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Outlook
Investment Management Division
Half Full
“ Everything we hear is an opinion, not a fact. Everything we see is a perspective…”
Attributed to Marcus Aurelius
Investment Strategy Group | January 2017
Sharmin Mossavar-Rahmani
Chief Investment Officer
Investment Strategy Group
Goldman Sachs
Brett Nelson
Head of Tactical Asset Allocation
Investment Strategy Group
Goldman Sachs
Additional Contributors
from the Investment
Strategy Group:
Matthew Weir
Managing Director
Maziar Minovi
Managing Director
Angel Ubide
Managing Director
Farshid Asl
Managing Director
Matheus Dibo
Vice President
Mary Catherine Rich
Vice President
This material represents the views of the Investment Strategy Group in the
Investment Management Division of Goldman Sachs. It is not a product of
Goldman Sachs Global Investment Research. The views and opinions expressed
herein may differ from those expressed by other groups of Goldman Sachs.
2017 OUTLOOK
Dear Clients,
Readers of our previous Outlook publications may recall that this page typically
summarizes the key themes of our economic and financial market prospects for the
coming year. However, for 2017 we decided that a brief overview would not suffice,
given the current environment of high market valuations, great policy uncertainty,
significant geopolitical tensions and, in all likelihood, an unconventional US
presidency.
Since the trough of the global financial crisis, we have consistently emphasized US
preeminence and maintained a strategic overweight to US equities relative to global
market capitalization-weighted benchmarks. Tactically, we have had an overweight
allocation to US equities and US high yield bonds from as early as mid-2008. Even
when US equities became more expensive, we continued to recommend that clients
stay fully invested at their strategic allocations. Indeed, we have reiterated that
recommendation in our past Outlook publications, client calls and Sunday Night
Insight reports as many as 59 times since January 2010.
But now we have crossed into the 10th decile of valuations: US equities have been
more expensive than current levels only 10% of the time in the post-WWII period.
Yet we continue to recommend staying the course. We are duly aware that this
recommendation is long in the tooth, particularly given such high valuations and the
unusually high level of policy uncertainty.
Policy uncertainty, both economic and political, abounds globally: uncertainty with
respect to Brexit (the how and when), upcoming elections in Germany and France
(the who), transitional government in Italy (the how long followed by what) and new
appointments to the Standing Committee in China and their significance (the who and
what of any reform agenda), to name a few.
We are also facing rising geopolitical tensions that could trigger significant market
volatility. Tensions in the Middle East will not abate. Greater Russian involvement
in that region is stabilizing in some respects and destabilizing in others. Further
Russian incursions into Eastern Europe may elicit a more robust reaction from the
West. Terrorism could spread in the US and Europe as ISIL (Islamic State of Iraq and
the Levant) loses territory in Iraq and Syria and foreign fighters return home. North
Outlook
Investment Strategy Group
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Korea’s nuclear program and missile launches go unchecked. There is rising risk of
military incidents—or accidents—in the South China Sea and across the Taiwan Strait.
China is the most likely source of global economic shocks over the next two to
three years. The country’s leadership continues to prioritize imbalanced economic
growth over structural reforms, thereby increasing debt at an unsustainable pace. Such
increases will eventually prove to be destabilizing.
In Donald Trump, the US has elected an unconventional president in many
respects, including his more US-centric approach to China. If China responds to,
say, imposition of US tariffs on imports of Chinese products by sharply devaluing
the renminbi, significant downside volatility and tighter global financial conditions
will follow.
Given already high US equity valuations, uncertain economic and political policy
prospects and heightened geopolitical risks, readers may well ask why we continue to
recommend staying fully invested in US equities. Among the reasons:
• Our eight-year US preeminence theme is intact and continues into its ninth year.
As Professor Jeremy Siegel of the University of Pennsylvania wrote 23 years ago in
Stocks for the Long Run 1 and recently repeated in a Wall Street Journal interview, 2
“Stocks are the best long-run asset.” We refine that view by saying US equities are
the best long-run asset.
• We think that the policy backdrop in the US will be particularly favorable for
the economy, with looser fiscal policy, relatively easy monetary policy and a less
stringent regulatory environment. We expect US growth to continue through 2017.
• We expect global growth to improve modestly, from 2.5% in 2016 to 2.9% in
2017, with looser fiscal policy and still easy monetary policy in key countries.
• And last but not least, we expect that while President-elect Trump’s initial policy
measures with respect to tariffs and trade agreements risk jolting financial markets,
as a self-described “deal maker” he will likely adjust and change course as necessary
to achieve his desired results.
