- Investors will likely need to navigate more risks, including moderating growth, central bank tightening and geopolitical developments.
- We believe emerging market (EM) economies will outperform developed economies, supporting EM assets.
With the global economic expansion likely to continue, we prefer equities over credit and credit over rates. EM, outside of China, is a bright spot and we continue to prefer EM over developed market assets.
We prefer equity over credit, and credit over rates as we think the expansion has yet to fully mature. We prefer EM relative to DM.
2. Are equities overvalued?
No. We see US and other developed market government bonds as the overvalued asset. Outside of bonds, we think valuations are justified by current macro conditions.
- US equity valuations are elevated relative to history but continue to offer a reasonable risk premium over other assets.
- We think equity valuations in Europe, Japan and Emerging Markets are attractive relative to the US.
- Central bank tightening could be a catalyst for broad market volatility. Outside of bonds, we think the main impact will be in currencies though equities could also see a shorter-term drawdown.
We think global equity returns are likely to be positive in 2018 but much more moderate compared to 2017, with greater risk of meaningful drawdowns. We think this favors a dynamic approach to asset allocation and a preference for European, Japanese and Emerging Market equities.
Kane Brenan on why equities may continue to climb
3. Is 2018 the year central bank policy tightening starts to matter?
Probably. While investors may worry about changes to central bank asset purchase programs, we think rate hikes are the more likely source of volatility.
- We think markets are well prepared for a gradual and well-telegraphed unwinding of central bank balance sheets.
- Rate hikes are probably the bigger risk as we think market expectations for Federal Reserve rate hikes are unrealistically low.
- With tight labor markets, central banks are setting a lower bar for rate hikes despite only gradually rising inflation.
We are bearish on US and other developed market government bonds, and cautious on corporate and mortgage-backed bonds. We believe higher US rates are likely to temporarily favor the US dollar versus other developed currencies.
Mike Swell on navigating fixed income as central banks tighten
4. What gets disrupted next?
Consumer staples look vulnerable to disruption in 2018. Major online retailers are becoming bigger players in staples, pressuring traditional leaders in the sector.
- The internet has broken down traditional barriers to entry for consumer staples companies.
- Online retailers are developing their own staple brands and marketing them through voice-activated assistant devices with the advantage of proprietary data.
- Longer term, we see disruption coming to virtually every business sector we invest in, with autos a prime candidate to follow consumer staples.
We look to invest in the beneficiaries of disruption and limit our exposure to those that are being disrupted. Within consumer staples, we favor niche brands that are benefitting from lower barriers to entry, and we try to avoid second-tier brands that are vulnerable to the growth of on-line retailer brands.
Katie Koch on equity investing in an age of disruption
5. What market trends are we seeing through the lens of Big Data?
Big data can reveal subtle and often unnoticed connections between companies that may impact their performance.
- The digitalization of entertainment stretches across software companies as well as traditional brick-and-mortar firms.
- The resurgence of luxury goods and services has cut across economic sectors.
- More companies are pointing to changes in regulation as a possible business risk.
Our thinking shouldn’t be constrained by traditional definitions of businesses and sectors. As technological upheaval continues, the importance of thinking broadly about unexpected connections between companies will continue to grow. We believe that investors should think critically about what constitutes a company’s peer group and about market themes and secular changes that may connect otherwise disparate companies.
Nicholas Chan on the market signals hidden in big data
6. How to invest in 2018?
We believe investors should look beyond traditional asset classes and borders.
- Continued economic expansion favors global and emerging market equities
- Elevated valuations favor active and alternative approaches to traditional markets
- Central bank tightening favors diversified sources of yield
01 Invest for continued global growth
The economic and market cycle has yet to fully mature. Invest for continued global economic expansion through developed and emerging markets.
02 Manage the risks of elevated valuations
US equity valuations are high relative to history, but continue to offer an attractive premium over other assets. Consider implementing buy-write and alternative strategies for elevated valuations.
03 Diversify income sources as central banks tighten
We are bearish on US and other developed market government bonds, and cautious on corporate and mortgage-backed bonds. Consider investing in emerging markets debt and municipal bonds.
04 Navigate the forces of disruption
Disruption is an ongoing driver of risk and return globally. In our view, the disruptive impact of technology is likely to be even bigger in emerging markets, creating compelling opportunities.
05 Uncover insights from Big Data
Quantitative strategies employing deep analysis of big data can potentially uncover return opportunities through market themes and secular changes that connect otherwise disparate companies.
Source: Goldman Sachs
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