With volatility oddly low, Goldman Sachs strikes a pose that is not too dissimilar to that of Bridgewater’s Ray Dalio, who said the dance with central banks and their negative interest rates and free market antics won’t end until cracks become apparent. In a July 5 portfolio strategy report, Goldman’s European-based analysts Ian Wright, Christian Mueller-Glissmann and Alessio Rizzi say ignore the crowds. In today’s low volatility market environment Europe in the summer is a great place… to invest.
(Click on image to enlarge)
The music for the low-volatility market environment might not stop for another year
The music for this low volatility dance has not yet stopped and could, in the estimation of Goldman Sachs, warrant a one-year time horizon on an investment that benefits from such a market environment.
Typically, in a low-volatility market environment, both stocks and credit have been the assets to hold. This isn’t just on an absolute returns basis, but also when considering risk, which is most often measured by volatility of standard deviation to some degree.
But something is a little different during this volatility regime, Goldman’s analysts observe. Credit spreads have significantly tightened relative to the past. Separately, some algorithmic analysts point to low-volatility market environment post-2010 as being driven in large part by aggressive central bank bond buying that has brought interest to negative in some regions. For investments, the reach for high yield has most pointedly occurred during periods of low volatility.
High-yield US credit has typically been a favorite investment during low volatility, the report noted, pointing to statistical evidence dating back to 1990. During the current low-volatility market environment, high yield investments performed almost 1% higher than during the report's near 27-year sample size look back. In fact, high yield has been on a relative performance sprint in 2017 year to date, outperforming the past average, but this strong early start is likely to mean revert, Goldman predicts.
“We forecast a lower return in (the second half of 2017) compared with (the first half) given the rally has been so strong and that real rates rising further should weigh on the asset class,” the report said, pointing to a Neutral high yield investment rating for what has been the go-to investment during low volatility periods. “We think it will likely take the time to firmly move to a higher volatility regime, which raises the question of what to own should low vol continue.”
There is one investment to consider as a dance partner when looking for a long-term relationship, assuming that one year defines long-term.
(Click on image to enlarge)
European equities are the investment to dance with for at least one year, Goldman says
There has been a crowd moving in one direction, Goldman Sachs notes, and the crowd is moving decidedly towards European equities. While the MSCI Europe has slightly underperformed the S&P 500 industrial average during all market periods since 1990, during low volatility environments and even in the current market environment, Goldman says the trend will mean revert.
“Long non-US equities is a crowded trade, but makes the most sense,” the report opines.
The low-volatility market environment that Goldman says will extend over the near term will not treat certain investments kindly, as developed nations and their long-term debt along with long gold and oil suffering in the past, a point made strongly as oil analysts eye the $30 range.
The S&P 500 and US high yield credit have experienced 9 and 19 times better risk-adjusted returns respectively during low volatility when compared with that of US 10-year US Treasuries, the report noted, “while commodities have lagged materially.”
In connecting dots that an algorithm might miss, the report authors observe that traditional correlation analysis might be off this time due to the anomaly of technology changing society. “Prior to 1990 non-US bonds did quite well, but this is likely because global markets were less connected than today and that we use the S&P 500 to determine our volatility periods,” the report authors observed, noting a variation of the the theme "this time it might be different."
Forget bonds. Its European equities who investors should be dancing with until the low volatility period ends. Interesting but left unsaid, if Goldman’s rough trade timing is correct, the low volatility period might just end as US Congressional mid-term elections approach.
(Click on image to enlarge)
Comments
Log in or sign up to join the conversation.