We may have a bumpy ride, but the US economy will not be derailed.
Over the years, we have viewed the glass as half-full—if not full—when it comes
to the US economy. Many others have seen the glass as half-empty, pointing out that
productivity growth has decreased, US labor demographics are less favorable and
government policies have been ineffective. While it is correct that productivity growth
has decreased and labor demographics are less favorable, it does not follow that the
US economy is in stagnation. Quite the reverse.
2 Goldman Sachs january 2017
We should note that our conviction in US preeminence and US economic growth in
2017 is greater than our conviction in the direction of the equity markets. Just as we
were appropriately humble about how much further equity markets could fall when
we published our 2009 Outlook, we are equally humble today about our financial
market outlook given the significant uncertainties ahead.
Here, we are reminded of Voltaire’s famous words: “Doubt is not an agreeable
condition, but certainty is an absurd one.” A client with a well-diversified portfolio
that is fully invested at its US equity allocation is generally well positioned for these
uncertain and probably volatile times.
We hope our 2017 Outlook is helpful as you evaluate your portfolio allocations.
We also wish you a healthy, happy and productive 2017.
The Investment Strategy Group
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2017 OUTLOOK
Contents
SECTION I
6 Half Full
We continue to view the glass as half-full—if
not full—when it comes to the US economy.
8 This Recovery in Context—An Update
9 A Hangover from a Crisis
10 Secular Stagnation: Unfavorable
Demographics
12 Secular Stagnation: Declining
Productivity Growth
14 Mismeasurement of GDP Statistics
18 Poor Policies in Washington
19 A Steady Onslaught of External Shocks
20 In Summary
20 One- and Five-Year Expected Total Returns
24 Our Tactical Tilts
25 The Risks to Our Outlook
26 Pace of Federal Reserve Tightening
27 Low Expectations of a US Recession
28 Rising Influence of Populist Parties
in the Eurozone
29 Geopolitical Hot Spots Get Hotter
30 Terrorism Escalates
30 Cyberattacks Continue
31 China Submerges Under Its Debt
Burden and Capital Outflows
33 US-China Relations Deteriorate
Under the Trump Administration
35 Key Takeaways
We expect a favorable global economic and
policy backdrop in 2017, but there is no
shortage of risks. We recommend clients stay
invested in US equities with some tactical tilts
to US high yield and European equities.
4 Goldman Sachs january 2017
SECTION II: WINDS OF CHANGE
36 2017 Global
Economic Outlook
SECTION III: THE HORNS OF A DILEMMA
48 2017 Financial
Markets Outlook
The winds of change should fill the sails of
the ongoing global recovery in 2017.
38 United States
42 Eurozone
44 United Kingdom
44 Japan
45 Emerging Markets
We expect the bull market ride to continue,
but we must stay vigilant to avoid the horns.
50 US Equities
56 EAFE Equities
56 Eurozone Equities
57 UK Equities
58 Japanese Equities
59 Emerging Market Equities
60 Global Currencies
64 Global Fixed Income
74 Global Commodities
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5
Half Full
Since the trough of the global financial crisis in
March 2009, US equities have returned nearly
300%, producing one of the longest bull markets
in the post-WWII period and outperforming all
other major developed and emerging market
country equities. US equities have also exceeded
their pre-crisis peaks of October 2007 and March
2000 by 75% and 103%, respectively, on a total
return basis. This bull market has exceeded all
other bull markets but one in length and exceeded
all but three in magnitude.
US economic growth has also exceeded that of
most other recoveries in length. This recovery is the
fourth-longest recovery in the post-WWII period 3
and if, as we expect, the US economy avoids a
recession in the first half of 2017, this recovery
will become the third-longest. While many critics
correctly point out that it is the slowest recovery
since WWII, it has actually created more economic
growth than some of the stronger recoveries
that lasted for shorter periods. On a cumulative
basis, this recovery ranks sixth out of the last 10
recoveries with respect to GDP growth. What this
recovery has lacked in strength, it has partially
made up for in length.
The slow but steady growth has also exceeded
that of all other major developed economies,
and US GDP per capita has increased more than
the GDP per capita of any major developed or
emerging market country.
This recovery has created over 15 million
jobs. The unemployment rate decreased from
a peak of 10.0% in October 2009 to 4.6% in
November 2016 and is now below its long-term
average of 5.8%. Even the broader U6 measure,
which adds the underemployed (such as parttime
and discouraged workers) to the number of
unemployed, has fallen from a peak of 17.1% to
9.3%, and stands below its long-term average of
10.6%. Unemployment claims are not only lower
than they were during pre-crisis troughs but also
at their lowest since 1973; they are also the lowest
on record as a percentage of the labor force (see
Exhibit 1).
