higher-frequency data shows this merger and
acquisition (M&A) momentum is continuing (see
Exhibit 75).
Second, the Bank of England may need to raise
interest rates sooner than markets now expect, as
erstwhile sterling depreciation is quickly feeding
Outlook
Investment Strategy Group
63
Exhibit 75: UK Cash Merger and Acquisition
Announcement Pipeline
Continued inbound M&A activity could benefit the pound.
6-Month Rolling Sum, $ bn
150
100
50
0
-50
-100
-150
Inbound M&A
Outbound M&A
Net M&A
Capital Into the UK
= Pound Appreciation
Capital Out of the UK
= Pound Depreciation
May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16
Data through December 31, 2016.
Note: October 2016 outbound M&A adjusted to exclude stock portion of British American
Tobacco’s takeover of Reynolds.
Source: Investment Strategy Group, Bloomberg.
through to higher domestic inflation. In turn,
higher UK interest rates would make sterlingdenominated
assets more appealing to foreign
investors and support the currency.
Finally, while sterling certainly has scope to
depreciate, market participants are already wellpositioned
for further weakness. Those positions
may become vulnerable if the UK’s negotiations
with its trade partners turn more amicable and the
domestic UK economy remains resilient.
With these upside risks being tempered by the
unknowable evolution of Brexit negotiations for
now, we see balanced risks for the pound this year
and thus remain tactically neutral.
Emerging Market Currencies
Emerging market currencies caught a welcome
updraft last year, following a 45% freefall since
mid-2011. The flight was not without turbulence,
however. Following a 12% rally in the first half of
the year—reflecting a dovish shift in US monetary
policy and waning fears about Chinese capital
outflows—emerging market currencies hit an air
pocket that erased much of these gains following
the surprise outcome of the US elections.
We believe this downdraft is likely to persist.
The prospect of higher US interest rates, a stronger
dollar and China’s bumpy deceleration spells
tighter global financial conditions and a risk
of capital outflows from emerging markets—
conditions that have historically constituted a stiff
headwind to their currencies.
These risks are magnified by the uncertainty
surrounding the incoming US administration’s
trade policies. Fears of protectionism have already
negatively impacted the currencies of China and
Mexico—the two largest sources of manufacturing
exports to the US—with the peso and Chinese
renminbi down 11.6% and 2.3%, respectively,
since the election.
Even so, we do not think a broad tactical short
in emerging market currencies is appealing at this
stage. Despite the small rally last year, emerging
market currencies remain attractively valued (see
Exhibit 76), particularly given their enticing 5%
yield differential to the US dollar. Moreover, the
new US administration may prove to be more
measured in its actions than its rhetoric—a nonnegligible
risk that could revive sentiment and
improve prospects for emerging market currencies.
The Mexican peso, in particular, could benefit in
that event.
For now, we remain tactically positioned to
benefit from further renminbi weakness given our
long-standing concerns about China’s economic
vulnerabilities and the likelihood of looser policy,
policy mistakes and capital outflows. The potential
for US trade protectionism directed at China,
though not our base case, would further benefit
this position.
2017 Global Fixed Income Outlook
Last year witnessed a notable reversal of fortune
for global interest rates. Despite reaching all-time
closing lows shortly after the surprise Brexit vote,
10-year yields in developed markets had reclaimed
much—if not all—of those declines by year-end.
In the US, a more than one percentage point swing
was sufficient to turn the 10-year bond’s 9% gain
into a loss.
While some have portrayed this reversal as
just another setback in the now three-decade-old
bond bull market, we are more skeptical. The
policy mix that has depressed interest rates in
the post-crisis period—a combination of fiscal
austerity, negative or near-zero central bank policy
rates and large-scale asset purchases—is losing
favor, as even policymakers acknowledge the often
counterproductive impact of these policies. At
64 Goldman Sachs january 2017
Exhibit 76: Emerging Market Currency Valuation
Despite the recent rally, emerging market currencies remain
undervalued against the US dollar.
Exhibit 77: Estimated Duration of US Bond Market
The bond market’s sensitivity to rising rates is the highest
on record.
Average Deviation from Fair Value vs. US Dollar (%)
20
15
10
5
0
-5
-10
EM Currencies
Overvalued
on Average
Duration (Years)
7
6
5
4
-15
-20
-25
2008 2009 2010 2011 2012 2013 2014 2015 2016
-15
3
2
1989 1994 1999 2004 2009 2014
Data through November 30, 2016.
Note: Average of Goldman Sachs Dynamic Equilibrium Exchange Rate, 5-year moving average,
and Fundamental Equilibrium Exchange Rate misalignments of currencies in the JP Morgan
Government Bond Index—Emerging Markets Global Diversified.
Source: Investment Strategy Group, Bloomberg, Datastream, Goldman Sachs Global Investment
Research, Peterson Institute for International Economics.
Data through December 31, 2016.
Note: Based on the Barclays US Aggregate Bond Index.
Source: Investment Strategy Group, Bloomberg.
the same time, the recovery in commodity prices,
recent firming in global growth and potential for
expansionary fiscal policy are shifting the focus
from deflation to reflation.
This shift in perspective arrives at a time when
the market’s vulnerability to rising rates is the
highest on record (see Exhibit 77). Losses from
these long-duration positions in response to higher
rates could beget more bond sales, creating a
vicious cycle. That yields are still extremely low
by historical standards does little to assuage these
fears. Consider that 10-year government bond
yields in all G-7 countries have been higher at least
90% of the time since 1958. Given all the above,
For now, we remain tactically
positioned to benefit from further
renminbi weakness given our longstanding
concerns about China’s
economic vulnerabilities and the
likelihood of looser policy, policy
mistakes and capital outflows.
we believe the ascent of interest rates remains in
its infancy.
Still, it is important to differentiate between
a normalization of interest rates and a disorderly
backup. While we expect higher interest rates over
the coming years, secular headwinds—like aging
demographics and slower productivity growth—
suggest the terminal point of that increase will be
lower than the historical average. This fact is not
lost on the Federal Reserve, which has reduced
its estimate of the long-run equilibrium nominal
rate—the rate consistent with full employment and
stable inflation in the medium term—from 4.25%
to 3% over recent years.
With a lower interest rate target
to reach, the Federal Reserve is likely
to proceed slowly, particularly given
uncertainty around its estimate of the
economy’s equilibrium rate and lingering
international risks. Even if the Federal
Reserve were to raise rates three times in
2017, that pace would still be less than
half of the historical median tightening
pace. 113 Thus far in this cycle, the
Federal Reserve has raised rates only
once per year.
Against this backdrop, we recommend
investors favor credit over duration risk
Outlook
Investment Strategy Group
65
by remaining overweight US corporate high yield
credit versus investment grade fixed income and by
funding various tactical tilts from their high-quality
bond allocation. While most investment grade
bonds may have uninspiring tactical prospects, we
emphasize that investors should not completely
abandon their bond allocation in search of higher
yields. As the last several years have reminded
us, investment grade fixed income serves a vital
strategic role in the portfolio, due to its ability to
hedge against deflation, reduce portfolio volatility
and generate income.
In the sections that follow, we review the
specifics of each fixed income market.
US Treasuries
While 2016 began as a bumper year for US
Treasuries, it ended in a rout. The yield on 10-year
Treasury bonds, for example, reached an all-time
low of just 1.36% by the middle of last year before
jolting higher by more than one percentage point
by year-end. As a result, investors’ nearly doubledigit
gains devolved into a small loss. Even worse,
the bulk of the rate increase occurred in just the
last three months of 2016, generating a 7% loss for
the quarter that has been exceeded less than 1% of
the time historically since 1981.
We expect rates to continue to increase, albeit
at a slower pace in 2017, as many of the forces
that have restrained yields are slowly fading.
