A year of divergence
At Goldman Sachs Asset Management (GSAM), a key theme for 2015 is that divergence creates opportunity. Our forecast is that the U.S. should start growing north of 3% year over year, while we expect the euro area and Japan to grow around 1%. We project China’s growth to hover around 7%, down from its double-digit-level growth over the past decade. We also expect central bank policies to continue to diverge. In the U.S., the Federal Reserve exited its stimulus program, commonly known as quantitative easing (QE), but the European Central Bank has just announced its own program, and the Bank of Japan is continuing its QE program. We anticipate further divergence in currencies as well, with the U.S. dollar expected to continue gaining against virtually every major currency across the globe.
What divergence means for equities
A lot of the stock market’s gains in recent years have come from rising valuations. Now we expect earnings to be a central driver of performance. After double-digit-level returns over the past few years, we believe annual equity returns will be mid-single digit for the next five years. Although we envision more muted performance than in the recent past, equities are still quite attractive, in our view, particularly compared with fixed income. Given the improving U.S. economy and our focus on earnings, cyclical parts of the market—sectors that perform well when economic activity increases—look attractive. Technology, energy, and telecom potentially provide opportunities.
Divergence strengthens the case for active management. The individual P/E ratios of the stocks in the S&P 500® Index are trading at their narrowest distribution in more than 30 years—that is, the gap between the least expensive and the most expensive stocks is among the tightest in recent memory. We see opportunities emerging if these valuation discrepancies return to more historically normal levels.
Fixed income and diversification
After a 30-year bull market in bonds, at GSAM, we think investors should temper their return expectations. We believe the bond market might return about 2% a year going forward, without adjusting for inflation. While global conditions may suppress the ability of U.S. rates to normalize in the near term, we believe fundamentals from broadening global expansion may support higher rates over time. We expect the 10-Year Treasury yield to move up to about 3% by the end of the year, which may depress returns along the curve. Additionally, investors focused on the short end may be surprised if and when the Federal Reserve raises rates.
Given the current environment, we think that investors should diversify their sources of yield and look for potential opportunities in areas like high yield, bank loans, and emerging market debt. An active approach could be another potential solution, where investors may consider using diversified fixed income portfolios to take advantage of these opportunities.
What lower oil prices mean for investors
Given the structural shifts in the energy market, prices may need to trade below—or perhaps even well below—equilibrium to address global oversupply. This may leave high-cost, or highly levered, producers vulnerable in the near term. As supply and demand come back into balance, we see West Texas Intermediate approaching $65 by the end of the year.
We like master-limited partnerships (MLPs), which have sold off as the price of oil has fallen. These companies focus on the midstream portion of the energy process, including pipelines and infrastructure, and they typically have long-term contracts. These areas are driven more by volume over the long term and are less directly affected by the drop in oil prices. In addition, we believe MLP valuations have become more attractive given their yield and distribution growth potential.