As a result of more robust employment, wages
have increased as well. Wage growth, as measured
by the Atlanta Federal Reserve Bank Wage Growth
Tracker (which, in our opinion, is a better gauge
of the employment backdrop than average hourly
Exhibit 1: US Initial Unemployment Claims as a
Share of the Labor Force
Claims as a share of the labor force are at record lows.
Monthly Average (%)
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
1967 1975 1983 1991 1999 2007 2015
Data through December 2016.
Source: Investment Strategy Group, Datastream.
Exhibit 2: Corporate Profits as a Share of US GDP
Profits have been higher than current levels only 17% of the
time since 1950.
% of GDP
14
12
10
8
6
Corporate Profits
Historical Average
4
1950 1956 1962 1968 1974 1980 1986 1992 1998 2004 2010 2016
Data through Q3 2016.
Note: Showing US corporate profits with inventory valuation adjustment and capital consumption
adjustment.
Source: Investment Strategy Group, Datastream.
earnings, since it is not affected by the changing
composition of the labor force as new entrants are
hired at lower wages), has picked up from a low of
1.6% year-over-year growth in May 2010 to a high
of 3.9% in November 2016—just below the 4.4%
peak of September 2007. More robust employment
and better wage growth have, in turn, led to a
steady increase in consumer confidence, reaching
levels last seen in August 2001, as measured by the
0.2
11.5
9.6
6 Goldman Sachs january 2017
The Declinists at Work
March 1979
Used with permission of Bloomberg L.P.
Copyright© 2016. All rights reserved.
July 2016
Source: Financial Times. Martin Wolf/James Ferguson, 2016. “Global elites must heed the warning
of populist rage.” Financial Times / FT.com, 20 July. Used under licence from the Financial Times. All
Rights Reserved.
Conference Board. Even median household income,
as measured by the US Census Bureau, rose in
2015 at the fastest rate on record.
In the corporate sector, total profits of domestic
corporations as a percentage of GDP, as measured
by the national income and product accounts
(NIPA), are close to all-time highs. At 11.5% of
GDP, profits not only are well above the historical
average of 9.6%, but have been higher than
current levels only 17% of the time since 1950, as
shown in Exhibit 2.
Despite these “glass half-full” facts, the
announcements of US decline that pervaded the
airwaves in the depths of the global financial
crisis have persisted. We continue to be inundated
with analysis of “America’s relative decline,” 4
“America’s slow-growth tailspin” and “sclerotic
growth,” 5 “an economic in-tray full of problems” 6
and, of course, “secular stagnation.” 7 Two books
published in 2016 that have received extensive
coverage epitomize the sentiment: Robert Gordon’s
The Rise and Fall of American Growth 8 and
Marc Levinson’s An Extraordinary Time: The
End of the Postwar Boom and the Return of the
Ordinary Economy. 9
Some of the images are equally telling. We
were struck by a recent image of the Statue of
Liberty on its side that resembles a BusinessWeek
cover of March 1979 with a tear trickling down
Lady Liberty’s face. Since WWII, the waning of US
preeminence has been a topic of recurrent handwringing.
Whether prompted by the flexing of
Soviet muscle, most spectacularly with the launch
of Sputnik in the 1950s; the civil rights upheavals
and growing fallout from the Vietnam War in the
1960s, the Arab oil embargo and the Watergate
scandal of the 1970s, the rise of Japan in the 1980s
or the rise of China in the 2000s, the declinists
have foretold the ebbing of American preeminence.
Typical of the genre is a 2009 book provocatively
titled When China Rules the World 10 by British
columnist Martin Jacques.
Yet, as we wrote in our 2011 Outlook: Stay
the Course, neither the global financial crisis nor
the rise of China will hinder what we described
as “America’s structural resilience, fortitude
and ingenuity” and remove the US from its
preeminent perch.
What explains our difference of opinion, which
has consistently underpinned our investment
recommendation for a greater allocation to US
assets and for remaining invested at such high
valuations? Why do we believe that the US is on
a more solid footing both absolutely and relative
to all other major countries in the world? Is it a
matter of perspective, analytical rigor, bias, review
of longer economic history, or reliance on a big
cadre of external experts in specialized fields?