Inflation, in particular, has been a persistent drag,
reflecting a toxic combination of excess labor slack
that depressed wages, a strong dollar that lowered
import prices and a significant decline in oil prices
that weighed on breakeven inflation rates. But
as we begin the eighth year of the US expansion,
labor slack has been largely absorbed, evident in
today’s firming wages. Moreover, the impact of the
dollar is diminishing as its pace of ascent slows,
while the recovery in oil is boosting breakeven
inflation rates.
Other headwinds are also receding. The fiscal
austerity among the advanced economies that
has dampened economic growth and decreased
sovereign bond issuance—both of which depress
interest rates—is now reversing (see Exhibit 78).
Indeed, US fiscal spending is expected to add
0.3–0.5 percentage points to GDP growth in each
of the next two years. 114
At the same time, there is reduced demand
for risk-free assets, like US Treasuries, given
the unexpectedly sanguine reaction to negative
Exhibit 78: Fiscal Stance of Advanced Economies
Fiscal austerity in developed markets has reversed in
recent years.
Number of Countries
35
30
25
20
15
10
5
0
5 6
6
6
23 22 22
8
4
10 9
9 12
2011 2012 2013 2014 2015 2016
Data as of December 31, 2016.
Source: Investment Strategy Group, IMF.
Tightened Remained Neutral Loosened
geopolitical events—such as the UK and Italian
referenda—and the results of the US election.
Finally, the deleterious impact of depressed interest
rates on banking sector profitability has raised the
hurdle for global central banks to cut interest rates
further and/or increase the scale of QE programs. In
turn, market focus has shifted toward the eventual
tapering of BOJ, ECB and BOE accommodation,
which has helped lift bond term premiums and
boosted long-term yields (see Exhibit 79).
In light of these waning headwinds, the Federal
Reserve is likely to hike two or three times in 2017,
with upside risks from a larger-than-anticipated
fiscal expansion. Combined with some further
normalization in the term premium, we expect 10-
year rates to increase to 2.50–3.00% by year-end.
Given the balance of risks, we remain comfortable
funding tactical tilts out of investment grade
fixed income.
Treasury Inflation-Protected Securities (TIPS)
TIPS fared better than nominal bonds in 2016,
delivering a positive mid-single-digit return. Their
outperformance was driven by the recovery in
breakeven inflation rates, which began the year at
very depressed levels consistent with only 1.5%
annual inflation over the next 10 years—well
below long-run forecasts (see Exhibit 80). In fact,
our work suggests that breakeven inflation rates
were reflecting high odds of a deep recession over
the course of 2016, well above the risk suggested
by our recession models.
15
13
16
9
9
66 Goldman Sachs january 2017
Exhibit 79: US 10-Year Yields and Term Premium
Expected tapering from major central banks has contributed
to higher long-term yields and bond term premiums.
Exhibit 80: US 10-Year Breakeven Inflation Rate
and Consensus Inflation Rate Forecasts
TIPS benefited from a recovery in breakeven inflation
rates in 2016.
%
4
3
10-Year Treasury Yield
Risk-Neutral Yield
Term Premium
% Annualized
3.0
2.5
10-Year Breakeven Inflation
10-Year Ahead Inflation Forecast
2.0
2
1.5
1
1.0
0
0.5
-1
2011 2012 2013 2014 2015 2016
Data through December 31, 2016.
Source: Investment Strategy Group, Bloomberg.
0.0
2011 2012 2013 2014 2015 2016
Data through December 31, 2016.
Source: Investment Strategy Group, Bloomberg.
We think that breakeven inflation rates have
further room to rise as the concerns that depressed
them last year fade. First, oil prices are recovering,
reversing the persistent drag they had exerted
throughout much of early 2016. Second, wages are
firming and fiscal policy is being eased, dampening
deflation worries. Finally, recession odds are
falling as the drag from oil weakness and dollar
strength fades.
With breakeven inflation rates still below longterm
consensus forecasts and the Federal Reserve’s
target, we expect positive total returns from TIPS
in 2017. Still, TIPS’ absolute returns are likely to
be modest, as their eight-year duration will make it
difficult for coupon income to meaningfully exceed
principal losses as rates rise. Moreover, given TIPS’
unfavorable tax treatment (discussed at length
in our 2011 Outlook), we continue to advise US
clients with taxable accounts to use municipal
bonds for their strategic allocation.
We expect rates to continue to
increase, albeit at a slower pace in
2017, as many of the forces that have
restrained yields are slowly fading.
US Municipal Bond Market
Municipal bond holders were not immune from
2016’s about-face in US Treasury yields. Last
October, municipal bonds were enjoying some of
their best returns in years, only to be hit by losses
arising from both rising interest rates and budding
concerns about tax changes in the wake of the US
presidential election. The abrupt redemptions of
municipal bond mutual funds only exacerbated
these losses, with the pace of outflows second only
to the mid-2013 taper tantrum (see Exhibit 81).
All told, municipal bonds suffered one of their
worst years in recent history, with intermediate
municipal bonds actually experiencing a rare loss
(see Exhibit 82).
Unfortunately, the near-term outlook remains
challenging. As Exhibit 81 reminds us, mutual
fund flows tend to be sticky in this asset class,
with persistent periods of both buying and selling
depending on the trajectory of interest rates. Based
on historical episodes, there is scope for the current
string of outflows to extend further.
Moreover, clarity on tax policy will
remain elusive for months, during which
time headline risk will be significant.
Even worse, a sizable reduction in the
top individual tax rate for municipal
bonds—if ultimately passed—could
significantly shift the economics of
owning them, leading to further sales.
These fresh worries on tax policies
Outlook
Investment Strategy Group
67
Exhibit 81: Municipal Bond Mutual Fund Flows
The pace of outflows at the end of 2016 was surpassed in
recent history only by the 2013 taper tantrum.
4-Week Rolling Average, $ bn
3
Exhibit 82: Annual Municipal Bond Returns
Since 1994
Intermediate municipal bonds experienced a rare
loss in 2016.
Ranked Annual Returns (%)
15
2
1
10
0
-1
5
-2
-3
0
-4
-5
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
-5
1995
2002
2000
2011
1997
2009
1998
2001
2007
2014
1996
2003
2008
2006
2012
2010
2004
2015
2005
1999
2016
2013
1994
Data through December 31, 2016.
Source: Investment Strategy Group, ICI.
Data as of December 31, 2016.
Source: Investment Strategy Group, Barclays.
only add to existing concerns about pension
funding levels.
While there is clearly no shortage of risks, the
silver lining to last year’s rout is that we begin
2017 with a much larger valuation buffer to help
absorb them. As seen in Exhibit 83, the ratio
of municipal yields to Treasury yields is above
average for both 5- and 10-year maturities. In
turn, investors can currently earn an extra 70
basis points of after-tax yield by owning fiveyear
municipal bonds instead of same-maturity
Treasuries—a yield pickup more than double the
post-crisis median of 31 basis points. Moreover,
this incremental after-tax yield would still be
around 50 basis points if the top individual tax on
investment income were reduced by 10 percentage
points—from 43.4% with the Affordable
Care Act (ACA) tax to 33% under new policy
recommendations. In short, municipal spreads
currently offer a potential offset to rising rates and
potential tax changes.
Also keep in mind that municipal fundamentals
remain stable. Major state and local tax revenues
have continued to increase at a moderate 3% pace,
which should be supported by the above-trend
US economic growth and rising home prices we
forecast. Meanwhile, governments have exercised
restraint on capital spending. Consider that net
issuance expectations of $30 billion for 2017 stand
well below the pre-crisis 10-year annual average
of $110 billion. 115 This restraint has not only kept
net supply low—as new issuance has been largely
offset by maturing debt—but has also helped
municipal finances. Ratings trends have improved
as a result of both stable revenue and spending
discipline, with upgrades in the Moody’s universe
seeing a notable uptick in last year’s third quarter
(see Exhibit 84).
