Following a whirlwind start to 2016, something that saw risk assets cascade lower before staging an equally remarkable recovery, investors worldwide are now pondering what could possibly arrive next.
Will the central bank-induced recovery persist, or is the carnage seen earlier in the year likely to return? Or will markets continue to amble along around current levels, underpinned by what appears to be constant, and in many cases ever aggressive, levels of monetary policy support?
After the recovery in risk assets over the past three months, analysts at the Goldman Sachs portfolio strategy research team are now positioning their investments for what it calls a volatile, but trend-less market, remaining overweight in cash and credit, while lowering their exposure to stocks from overweight to neutral.
“Markets have been calmer and cross-asset correlations with oil have fallen since March 21”, the bank wrote in its latest Global Opportunity Asset Locator.
“Declines in bond yields, owing to a continued dovish Fed, a weaker dollar and stronger commodity prices, have been the key cross-asset moves. This has lifted bond and credit returns, but equities have not benefited much. Global earnings growth revisions have been negative and equity valuations remain high, with the equity risk premium a less useful predictor of returns owing to uncertainty over trend growth and normalisation of bond yields.”
Of the changes Goldman has made to its asset allocation mix, the most noticeable involves its view on stocks, downgrading its 3 and 12-month view to neutral on growth and valuation concerns.
“Until we see sustained earnings growth, equities do not look attractive, especially on a risk-adjusted basis. We expect particularly poor returns in dollar terms, with our forecast of a stronger dollar and the prospect of less negative equity/FX correlations,” it says.
“While we see some upside to equities in local currency (particularly Japan), we expect the dollar to strengthen, resulting in poor USD returns over the next 12 months”, adding “we prefer to implement the divergence theme via FX rather than equities.”
Fitting with the caution on the outlook for stocks, Goldman retains an overweight rating in cash.
“Given we do not see much value across asset classes and we see a variety of cross-asset risks, we remain overweight cash near term,” it says.
“We believe the market’s dovish pricing of the Fed increases rate shock risk, in which case both equity and bonds could sell off.”
It is also wary on whether the rally in emerging markets can last, indicating that a reversal could weigh on commodity prices, particularly those for metals.
“China growth concerns could also come back into focus, as we think the support from policy will fade during 2H2016,” it says.
On commodities in particular, the bank has upgraded its allocation to neutral over a 3 and 12-month horizon, largely due to expected strength in crude oil prices that the bank communicated earlier this week.
Outside of crude, the bank remains bearish on the outlook for metals prices.
Keeping with previous asset allocations, Goldman retain an overweight allocation to credit but underweight for bonds.
“We stay overweight credit over both 3 and 12-month horizons,” says Goldman.
“We prefer US high yield within the asset class over 3 months (in line with 12 months), while we would avoid US investment grade owing to limited total return potential.”
As for bonds, Goldman retain an underweight allocation despite the bank lowering its yield forecasts for major economies by an average of 30 to 40 basis points earlier this month.
It’s a lot to take in. To help you piece it all together, or perhaps to keep a scorecard, here’s the bank’s 3, 6 and 12-month forecasts.
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