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Investment Strategy Group
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Exhibit 3: Growth in US Real GDP Across Post-
WWII Expansions
In this recovery, GDP has grown at half the average pace of
prior expansions.
Exhibit 4: Change in US Household Leverage
Following Recessions
A large reduction in household debt served as a drag on the
pace of this recovery.
Cumulative Growth (%)
60
50
40
Q2 1954
Q2 1958
Q1 1961
Q4 1970
Q1 1975
Q3 1980
Q4 1982
Q1 1991
Q4 2001
Q2 2009
Change in Debt-to-GDP (Percentage Points)
10
Previous Post-WWII Recoveries (Median)
Current Recovery
5
0
4.8
30
-5
20
-10
10
-15
0
0 4 8 12 16 20 24 28 32 36 40
Quarters After Trough
-20
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28
Quarters After Recession End
-18.3
Data as of Q3 2016.
Source: Investment Strategy Group, Datastream, National Bureau of Economic Research.
Data through Q3 2016.
Source: Investment Strategy Group, National Bureau of Economic Research, Federal Reserve
Economic Data.
We believe that no one factor explains the
difference in opinion. Instead, we rely on a
comprehensive framework of investigation that
blends all of these elements, combining rigorous
fundamental, quantitative and technical analysis,
as well as the insights of an extensive network of
external experts. At the same time, we continually
endeavor to overcome the behavioral biases Nobel
Laureate Daniel Kahneman and his collaborator
Amos Tverksy have shown to affect economic
decision-making and tolerance for risk. These key
characteristics of our investment process not only
underpin our continued view of US preeminence,
but also allow us to form a holistic view across
global economies and asset classes. Of equal
importance, our framework provides us with a
consistent process by which to assess investment
opportunities. While we believe our approach is
robust, we acknowledge that nothing can ensure
we will avoid the next downdraft.
We begin our Outlook with a brief review of
this recovery and place it in the context of past
recoveries showing that the glass is indeed half-full.
We address some of the key concerns regarding
demographics and declining productivity growth.
We show that US labor force demographics have
deteriorated and will continue to do so, especially
in the absence of policy changes. Nonetheless, we
demonstrate why there is room for optimism about
productivity growth. The analysis leads us to a
view of slightly above-trend growth for 2017 with
some upside potential from higher productivity
and fiscal stimulus from a Trump administration.
We then turn to our one- and five-year expected
returns, which are driven by our view of a solid
economic foundation, a well-balanced economy
and a positive growth trajectory in the US. We
conclude our introductory section with the risks
to our view, both upside and downside, including
a low probability of recession in 2017, high policy
uncertainty under a Trump administration, possible
global shocks from economic and currency policies
in China, and the risks of geopolitical mishaps in
Europe, the Middle East and the Far East.
This Recovery in Context—An Update
This recovery has been the slowest of the 10
recovery cycles since WWII, as shown in Exhibit
3. Since the trough, US GDP has grown at an
annualized rate of 2.1% through the third quarter
of 2016, which is half the pace of the median and
average growth rates of all other recoveries. The
slow GDP growth rate stands in stark contrast to
the recovery in the labor market and, most recently,
in wages and household income. Impressively, the
decline in the unemployment rate has been the
second-largest of all post-WWII recoveries.
8 Goldman Sachs january 2017
Exhibit 5: Change in US Personal Savings Rate
Surrounding Historical Recessions
The increase in the personal savings rate in this recovery
has been unusually large.
Exhibit 6: Ratio of US Household Net Worth to
Disposable Income
Real estate price and financial asset gains have boosted the
ratio to near pre-crisis highs.
%
Deviation from Start of Recession (Percentage Points)
8
Historical Range
Median
6
Current
700
639
4
2
3.0
600
0
500
-2
-4
-6
-3.4
400
-8
-6 -4 -2 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34
Quarters Relative to Start of Recession
Data through Q3 2016.
Note: Quarter 0 marks the start of each recession since 1950, defined as the NBER recession
cycle start. The cycle is measured from the start of each recession until the beginning of the next
recession.
Source: Investment Strategy Group, Datastream, National Bureau of Economic Research.
300
1951 1959 1967 1975 1983 1991 1999 2007 2015
Data through Q3 2016.
Source: Investment Strategy Group, Datastream.
The anemic (but steady) pace of this recovery
has fueled a debate about its causes. The theories
fall into six categories:
• A “hangover” from the global financial crisis 11
• “Secular stagnation” due to unfavorable
demographics
• “Secular stagnation” due to declining
productivity growth
• Mismeasurement of GDP statistics