Of course, underfunded long-term pension
liabilities remain a source of concern. But with
aggregate funding levels holding steady at around
74%, we do not think this will be a primary focus
in 2017, particularly given last year’s increase in
stock prices. While rising equity values will do
little to remedy municipals’ inadequate funding
contributions, they will help increase the value
of pension assets. Moreover, these medium-term
concerns are not the primary driver of recent
municipal bond weakness. After all, today’s
funding levels are no worse than they were in
October of last year, a time when municipal bonds
were enjoying some of their best returns ever.
All told, we expect intermediate municipal
strategies to gain about 1% in 2017. With
this return close to that of cash but with more
downside potential, we still think it makes sense
for clients to fund various tactical tilts from their
high-quality municipal bond allocation. This
recommendation is motivated primarily by rate
risk and not credit concerns, since we expect
municipal defaults to be rare events. Outside
tilt funding, we recommend clients target their
68 Goldman Sachs january 2017
Exhibit 83: Ratio of Municipal Bond Yields to
Treasury Yields
Current municipal bond yields offer a larger valuation buffer
to absorb risks than in the past.
Exhibit 84: Municipal Issuer Rating Changes
Stable revenue and spending discipline have led to recent
issuer rating upgrades.
Ratio (%)
100
90
80
Current Average Since 2000 Average Since 1987
95
93
91
85
80
85
Share of Rating Changes (%)
100
90
80 37
49
70
60
56
42
56 54
Upgrades
50
39
Downgrades
63
50
70
40
60
30
20
63
51
44
58
44 46
50
61
37
10
50
5-Year Ratio
10-Year Ratio
0
3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16
Data as of December 31, 2016.
Source: Investment Strategy Group, Bloomberg, Thomson MMD.
Data as of Q3 2016.
Source: Investment Strategy Group, Moody’s.
benchmark duration. Given their important
portfolio hedging characteristics, municipal bonds
should remain the bedrock of the “sleep-well”
portion of a US-based client’s portfolio.
The same can be said for high yield municipal
bonds. Despite their almost 10-year duration, these
bonds currently offer attractive spreads of close to
3%, a level that has been higher only 29% of the
time since 2000. This spread provides a substantial
buffer that could partially offset higher Treasury
yields, enabling the high yield municipal market
to deliver positive returns of around 4% in our
base case. Therefore, we recommend clients stay
invested at their customized strategic weight.
US Corporate High Yield Credit
Even for the bullish among us, last year’s
17% total return in corporate high yield was
surprisingly strong. Not only was it the largest gain
within US fixed income, but it also ranked among
While there is clearly no shortage of
risks, the silver lining to last year’s
rout in municipal bonds is that
we begin 2017 with a much larger
valuation buffer to help absorb them.
the top annual returns of all time for the asset
class. What makes this performance even more
impressive is that high yield was down about 5%
at its worst point in early 2016.
But these sizable gains have come at a cost.
Spreads—which compensate investors for the risk
of default losses—now stand well below their longterm
average. In fact, the level of spreads has been
lower only a third of the time in the last 30 years.
Moreover, yields have fallen from above 10%
early last year to less than 7% now, diminishing
the allure of these bonds to investors searching for
high returns.
Even so, we think the strong fundamentals
underpinning the asset class still warrant an
overweight, though returns are almost certain to
be more modest going forward. At the heart of
this stance is our benign view on default losses,
which are the primary risk to high yield investors.
Here, several factors support our below-historicalaverage
2.5% par-weighted default
forecast for 2017.
First, high yield firms stand to benefit
directly from the strengthening US
economy we expect this year, considering
almost three-quarters of their sales
originate domestically. 116 Second, leading
indicators of defaults—such as Moody’s
liquidity and covenant stress indexes—
are trending downward, suggesting
fewer speculative-grade companies are
Outlook
Investment Strategy Group
69
Exhibit 85: Moody’s Liquidity Stress Index and
Default Rates
Leading indicators suggest the path of defaults for high
yield is lower.
Exhibit 86: Cumulative US High Yield Debt
Maturity by Year
Less than 10% of existing debt matures in the next
two years.
Index (%) Trailing 12-Month Rate (%)
25
Composite Liquidity Stress Index
16
Speculative-Grade Issuer-Weighted Default Rate (Right)
14
Cumulative Maturity (%)
100
High Yield Bonds
90
Bank Loans
86
100 100
20
15
12
10
80
70
60
67
63
8
10
6
4
5
2
0
0
2002 2004 2006 2008 2010 2012 2014 2016
50
40
30
20
10
0
47
42
33
20 19
10
7
4
1
2017 2018 2019 2020 2021 2022 2023 or later
Data through November 30, 2016.
Note: Moody’s Liquidity Stress Indexes fall when corporate liquidity appears to improve and rise
when it appears to weaken.
Source: Investment Strategy Group, Moody’s.
Data as of December 31, 2016.
Source: Investment Strategy Group, JP Morgan.
experiencing liquidity problems or are at risk of
breaching financial covenants. As seen in Exhibit
85, Moody’s composite Liquidity Stress Index
(LSI) began to deteriorate in advance of previous
default cycles. Third, the commodity sectors of the
high yield universe—which collectively generated
a staggering 85% of last year’s defaults—are
recovering along with oil prices. Keep in mind
that the par-weighted default rate excluding
these sectors was just 0.5% last year, a fraction
of the 3.2% long-run average. 117 Finally, our
default model—which incorporates the leading
characteristics of the Federal Reserve’s Senior Loan
Officer Opinion Survey and the percentage of
distressed bonds—is projecting 2–3% par-weighted
defaults in the year ahead.
Other factors corroborate our low-default view.
As seen in Exhibit 86, there is very little refinancing
We think the strong fundamentals
underpinning US corporate high yield
still warrant an overweight, though
returns are almost certain to be more
modest going forward.
risk, given that less than 10% of existing debt
matures in the next two years. Of equal importance,
interest coverage stands near all-time highs today,
in stark contrast to the period preceding the
financial crisis (see Exhibit 87). This point is further
illustrated by Exhibit 88, which shows that today’s
high yield universe is much healthier than the precrisis
cohort, regardless of measure. Keep in mind
that low-rated CCC bonds represented just 8% of
high yield issuance last year, a 14-year low. 118
We also note that high yield may be a better
interest rate hedge than many investors realize.
Consider that during unexpected interest rate
backups in the past, high yield has generated a
positive return 69% of the time and a return that
exceeded investment grade fixed income 85%
of the time (see Exhibit 89). This last point is
important, as our high yield overweight is funded
out of investment grade fixed income.
High yield’s hedging qualities were
apparent last year, as the asset class
appreciated nearly 7% in the second
half of the year despite an increase in
Treasury yields of more than 100 basis
points. Although we assume that any
further increase in 10-year Treasury
rates this year will not be offset by high
yield spreads, this historical relationship
suggests that may be overly conservative.
70 Goldman Sachs january 2017
Exhibit 87: High Yield Par-Weighted Interest
Coverage Ratio
Interest coverage today stands near all-time highs,
unlike the pre-crisis period.
Exhibit 88: Characteristics of US High
Yield Issuance
Today’s high yield universe is much healthier than the
pre-crisis cohort.
Coverage Ratio
Use of New Issuance Proceeds (%)
5
4.5
4.6
4.4
60
2006–07 Average 2015–16 Average
4
50
48
40
3
30
27
29
2
20
1
10
12
10
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
1Q16
2Q16
3Q16
0
LBO and M&A Low-Rated Companies Aggressive Securities
(PIK/Toggle Bonds)
0
Data through Q3 2016.
Source: Investment Strategy Group, Barclays.
Data as of December 31, 2016.
Source: Investment Strategy Group, JP Morgan.
