About the author: Ashish Shah is chief investment officer and co-head of public investing at Goldman Sachs Asset Management.
As 2024 began, interest rates had remained high for an extended period of time, geopolitical risks were rising, and secular megatrends were rapidly transforming industries around the world. Now halfway through the year, these trends are creating a complex environment of opportunity and risk.
The U.S. Federal Reserve is likely to start cutting interest rates in September. Other developed central banks have already begun to pivot to a rate-cutting cycle. Corporate balance sheets are strong, and while the cost of capital is high, there is plenty of room for refinancing in the market. The global economy appears to be on track for a soft landing, something that would have been unthinkable to many market participants just a few years ago.
This creates a particularly good environment for bonds. Bonds have less upside potential than stocks, but they also have less volatility, which is what many investors want amid geopolitical uncertainty. Yields are at their highest in more than a decade. Bonds can provide a safe haven balance and add insurance to a portfolio. Investors should diversify their asset mix.
To be successful in fixed income investing in the coming months and quarters, you need to move outside the curve: Invest from Treasury or money market accounts into investment grade or below investment grade funds to boost your yield. For this reason, we favor high-quality structured products with built-in protections.
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Low default rates mean parts of the high yield market remain very attractive, particularly BB and B rated issuers. While spreads and yield levels are excellent, the lowest quality high yield group, CCCs, offer too low a risk premium for distressed companies. At the BB and B levels, investors can take advantage of all-in yields of 7-8%.
Meanwhile, stock markets have been strong, with global indexes posting an impressive 12% total return so far this year after a four-and-a-half-year rally. Since the COVID-19 pandemic began in February 2020, stock markets have returned 11.5% annualized, including dividends. This shows the value of staying invested as a long-term investor, rather than trying to time the market.
What’s different is the unique concentration of the stock market. Of the 11 sectors, only two performed well in 2024: IT and communications services. Only 27% of stocks outperformed the index, which is up 12% year-to-date, while the average stock price is up 3%, a surprising deviation.
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Even more unique, the mega-caps have been driving the market. While typically led by smaller companies that tend to grow faster, the top 10 stocks account for 60% of the index’s return through 2024. Of those, five stocks accounted for half of that return, and all of them have been driven by one theme: innovation, specifically innovation around artificial intelligence.
Good investors know that diversification usually pays, but this concentration of returns has made most forms of normal diversification – global vs. US, small cap vs. large cap, stocks and bonds vs. stocks only – a disadvantage over the past few years, but history suggests that this will reverse over time.
Going forward, we expect revenue growth to slow. The stock market is essentially flat and not very strong. In fact, the full year market return may have been achieved in the first half of the year. However, as AI matures and moves into the adoption phase, it should see market breadth increase and ultimately benefit a broader range of businesses.
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What has worked in the past 6 to 18 months may not work in the next 18 months. In this slowing environment, investors need to diversify and focus on companies that can weather economic cycles, grow earnings sustainably and provide resilient growth. We look for quality companies with well-constructed balance sheets and high profit margins that can absorb shocks.
To find these stocks, look for megatrends and long-term structural cycles. First, digitalization in the broad sense. AI (maybe a bit overblown) can be an accelerator. Second, reshoring. Every country wants more jobs to make their economy more secure. Third, climate change and resilience. The world just experienced its warmest June ever, raising concerns about water and food availability.
Finally, innovations in genomics and robotics promise to transform healthcare by making it easier to tackle diseases proactively and in a scalable manner. Anti-obesity drugs are in the early stages of adoption worldwide and are expected to grow from approximately $6 billion in 2023 to $100 billion by 2030.
Geographically, we tend to prioritize the US over Europe as the US has more innovation, more resources, less debt and more companies with higher profit margins and revenues. We also find attractive companies in Japan. Corporate governance reforms through the elimination of cross-shareholdings have made a larger portion of the Japanese market investable. We also prioritize India as it is home to some of the most advanced technology companies in the world that are benefiting from digitization and AI.
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