Fiscal Concerns: Goldman Sachs Asset Management Offers an Update

By Randy Myers


Continued modest economic growth, low interest rates and benign inflation should provide a fertile backdrop for the U.S. equity market in the year ahead, says Samantha Davidson, managing director with the Global Portfolio Solutions Investment Team at Goldman Sachs Asset Management.

Speaking at the 2013 SVIA Spring Seminar in April, Davidson reeled off a string of reasons why the U.S. economy appears poised for further growth. Five years after the 2008 credit crisis, she said, the U.S. financial system is largely healthy. Corporate balance sheets are improving. Consumer spending is on the upswing and so is the housing market. Its improvement should contribute about half a percentage point to GDP growth this year.

The U.S. also is experiencing an energy boom in the form of increased oil and natural gas production, which should make it less dependent on foreign oil and could create a meaningful competitive advantage for domestic companies sensitive to energy costs. By the end of this year, Davidson said, the U.S. could be exporting more oil than it imports.

Washington has also been the source of some good news lately, Davidson noted, even if it has gone little noticed. The federal deficit, for example, has been shrinking at a rapid pace relative to the size of the economy. It stood at about 10 percent of GDP in 2009, but should be only about 3 percent of GDP by 2015, Davidson said. Congress and the White House showed some surprising harmony in getting things done in the first quarter, raising the federal debt limit and making sure that the federal government did not shut down.

Goldman Sachs Asset Management is projecting that the economy will grow approximately 2.3 percent this year, Davidson said, although potential pitfalls abound. Key risks include the possibility that the federal government will tighten fiscal and/or monetary policy prematurely or excessively, and that Europe’s sovereign debt woes might flare anew. The Euro zone economies are already weak, Davidson said, and GDP there could fall by around 3 percent this year.

Looking to Asia, China is a concern as well. Its economy grew approximately 10 percent annually for the past decade, but the consensus is that it will grow only around 7 percent a year for the next decade, Davidson said. Even that is dependent in part on the country being able to drive consumer spending without excessive reliance on credit.

Closer to home, the U.S. economy faces headwinds, Davidson conceded, including the sequestration spending cuts that began to take effect earlier this year. They will be negative for the economy, she said, but also temporary and manageable, as will recent income tax increases. Meanwhile, she said, improved corporate profit margins should help to offset those negatives. She noted that rising profit margins preceded investment growth during the last two business cycles.

Davidson said interest rates are likely to remain low over the next 12 months, with the yield on the 10-year Treasury bond possibly climbing to 2.5 percent, up from about 1.7 percent in mid-April. Guidance from the Federal Reserve, which has vowed to keep interest rates low until unemployment falls to 6.5 percent, suggests that interest rates may not start to rise in earnest until the 2015-2016 time frame. Inflation, Davidson added, is likely to remain below 2.0 percent through 2015, although the risk that it might unexpectedly accelerate has picked up. Here again, the concern is that the Fed might misread signs of falling unemployment and tighten monetary policy too soon. Alternatively, some geopolitical event could cause commodity prices to spike, which typically spurs inflation.

In light of her firm’s economic outlook, Davidson said Goldman Sachs Asset Management in mid-April considered equity valuations “still somewhat attractive,” even if they were less attractive in both the U.S. and Europe, due to recent rallies, than they had been several months earlier. “We expect equity markets to be quite strong,” she said. Davidson added that her firm was recommending an overweighting in Japanese equities in the wake of the Bank of Japan’s recently announced plan to double the country’s monetary base.

In the credit markets, Davidson said, strong corporate balance sheets suggest that defaults should remain low. In mid-April, her firm considered high-yield bonds more attractive than either investment-grade corporate debt or emerging markets debt. The firm also saw less risk in shorter-duration assets than in longer-duration assets. “Relative to other asset classes,” she said, “muted returns can be expected from emerging markets debt, corporate credit, and government bonds, given their current low yields and potential for rising rates.”

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