Of course, a more constructive view of high
yield fundamentals does not necessarily suggest
robust returns. In high yield bonds, today’s belowaverage
spreads already reflect our subdued default
expectations and are less likely to offset any further
increase in rates. We thus expect returns of around
4% in the year ahead. Although high yield energy
is likely to generate similar gains, the potential
upside is more significant given wider starting
spreads and the potential for distressed bonds to
pull to par amid higher oil prices. Finally, with a
5% return, bank loans should perform marginally
better than bonds, reflecting their attractive
0.25-year duration and continued investor demand
for floating rates—a feature that is back in vogue
now that 3-month LIBOR is almost above the
1% LIBOR floor that more than 90% of bank
loans possess.
While these returns may pale in comparison to
those of last year, they remain attractive relative to
investment grade fixed income, where we expect
rising rates to generate lower returns. Even if rates
stagnate while US growth remains positive, the
default-adjusted return in high yield should still
trump high-quality bonds. Said differently, US
corporate high yield credit remains a better house
in a bad fixed income neighborhood, supporting
our modest overweight recommendation.
Exhibit 89: High Yield Credit Performance During
Periods of Rising Rates
High yield has historically outperformed investment grade
bonds during episodes of rising rates.
Average Return (%)
5
Average Total Return During
Episodes of Rising Rates*
4
% of Time Positive (Right)
3
2
1
0
-1
-2
Inv. Grade Fixed
Income (IGFI)
High Yield
High Yield
Less IGFI Return
Bank Loans
% of Time Positive
100
Bank Loans
Less IGFI Return
Data as of December 31, 2016.
Source: Investment Strategy Group, Barclays, Credit Suisse.
* Defined as 5-year Treasury yield rising more than 70 basis points over a 3-month period.
European Bonds
Unlike their US counterparts, European fixed
income markets did not forfeit all their gains by
the end of last year. This served as a poignant
reminder of how divergent monetary policies
can shape returns. Three ECB actions in March
drove this robust relative performance. First,
the ECB reversed its prior commitment to avoid
75
50
25
0
Outlook
Investment Strategy Group
71
further rate cuts and lowered the deposit rate to
-0.40%. Second, it increased the size of its asset
purchase program from €60 billion to €80 billion
per month, effectively buying more Eurozone
bonds each year than are actually issued (see
Exhibit 90). Finally, it continued to limit its buying
to bonds with yields above the deposit rate,
which concentrated its purchases toward longmaturity
bonds.
These measures created an extreme scarcity
effect in long-term German bunds, as investors
scrambled to buy today for fear of even lower
interest rates tomorrow. In response, German
10-year rates fell to an all-time low of -18 basis
points in July of 2016. During these same summer
months, all German government bonds with less
than a 15-year maturity offered negative yields.
However, monetary policy does not operate in
a vacuum. With negative interest rates impairing
the profitability of the European banking system,
the ECB has already begun to alter its policy mix.
At its December 2016 meeting, the ECB reversed
the increase in asset purchases mentioned above,
targeting €60 billion per month for the upcoming
March–December 2017 period. Moreover, it lifted
the restriction on purchasing bonds with yields
below the deposit rate, alleviating the scarcity
premium attached to long-maturity bonds meeting
this criterion. While these adjustments are well
short of QE “tapering,” they have shifted the
market focus toward the eventual end of asset
purchases and the timing of the first ECB rate
hike—currently priced for late 2018.
With less ECB policy pressure on long-maturity
bonds, coupled with continued above-trend
Eurozone growth and some further normalization
in global term premiums, we expect 10-year bund
yields to increase to 0.5–1.0% by the end of 2017.
While overall peripheral bond spreads should be
mostly range-bound in 2017, political woes in
Italy and France pose upside risks to the spreads of
those countries.
In the UK, we expect gilt yields to reach 1.5–
2.25%. Here, persistently high headline inflation
induced by the depreciation of sterling and a
less-than-feared economic drag from Brexit thus
far could encourage the BOE to unwind a portion
of the preemptive easing it deployed in response to
the surprise referendum outcome.
Given this outlook and today’s still depressed
bond yields, we remain underweight UK and
Eurozone government bonds for European
Exhibit 90: European Government Bond Issuance
and ECB Purchases
ECB buying is outpacing net issuance of Eurozone bonds.
€ bn
400
200
0
-200
-400
-600
-800
Net Issuance ECB Purchases Net Issuance Including ECB Purchases
240 211
-626
Data as of December 31, 2016.
Source: Investment Strategy Group, JP Morgan.
investors. After all, just a 2 basis point increase in
German 10-year bund yields generates a capital
loss sufficient to offset an entire year of income.
That said, we should not confuse an underweight
with a zero weighting, as European clients should
retain some exposure to German bunds and other
high-quality Eurozone bonds in the “sleep-well”
portion of their portfolios. These high-quality
bonds would provide an attractive hedge in the
event of a Eurozone recession or the return of
deflationary concerns.
Emerging Market Local Debt
Last year’s 10% return for emerging market local
debt (EMLD) provided some solace to those who
have suffered through nearly three years of losses
totaling more than 30%. But investors had to
endure considerable volatility to realize this gain,
as returns fluctuated between -4% and +18% in
2016. In fact, the asset class lost roughly 5% in just
the last two months of the year.
This last point is important, since many of the
tailwinds that drove EMLD’s strong returns in the
first half of 2016 reversed toward year-end and are
likely to impact the asset class again in 2017. Here,
we refer specifically to the resumption of Federal
Reserve rate hikes, renewed US dollar appreciation
and a resumption of Chinese renminbi depreciation
against the dollar. Just as falling global interest
rates helped the asset class for the first part of
2016, so too should the rising rates we expect
-386
-511
2016 2017
-300
72 Goldman Sachs january 2017
Exhibit 91: EM Local Debt Currencies and
Developed Market Interest Rates
Rising global interest rates would be a headwind to EM
local debt.
Exhibit 92: S&P Goldman Sachs Commodity Total
Return Index
Commodities generated their first double-digit return
since 2009.
%
1.2
1.0
Average G3 10-Year Rate
EM Local Debt FX (Right, Inverted)
1/1/2016 = 100
94
96
Annual Returns (%)
60
40
98
0.8
100
20
2016 Return: 11%
0.6
102
0
0.4
104
-20
106
0.2
108
-40
0.0
Jan-16 Apr-16 Jul-16 Oct-16
Data through December 31, 2016.
Source: Investment Strategy Group, Bloomberg, Datastream.
110
-60
1980 1984 1988 1992 1996 2000 2004 2008 2012 2016
Data through December 31, 2016.
Source: Investment Strategy Group, Bloomberg.
represent a headwind this year (see Exhibit
91). Meanwhile, any boost to emerging market
exports from the modest pickup in global growth
we expect is likely to be dwarfed by ongoing US
trade policy uncertainty, European political risk
and China fears. Lastly, an acceleration of recent
outflows from EMLD markets could magnify these
risks, particularly since 60% of the cumulative
inflows into the asset class since 2004 are
experiencing losses at current market levels.
Although the number of concerns is large, so is
the risk premium of the asset class. As previously
seen in Exhibit 76, the currencies in the EMLD
index are 15% undervalued. From this starting
point, the asset class could deliver attractive total
returns if US trade policy proves to be more benign
than feared and China worries abate.
Considering this balance of risks, our central
case calls for low single-digit returns. While
positive, this return is not sufficient to justify
a tactical long position in EMLD in our view,
given the still considerable downside risks
discussed above.
Emerging Market Dollar Debt
Emerging market dollar debt (EMD) returned 10%
in 2016, capping a surprising four-year period
of outperformance that has greatly benefited
from stable US rates and dollar strength. But the
prospects for a fifth year of upside are questionable
for several reasons.
First, EMD’s almost seven-year duration is
a liability in a rising-rate environment. This is
particularly true now that the Federal Reserve
has resumed tightening policy, a fact evident in
EMD’s 4.3% drop in response to increasing rate
hike expectations late last year. Second, with
spreads standing near two-year lows, there is scope
for spread widening based on US and European
policy uncertainty and renewed China growth
fears. Third, countries accounting for 37% of
EMD—including Mexico, China, South Africa
and Brazil—have negative outlooks from at least
two rating agencies, raising the potential for
downgrades. 119 A potential default by Venezuela
and its national oil company could also sour
sentiment, as could unfavorable tariffs or trade
restrictions from the new US administration.
