Politics, Populism and Policy: Confronting Another "Wall of Worry"
Markets are once again facing a proverbial wall of worry, built of political uncertainty, populism, and fiscal and monetary policy concerns. Although the market’s ascent is not likely to be straight up (it never is), we are cautiously optimistic that the wall can be surmounted. We believe the U.S. and global economies can maintain a pace of slow expansion over the near term, creating opportunities across asset classes for the active manager.
Over recent months, risk-on sentiment has prevailed (Figure 1), as globally accommodative monetary policy continued to offset near-term global growth challenges. However, we believe investors should be prepared for volatility ahead. We expect the political environment and populist currents will continue to complicate the markets, putting downward pressure on investor sentiment. In addition to U.S. elections, an upcoming constitutional referendum in Italy and national elections in France and Germany in 2017 could have a significant impact on the financial markets and global economic landscape.
FIGURE 1. GLOBAL ASSET CLASS PERFORMANCE, 3Q16 AND YTD
Small-caps and growth led within the U.S. equity markets during the quarter, while an easing of dollar appreciation and stabilizing commodity prices contributed to a rebound in emerging markets. After lagging the S&P 500 Index during 4Q 2015 and 1Q 2016, the BofA Merrill Lynch All U.S. Convertibles Index has outperformed for the past two quarters and now leads year to date, supported by narrowing spreads and small-cap gains. High yield extended its rally, boosted by a quest for yield and a preliminary agreement by OPEC to cap oil production.
Past performance is no guarantee of future results. Source: Bloomberg.
This material is distributed for informational purposes only. The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the information mentioned, and while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable.
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Global liquidity is at an all-time high as the major central banks work to support a weak growth and low inflationary environment (Figure 2). Although rates are likely to stay very accommodative, policy divergence may become more of an issue as the Fed signals a bias for increasing rates modestly. Meanwhile, fiscal policy (or a lack thereof) remains a formidable hurdle for many countries. While monetary policy acts as a short-term fix by supporting asset prices and financial markets, real economic growth requires fiscal policies that encourage private sector growth and entrepreneurship, such as a reasonable regulations and tax reform.
FIGURE 2. MONETARY SUPPORT CONTINUES TO EXPAND
TOTAL ASSETS ON CENTRAL BANK BALANCE SHEETS
Source: Goldman Sachs, Investment Research, Robert D. Boroujerdi, “Framework in Pictures,” September 2016 using Bloomberg and Goldman Sachs Global Investment Research. Balance Sheet Total Assets are as of 2Q16.
While we see many opportunities, security selection remains paramount given the highly consequential events on the horizon. Valuations are elevated in many segments of the market, with the ongoing yield play in dividend-oriented stocks likely to influence the market for the foreseeable future. We believe the risks in traditional fixed income remain formidable, as many investors in this crowded trade are underestimating the downside. In our view, growth-oriented companies remain more attractive than value companies in this environment. However, there are select opportunities among cyclicals, calling for a degree of balance in our positioning. With many historically low volatility stocks trading at high prices, convertible securities and select alternative strategies (such as market neutral income and hedged equity) may provide a more attractive means of addressing downside equity volatility. Finally, we are vigilant to the potential impact of currencies, both on individual companies as well as market performance.