The article below is from our BRIEFINGS newsletter of 23 July 2021
With economic growth expected to moderate amid signs of tighter monetary policy, how should investors adjust their asset allocation strategies? We sat down with Goldman Sachs Research’s Christian Mueller-Glissmann, who leads asset allocation research efforts within portfolio strategy, to discuss his outlook for economic growth in the second half of 2021, the impact across asset classes and the implications for investors.
Christian, how do you expect riskier assets to move in this changing environment?
Christian Mueller-Glissmann: While the macroeconomic backdrop has become less supportive, we remain broadly pro-risk in our asset allocation. We are overweight equities over both a three- and a 12-month horizon, but we’ve turned more selective, focusing either on underperforming pockets of the market or on areas that benefit from structural trends. For instance, we’d highlight defensive growth stocks such as healthcare and see potential for select value areas like commodities sectors to outperform growth again in the second half of the year. Beyond that, however, stock picking will likely become more important across the board. We continue to prefer non-U.S. to U.S. equities as they will likely benefit from delayed post-pandemic recoveries and U.S. earnings could face headwinds from increased taxes next year.
You and your team also developed a Risk Appetite Indicator, which aims to track the level of global market risk appetite and risk aversion based on various market variables. What is it telling you about how investors perceive this next phase of the cycle?
Christian Mueller-Glissmann: Our Risk Appetite Indicator revealed that risk appetite has been falling since the first quarter of this year, and it has recently dropped further as investor optimism about growth has waned. Historically, such a moderation in risk appetite has coincided with positive, though lower, returns from risky assets. After the strong equity rally of the past year, the next phase of this cycle will likely bring more range-bound returns that are less supported by rising valuations. As a result, we think carry—the income or regular return obtained from holding an asset—is likely to become a more important driver of portfolio performance relative to capital gains.
Tell us more about your outlook for other asset classes.
Christian Mueller-Glissmann: We are still bullish on commodities over a three- and 12-month horizon despite the pullback in the second quarter, as physical demand has mostly remained above supply across the board. We remain neutral on credit over both horizons—with very tight credit spreads and all-time lows for yields in most markets, we see better opportunities to generate income elsewhere. We are also underweight bonds over both horizons. After the bond rally, we think we could see higher yields into year-end. In the case of a larger “risk-off” move in markets, bonds are unlikely to protect portfolios much. Meanwhile, uncertainty surrounding central bank policy remains high. Amid the continued reopening of economies, inflation has surprised to the upside. And supply chain disruptions, a booming housing market and labor shortages could keep inflation at an elevated level.
What else should investors look out for in the months ahead?
Christian Mueller-Glissmann: In hindsight, investors may have been too optimistic about inflation across asset classes, but we think it’s too early to dismiss the potential for higher inflation in the coming cycle. With that in mind, we still see value in selective strategies to protect portfolios from inflation risks in the medium term. While overall volatility has declined due to the strong macroeconomic backdrop into the second half, the near-term risk of growth and rate shocks to the market—which could come from renewed COVID-related disruptions or hawkish central bank surprises—remains. This goes back to our stance that it’s crucial to be selective about adding risk to portfolios.