Finally, the backup in interest rates we expect
could raise funding costs for EM corporate issuers,
which could also heighten concerns about spillover
into EMD. Indeed, a recent stress test by Standard
& Poor’s revealed that EM corporate borrowers—
who must repay $200 billion per year through
2020 120 —are twice as susceptible to downgrades
as US corporates if dollar funding costs rise by
a third. 121
Based on the above, we do not recommend a
tactical position in EMD at this time.
Outlook
Investment Strategy Group
73
Exhibit 94: US Crude Oil Production
Supply has stabilized after declining by 1 million barrels/day
from its peak.
Exhibit 95: OPEC Crude Oil Production
OPEC producers have exceeded their quota 90% of the time
since 2000.
Million Barrels/Day
2.0
1.5
9.6
Million Barrels/Day
10
Million Barrels/Day
36
34
OPEC Production Subject to Quota
Historical OPEC Quota Levels
8.8
9
32
1.0
8.6
30
0.5
8
28
0.0
26
7
24
-0.5
YoY US Crude Production Change
US Crude Production Levels (Right)
22
-1.0
Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16
6
20
2000 2002 2004 2006 2008 2010 2012 2014 2016
Data through November 30, 2016.
Source: Investment Strategy Group, US Department of Energy.
Data through November 30, 2016.
Source: Investment Strategy Group, Bloomberg.
2017 Global Commodity Outlook
After losing more than half its value in the span
of two years, the S&P GSCI broke its downward
trend with an 11% gain in 2016, its first doubledigit
return since 2009 (see Exhibit 92). The
rebound in oil prices was a key contributor, as oil
finished the year with a staggering 52% spot price
gain—an outcome made all the more remarkable
by the fact that oil was down 25% at its worst
point early last year. This strength was not limited
to the oil patch, as industrial metals rallied 17%
on average and precious metals advanced 8% (see
Exhibit 93).
Despite last year’s broad-based gains, we are
more circumspect about the outlook for 2017.
While we expect oil to advance, it begins the
year closer to the midpoint of our target range,
providing a more balanced risk/reward profile.
Meanwhile, we believe the key elements of
our macroeconomic forecast—Federal Reserve
tightening, rising interest rates, modest US dollar
gains and average inflation—represent continued
headwinds to gold prices. Comparable headwinds
exist for industrial metals and agricultural goods,
given the continued slowdown we expect in
Chinese growth.
We discuss the specifics of our outlook for oil
and gold in the sections that follow.
Oil: Regaining Its Balance
Oil is finding its footing again after having
stumbled dramatically over the last two years.
While the market is still awash in oil inventories,
the sizable reductions in capital expenditures by
the largest international oil and gas companies
Exhibit 93: Commodity Returns in 2016
Most commodity subcomponents saw positive returns in 2016, reversing several years of declines.
S&P GSCI Energy Agriculture Industrial Metals Precious Metals Livestock
Spot Price Average, 2016 vs. 2015 -10% -14% 0% -6% 8% -17%
Spot Price Return 28% 48% 3% 19% 9% -10%
Excess Return* 11% 18% -5% 17% 8% -8%
Data as of December 31, 2016.
Source: Investment Strategy Group, Bloomberg.
* Excess return corresponds to the actual return from being invested in the front-month contract and differs from spot price return, depending on the shape of the forward curve. An upward-sloping
curve (contango) is negative for returns, while a downward-sloping curve (backwardation) is positive.
74 Goldman Sachs january 2017
Exhibit 96: OPEC 2016 Production Cut Agreement
and Recent Changes
If fully implemented, OPEC’s proposed cut would reverse
production growth from the prior 6 months.
Exhibit 97: US Energy Sector Ratio of Capital
Spending (Capex) to Depreciation
Low capex levels suggest there is upside to investment.
Million Barrels/Day
1.4 Production Change in 6 Months Leading up to
the November 2016 OPEC Meeting
1.2
November 2016 Agreed Cut
1.0
1.2
Ratio
3.5
3.0
Capex-to-Depreciation Ratio
Long-Term Average
0.8
2.5
0.6
0.4
0.2
0.0
-0.2
0.1 0.1
-0.1
0.2
0.1
0.5
0.1
0.1
-0.4
Algeria
Angola
Ecuador
Iran
Iraq
Kuwait
Libya
Nigeria
Qatar
Saudi
UAE
Venezuela
Total
2.0
1.5
1.0
1.04
0.89
0.5
0.0
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Data as of November 30, 2016.
Source: Investment Strategy Group, Bloomberg, OPEC.
Data through September 30, 2016.
Source: Investment Strategy Group, Empirical Research Partners.
suggest the transition toward a balanced market is
underway. The same could be said for the dramatic
cuts in US drilling budgets, which have precipitated
notable declines in US shale output (see Exhibit
94). Lower oil prices have also supported aboveaverage
global demand growth, helping to absorb
excess inventories. Lastly, OPEC agreed to
lower production in November 2016, while also
securing a promise from its significant non-OPEC
counterparts to do the same. Taken together, these
developments support our forecast for moderately
higher oil prices in 2017.
This balancing act is still precarious, however.
Oil inventories stand well above seasonal averages,
so failure to honor the announced production
cuts could delay the recovery in oil prices or, even
worse, cause renewed declines. The risk of poor
compliance is not trivial, given that producers
have exceeded their quota 90% of the time by an
average of 1 million barrels per day (mmbd) since
2000 (see Exhibit 95). The pledges from Russia
and certain smaller non-OPEC producers are
particularly suspect, as similar promises to cut their
Oil is finding its footing again after
having stumbled dramatically over
the last two years.
own output along with OPEC have been broken
in the past.
Moreover, while the announced cuts are
significant—the OPEC agreement would reduce
production by up to 1.2 mmbd, equivalent to
about one year of average global demand growth—
they are largely a reversal of production growth
seen over the last six months (see Exhibit 96).
Meanwhile, Libya and Nigeria were excluded from
these new OPEC quotas given sizable domestic
disruptions that have depressed their production.
Recent signs of improvement, however, suggest a
rebound in their production cannot be dismissed.
Therefore, the announced cuts are not a panacea to
the current oil imbalance, particularly if US shale
output increases meaningfully in response.
This last point is important, as US shale
accounted for 60% of global production growth
between 2012 and 2015 despite representing
less than 5% of the total output. Although US
production is now declining, two factors may
arrest its slide in 2017. First, the breakeven price
for shale drilling has fallen to an average of $50
per barrel, reflecting a 20% decline in
production costs and improvements to
the shale model, including faster drilling,
larger wells and better resource recovery.
In response, more than 200 oil rigs have
been placed in service since their number
troughed in May 2016. 122 Second, capital
spending by the US energy sector is
Outlook
Investment Strategy Group
75
Exhibit 98: Full-Year Average Global Crude Oil
Supply and Demand
Oil consumption in 2017 could exceed supply for the first
time since 2013.
Exhibit 99: Gold Prices and US 10-Year Real
Interest Rates
Gold prices and real interest rates are closely linked.
Million Barrels/Day
100
98
96
94
92
World Production
World Consumption
Production
Exceeded
Consumption
Between 2014 and 2016
World
Consumption
Exceeded
Production
Average Forecast
Supply/Demand
Forecasts Point to
Small Deficit in 2017
$/Ounce
2,000
1,600
1,200
%
-1.5
-1.0
-0.5
0.0
0.5
1.0
90
800
1.5
88
86
400
Gold Price
10-Year US Real Rate (Right, Inverted)
2.0
2.5
3.0
84
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016e 2017f
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
3.5
Data through December 31, 2016.
