From Our Briefings Newsletter

Published on10 SEP 2018

The article below is from our BRIEFINGS newsletter of 10 September 2018:

Briefly . . . on the Return of Low Returns

Equity markets are about to enter a "flat and skinny" period of relatively low returns in a narrow trading range, according to analysis from Goldman Sachs Research. We sat down with Peter Oppenheimer and Sharon Bell from the global equity strategy team to discuss their findings, including where to find returns when growth is scarce.

Peter, what's so unusual about this bull market in equities?

Peter Oppenheimer: Well, it's difficult to compare the current cycle with previous ones given the impact of the financial crisis and the subsequent aggressive policy easing – first with zero interest rate policies and quantitative easing, and, more recently, with the US fiscal boost. This "double shot" of stimulus has had a dramatic effect. While it has been the weakest economic recovery in 60 years, the market recovery – particularly in the US – has been unusually strong. The success of this cycle has been its length. The S&P 500 recorded its longest rally ever, with a near decade-long boom.

Sharon, where do we go from here? What's your market outlook?

Sharon Bell: It's nuanced. Rising valuations and a tight labour market – at least in the US – have contributed to a sharp rise in our Bull-Bear indicator. But we think that lower returns are more likely than an impending sharp bear market. Bear markets are not common without recessions or a sharp reversal of financial imbalances. Given low inflation and low unemployment, our economists think that a recession is unlikely in the near term. This may have been the weakest US economic cycle in 60 years but it is likely to be the longest. Also, financial imbalances have moderated over the past decade. Much of the debt has been transferred to the public sector or central banks' balance sheets. A flatter market environment over the next three to five years is likely, breaking the uptrend that we've seen since 2009.

Peter, in your research you discount the possibility of volatile and sideways moving markets -- why is that?

PO: Yes, we see a "flat and skinny" market as a more likely scenario than "fat and flat." Why? Because to get the large swings, we would likely need to see bigger rises in term premia – that is, the outlook for inflation would need to become less certain – or slower growth than we currently forecast. A more likely alternative would be a flat and skinny market, which we see as a period of low returns in a narrow trading range. Since 1970, Europe has had a flat and skinny market for 30% of the time, compared with 20% for the US market since 1945. They've tended to be relatively short – roughly two years. These flat and skinny markets are also more likely in an environment where macro volatility is low.

Are there any pockets of optimism for investors?

SB: In a lower growth environment, we think genuine growth stocks will still perform well. The problem is that growth as a factor, particularly outside of technology, looks expensive. We like companies that are re-investing for future growth. We also still like Technology, which, given its growth prospects, remains reasonably valued. Parts of value also look attractive, particularly in sectors where there is a transition from value trap to value opportunity, where dividends are growing. We would highlight US banks and European oil majors as examples. Companies that are restructuring in the value space, or creating value by simplifying their business models, also look attractive. We would expect less of a clear binary shift between macro factors in the market such as growth-and-value or defensives-and-cyclicals. Idiosyncratic stock drivers are likely to become more important.