Source: Investment Strategy Group, Goldman Sachs Global Investment Research, International
Energy Agency, OPEC, US Department of Energy, Energy Aspects, PIRA, Bloomberg, Barclays,
JP Morgan.
Data through December 31, 2016.
Source: Investment Strategy Group, Bloomberg.
very depressed despite the recent uptick in rigs,
providing scope for further increases (see Exhibit
97). As a result, we expect shale production to
recover in 2017, partially offsetting cuts elsewhere.
Despite these potentially destabilizing forces,
we still think the oil market can swing to a small
deficit this year. While lower input costs create
upside risks to US shale production, these costs are
highly correlated with oil itself. As a result, today’s
$50 average breakeven level for shale is likely to
move higher with oil prices, limiting the rebound
in US production. Moreover, even if just half of
the proposed production cuts are realized, our
work suggests the oil market will still switch into a
deficit this year. Finally, OPEC spare capacity has
been largely exhausted by the production increases
of the last year, while Iran’s production has now
returned to pre-sanction levels. In turn, the risk of
another disorderly market-share battle has declined
significantly.
Against this backdrop, we expect oil supply
growth to moderate and enable oil demand to
again exceed oil production, creating the first
deficit since 2013 (see Exhibit 98). With balance
restored, we expect oil to trade in a $45–65 range
in the year ahead. Thus we continue to recommend
an overweight to US high yield energy bonds
and US MLPs.
Gold: Still Searching for Its Luster
Gold was not immune from the reversal of fortune
that befell interest rates last year, reminding us
that their fates are fundamentally linked (see
Exhibit 99). Put simply, higher interest rates raise
the opportunity cost of holding gold, since the
yellow metal generates no cash flow and must
be physically stored, often at a cost. A similarly
inverse relationship exists with the US dollar, as
investors often purchase gold as a hedge against
the debasement of fiat currencies; gold has traded
inversely to the dollar index 73% of the time on an
annual basis over the last 40 years.
Given these relationships, we believe the key
elements of our macroeconomic forecast—Federal
Reserve tightening, rising interest rates, modest US
dollar gains and average inflation—will represent
headwinds for the yellow metal in 2017. Keep in
mind that gold prices have declined in four of the
last five Federal Reserve tightening cycles, with
the only exception occurring during a period of
dollar weakness in the mid-2000s. Based on these
precedents, our expectation of two or three Federal
Reserve rate increases in 2017 does not bode well
for gold prices.
76 Goldman Sachs january 2017
Exhibit 100: Average Annual Gold Prices
Gold remains expensive relative to its inflation-adjusted
long-term average price.
2016 US $/Ounce
2,000
Annual Average Price
Long-Term Average
Post Bretton Woods Average
1,788
1,743
1,600
1,200
12/31/16
800
822
547
400
0
1871 1885 1899 1913 1927 1941 1955 1969 1983 1997 2011
Data through December 31, 2016.
Source: Investment Strategy Group, Bloomberg.
The same could be said of continued outflows
from gold exchange-traded funds (ETFs). We
estimate that a net 280 tonnes of gold ETF
holdings—an amount even larger than the 210
tonnes of ETF outflows that pressured gold prices
in late 2016—were purchased over the past year
at levels above today’s price. Absent a rebound
in gold prices, these ETF holders might prefer to
realize their losses and rotate into instruments with
a yield component. Value-minded investors should
also consider that gold prices remains well above
their long-term average (see Exhibit 100).
Despite this challenging outlook, a number
of factors could still buoy gold prices in the year
ahead. Emerging market central banks have
continued to buy gold to diversify their reserves.
Moreover, the stronger global growth we expect
could lift jewelry demand, particularly in gold’s
two largest end markets—China and India. Finally,
gold’s allure as an inflation hedge could come back
into focus if the market begins to worry about
economic overheating in the US, although this is
not our base case.
In light of these crosscurrents, we are tactically
neutral on gold at this time.
Outlook
Investment Strategy Group
77
78 Goldman Sachs january 2017
2017 OUTLOOK
In Closing
we do not believe the coming year will bring an end
to the prolonged run of positive performance for either the
US economy or the bull market for equities. Despite greater
uncertainties, including those tied to a new US administration,
the policy backdrop in the US will likely prove particularly
favorable for the economy, with looser fiscal policy, still easy
monetary policy and a lighter regulatory burden. As these
factors diminish the probability of recession in 2017, they
also support the case for clients remaining invested in global
equities at their strategic allocation. We believe US equity
gains are likely to be modest but still more attractive than the
comparable returns of investment alternatives such as cash
and bonds. And, as last year demonstrated, US equities often
surprise to the upside.
While we see the glass as half-full, there is no shortage of
risks—some of which have high probability and uncertain
impact for the year ahead—that could cause our forecasts for
the economy and asset class returns to miss the mark.
As always, we will adjust and communicate our views
accordingly should the economic, financial or geopolitical
backdrop change materially over the course of 2017.
Outlook
Investment Strategy Group
79
Abbreviations Glossary
ACA: Affordable Care Act
BEA: Bureau of Economic Analysis
BIS: Bank for International Settlements
BLS: Bureau of Labor Statistics
BOE: Bank of England
BOJ: Bank of Japan
CAGR: compound annual growth rate
CDS: credit default swap
CFO: chief financial officer
CFTC: Commodity Futures Trading Commission
CPI: consumer price index
EAFE: Europe, Australasia and the Far East
ECB: European Central Bank
EM: emerging market
EMD: emerging market dollar debt
EMLD: emerging market local debt
EMEA: Europe, the Middle East and Africa
EMU: European Monetary Union
EPS: earnings per share
ETF: exchange-traded fund
FTSE: Financial Times Stock Exchange
FX: Foreign Exchange
GBP: British pound
GDP: gross domestic product
GFC: global financial crisis
GIR: [Goldman Sachs] Global Investment Research
GPIF: Government Pension Investment Fund
GSCI: Goldman Sachs Commodity Index
NAHB: National Association of Home Builders
NATO: North Atlantic Treaty Organization
NBER: National Bureau of Economic Research
NIPA: national income and product accounts
NIRP: negative interest rate policy
OECD: Organisation for Economic Co-operation and Development
OPEC: Organization of the Petroleum Exporting Countries
PBOC: People’s Bank of China
PCE: personal consumption expenditures
PE: price to earnings
PPI: Producer Price Index
PPP: purchasing power parity
QE: quantitative easing
S&P: Standard and Poor’s
TIPS: Treasury Inflation-Protected Securities
TOPIX: Tokyo Price Index
UK: United Kingdom
US: United States
VAT: value-added tax
YoY: year-over-year
IGFI: Investment grade fixed income
IMF: International Monetary Fund
ISIL: Islamic State of Iraq and the Levant
ISM: Institute of Supply Management
JGB: Japanese government bond
LBO: leveraged buyout
LIBOR: London Interbank Offered Rate
LSI: Liquidity Stress Index
M&A: merger and acquisition
MLP: master limited partnership
mmbd: million barrels per day
MSCI: Morgan Stanley Capital International
Notes
1. Jeremy J. Siegel, Stocks for the
Long Run: The Definitive Guide
to Financial Market Returns
and Long-Term Investment
Strategies, McGraw-Hill, 1994.
2. Lisa Beilfuss, “As Dow Nears
20000, Stock-Market Believer
Jeremy Siegel Gets a ‘Told
You So’ Moment,” Wall Street
Journal, December 10, 2016.
3. Throughout the text, “post-
WWII cycles” refers to
expansions beginning in Q2
1954. We exclude two prior
expansions, beginning in Q4
1945 and Q4 1949, to ensure
consistent data across all
variables used to analyze
the duration and strength
of recoveries (some data
series are only available since
1950) as well as to avoid
contaminating summary
statistics given idiosyncratic
economic policies that followed
the end of WWII (such as the
sharp reduction in military
spending or the GI Bill). Our
takeaway from the analysis
would not change if 1945
and 1949 were included for
the series for which data is
available.
4. Edward Luce, “Goodbye to
Barack Obama’s World,”
Financial Times, November 27,
2016.
5. John H. Cochrane, “Ending
America’s Slow-Growth
Tailspin,” Wall Street Journal,
May 2, 2016.
6. Martin Wolf, “New President
Has an Economic In-Tray Full
of Problems,” Financial Times,
November 8, 2016.
7. Michael Heath, “Summers
Urges U.S. to Spend 1% of GDP
Annually on Infrastructure,”
Bloomberg, October 18, 2016.
8. Robert J. Gordon, The Rise and
Fall of American Growth: The
U.S. Standard of Living Since the
Civil War, Princeton University
Press, 2016.
9. Marc Levinson, An Extraordinary
Time: The End of the Postwar
Boom and the Return of the
Ordinary Economy, Basic Books,
2016.
10. Martin Jacques, When China
Rules the World: The End of the
Western World and the Birth of
a New Global Order, Penguin
Press, 2009.
11. N. Gregory Mankiw, “One
Economic Sickness, Five
Diagnoses,” New York Times,
June 17, 2016.
12. Carmen M. Reinhart and
Kenneth S. Rogoff, This Time
Is Different: Eight Centuries
of Financial Folly, Princeton
University Press, 2011.
13. Alvin H. Hansen, “Capital
Goods and the Restoration of
Purchasing Power,” Academy of
Political Science, 1934.
14. Alvin H. Hansen, “Economic
Progress and Declining
Population Growth,” American
Economic Review, 1939.
15. Lawrence H. Summers,
“Remarks,” speech delivered at
the Fourteenth Jacques Polak
International Monetary Fund
Annual Research Conference,
Washington, D.C., November
8, 2013.
16. Jay Shambaugh, “How
Should We Think About This
Recovery?” Macroeconomic
Advisers’ 26th Annual Policy
Seminar, Washington, D.C.,
September 14, 2016.
17. Michael E. Porter, Jan W.
Rivkin, Mihir A. Desai and
Manjari Raman, “Problems
Unsolved and a Nation
Divided,” Harvard Business
School, September 2016.
18. Council of Economic Advisers,
“The Long-Term Decline in
Prime-Age Male Labor Force
Participation,” June 2016.
19. Ibid.
20. Etienne Gagnon, Benjamin
K. Johannsen and David
Lopez-Salido, “Understanding
the New Normal: The Role
of Demographics,” Board
of Governors of the Federal
Reserve System, October 3,
2016.
21. Mitra Toossi, “A Century of
Change: The U.S. Labor Force,
1950-2050,” Monthly Labor
Review, Bureau of Labor
Statistics, May 2002.
22. Donald J. Trump, “Remarks,”
speech delivered at the New
York Economic Club, September
15, 2016.
23. Chair Janet L. Yellen, “Current
Conditions and the Outlook
for the U.S. Economy,” June 6,
2016. Vice Chairman Stanley
Fischer, “Remarks on the U.S.
Economy,” August 21, 2016.
24. Robert J. Gordon, The Rise and
Fall of American Growth: The
U.S. Standard of Living Since the
Civil War, Princeton University
Press, 2016.
25. Stephanie H. McCulla, Alyssa
E. Holdren and Shelly Smith,
“Improved Estimates of the
National Income and Product
Accounts: Results of the 2013
Comprehensive Revision,”
Bureau of Economic Analysis,
September 2013.
26. Paul Krugman, The Age of
Diminished Expectations: U.S.
Economic Policy in the 1990s,
MIT Press, 1990.
27. Lee Branstetter and Daniel
Sichel, “Seven Reasons to Be
Optimistic About Productivity,”
forthcoming.
28. Ibid.
29. Olivier Blanchard, “The State
of Advanced Economies and
Related Policy Debates: A Fall
2016 Assessment,” Peterson
Institute for International
Economics, September 2016.
30. Martin Feldstein, “Remarks,”
speech delivered at the
Brookings Institution
Conference on Productivity,
Washington, D.C., September
8, 2016.
31. Jan Hatzius, “Productivity
Paradox v2.0 Revisited,”
Goldman Sachs Global
Investment Research,
September 2, 2016.
32. David M. Byrne, Stephen D.
Oliner and Daniel E. Sichel,
“How Fast Are Semiconductor
Prices Falling?” Federal Reserve
Board, March 2015.
33. Hal Varian, “A Microeconomist
Looks at Productivity: A View
from the Valley,” September
2016.
34. Ibid.
35. Hal Varian, “Notes on
Productivity and Intangibles,”
November 2016.
36. Chad Syverson, “Challenges to
Mismeasurement Explanations
for the U.S. Productivity
Slowdown,” University of
Chicago Booth School of
Business, June 2016.
37. David M. Byrne, John G.
Fernald and Marshall B.
Reinsdorf, “Does the United
States Have a Productivity
Slowdown or a Measurement
Problem?” Brookings
Institution, March 1, 2016.
38. David Byrne and Carol Corrado,
“ICT Prices and ICT Services:
What Do They Tell Us About
Productivity and Technology?”
Conference Board, July 2016.
39. David Byrne, Wendy Dunn and
Eugenio Pinto, “Prices and
Depreciation in the Market for
Tablet Computers,” Federal
Reserve Board, December 2016.
40. Greg Ip, “The Economy’s Hidden
Problem: We’re Out of Big
Ideas,” Wall Street Journal,
December 5, 2016.
41. Johan Norberg, Progress: Ten
Reasons to Look Forward to the
Future, Oneworld Publications,
2016.
42. Fredrik Erixon and Björn Weigel,
The Innovation Illusion: How
So Little Is Created by So
Many Working So Hard, Yale
University Press, 2016.
43. N. Gregory Mankiw, “One
Economic Sickness, Five
Diagnoses,” New York Times,
June 17, 2016.
44. Alan S. Blinder and Mark W.
Watson, “Presidents and the
U.S. Economy: An Econometric
Exploration,” Princeton
University, July 2014.
45. Jay Shambaugh, “How
Should We Think About This
Recovery?” Macroeconomic
Advisers’ 26th Annual Policy
Seminar, Washington, D.C.,
September 14, 2016.
46. Lawrence H. Summers, “When
the Best Umps Blow a Call,”
Washington Post, July 14, 2016.
47. Martin Neil Baily and Nicholas
Montalbano, “Why Is US
Productivity Growth So Slow?
Possible Explanations and
Policy Responses,” Brookings
Institution, September 1, 2016.
48. Kevin Daly, “Arrested
Development: EMs Are Still
Converging, but Productivity
Growth Is Lower Everywhere,”
Goldman Sachs Global
Investment Research,
December 20, 2016.
49. Molly E. Reynolds and Philip A.
Wallach, “The Fiscal Fights of
the Obama Administration: An
Interactive Timeline,” Brookings
Institution, December 8, 2016.
50. As measured by the Goldman
Sachs Financial Conditions
Index.
51. “Default Monitor,” JP Morgan,
December 1, 2016.
52. Investment Strategy Group,
Outlook: The Last Innings,
January 2016.
53. These forecasts have
been generated by ISG for
informational purposes as of
the date of this publication.
Total return targets are
based on ISG’s framework,
which incorporates historical
valuation, fundamental and
technical analysis. Dividend
yield assumptions are based on
each index’s trailing 12-month
dividend yield. They are based
on proprietary models and
there can be no assurance
that the forecasts will be
achieved. Please see additional
disclosures at the end of this
publication. The following
indices were used for each
asset class: Barclays Municipal
1-10Y Blend (Muni 1-10); BAML
US T-Bills 0-3M Index (Cash);
JPM Government Bond Index
Emerging Markets Global
Diversified (Emerging Market
Local Debt); HFRI Fund of Funds
Composite (Hedge Funds);
MSCI EM US$ Index (Emerging
Market Equity); Barclays US
Corporate High Yield (US High
Yield); Barclays US High Yield
Loans (Bank Loans); MSCI UK
Local Index (UK Equities); MSCI
EAFE Local Index (EAFE Equity);
S&P Banks Select Industry
Index (US Banks); TOPIX Index
(Japan Equity); Barclays High
Yield Municipal Bond Index
(Muni High Yield).
54. LIBOR, the London Interbank
Offered Rate, is calculated as
the average of leading banks’
estimates of the interest rates
that they would be charged
were they to borrow from other
banks. It is one of the primary
benchmarks for global shortterm
interest rates.
55. Spain is the only Eurozone
country in which all banks clear
all of the following capital
hurdles: (1) CET1 ratio >100 bps
above each bank’s hurdle rate
(5.5% + GSIB buffer, where
applicable); (2) 4% leverage
ratio in the ECB stress test
base case scenario; and (3)
2% leverage ratio in the ECB
stress test adverse scenario.
Jernej Omahen, “Stress Test:
Worst Fears Avoided; Capital
Divergence Widens,” Goldman
Sachs Global Investment
Research, July 31, 2016.
56. Gideon Rachman, “Marine Le
Pen Looms Over a Trumpian
World,” Financial Times,
November 21, 2016.
57. Charles Lichfield, “Fillon
Presidency Now More Likely
Than a Juppé One,” Eurasia
Group, November 21, 2016.
58. Charles Lichfield, “Attack
Demonstrates Merkel’s
Vulnerability in 2017,” Eurasia
Group, December 20, 2016.
59. Alastair Gale and Kwanwoo
Jun, “North Korea Says It
Successfully Conducted
Hydrogen-Bomb Test,” Wall
Street Journal, January 6, 2016.
60. Kwanwoo Jun, “North Korea
Launches Missile From
Submarine,” Wall Street
Journal, April 24, 2016.
61. Alastair Gale and Gordon
Lubold, “North Korea Missile
Launch Portends Growing
Capabilities,” Wall Street
Journal, June 22, 2016.
62. Alastair Gale and Carol E. Lee,
“North Korea Conducts Fifth
Nuclear Test,” Wall Street
Journal, September 9, 2016.
63. Mike Mullen, Sam Nunn and
Adam Mount, “A Sharper
Choice on North Korea:
Engaging China for a Stable
Northeast Asia,” Council on
Foreign Relations, Independent
Task Force Report No. 74,
September 2016.
64. David Gordon (adjunct senior
fellow at the Center for a
New American Security), in
a conference call with the
Investment Strategy Group,
December 15, 2016.
65. Gerald F. Seib, Jay Solomon and
Carol E. Lee, “Barack Obama
Warns Donald Trump on North
Korea Threat,” Wall Street
Journal, November 22, 2016.
66. Andrew E. Kramer, “As New
Ukraine Talks Begin, What
Is the State of Europe’s Only
Active War?” New York Times,
October 19, 2016.
67. Warsaw Summit Communiqué,
issued by the heads of state
and government participating
in the meeting of the North
Atlantic Council in Warsaw,
July 8–9, 2016.
68. Thomas Gibbons-Neff, “2,900
Explosions in a Day. Heavy
Artillery and Tank Fire Returns
to the Front Lines in Ukraine.”
Washington Post, December
20, 2016.
69. Warsaw Summit Communiqué,
issued by the heads of state
and government participating
in the meeting of the North
Atlantic Council in Warsaw,
July 8–9, 2016.
70. “Transcript: Donald Trump on
NATO, Turkey’s Coup Attempt
and the World,” New York
Times, July 21, 2016.
71. Ben Hubbard and David E.
Sanger, “Russia, Iran and
Turkey Meet for Syria Talks,
Excluding US,” New York Times,
December 20, 2016.
72. John Davison and Stephanie
Nebehay, “Syrian Peace Talks
Limp on to Next Week with
Opposition Absent,” Reuters,
April 22, 2016.
73. Anne Barnard, “Death Toll From
War in Syria Now 470,000,
Group Finds,” New York Times,
February 11, 2016.
74. Jessica Hartogs, “Syria War
Could Cost Country $1.3T by
2020: Study,” CNBC, March
8, 2016.
75. Zalmay Khalilzad, “America
Needs a Bipartisan Foreign
Policy. Donald Trump Can Make
It Happen,” National Interest,
December 21, 2016.
76. Geoff Dyer, “Trump’s CIA
Nominee Mike Pompeo
Promises to Roll Back Iran
Deal,” Financial Times,
November 18, 2016.
77. General (Ret.) James N.
Mattis, speech delivered at a
conference at the Center for
Strategic and International
Studies, “The Middle East at
an Inflection Point with Gen.
Mattis,” April 22, 2016.
78. Ibid.
79. Carol E. Lee and Jay Solomon,
“Obama Seeks to Fortify Iran
Nuclear Deal,” Wall Street
Journal, November 20, 2016.
80. Kristina Peterson, “House
Passes 9/11 Bill That Would
Let Victims’ Families Sue Saudi
Arabia,” Wall Street Journal,
September 9, 2016.
81. Melissa Eddy and Alison Smale,
“Berlin Crash Is Suspected to
Be a Terror Attack, Police Say,”
New York Times, December
19, 2016.
82. Tom Burgis, Arthur Beesley and
Anne-Sylvaine Chassany, “ISIS
Claims Responsibility for Attack
in Nice,” Financial Times, July
17, 2016.
83. Pervaiz Shallwani and Devlin
Barrett, “How Police Tracked
Down Bombing Suspect Ahmad
Khan Rahami,” Wall Street
Journal, September 20, 2016.
84. Ben S. Bernanke, “How Do
People Really Feel About
the Economy?” Brookings
Institution, June 30, 2016.
85. Joint Statement, Department of
Homeland Security and Office
of the Director of National
Intelligence on Election
Security, October 7, 2016.
86. Courtney Weaver, Sam Fleming
and Kathrin Hille, “US Expels
Russian Spies over Election
Hacking,” Financial Times,
December 29, 2016.
87. Vindu Koel and Nicole Perlroth,
“Yahoo Says 1 Billion User
Accounts Were Hacked,” New
York Times, December 14, 2016.
88. Laura Sanders, “IRS Says
Cyberattacks on Taxpayer
Accounts More Extensive Than
Previously Reported,” Wall
Street Journal, February 26,
2016.
89. Dustin Volz and Jason Lange,
“Exclusive: FBI Probes FDIC
Hack Linked to China’s Military
– Sources,” Reuters, December
23, 2016.
90. Daniel Victor, “LinkedIn Says
Hackers Are Trying to Sell Fruits
of Huge 2012 Data Breach,”
New York Times, May 18, 2016.
91. Jamil Anderlini, “Beijing Clamps
Down on Forex Deals to Stem
Capital Flight,” Financial Times,
September 9, 2015.
92. Frank Tang, “China’s Foreign
Reserves Fall Again in
November Even as Beijing
Tightens Screws on Capital
Outflows,” South China Morning
Post, December 7, 2016.
93. Wendy Wu, “What China Has
Done to Stop Massive Amounts
of Cash from Fleeing the
Country,” South China Morning
Post, December 9, 2016.
94. Marcus Noland, Gary Clyde
Hufbauer, Sherman Robinson
and Tyler Moran, “Assessing
Trade Agendas in the US
Presidential Campaign,”
Peterson Institute for
International Economics,
September 2016.
95. Robert D. Blackwill, Henry
Kissinger and Ashley J. Tellis,
“Revising U.S. Grand Strategy
Toward China,” Council on
Foreign Relations Press, April
2015.
96. David Brunnstrom, “China
Installs Weapons Systems on
Artificial Islands,” Reuters,
December 15, 2016.
97. Mark Landler and David E.
Sanger, “Trump Speaks with
Taiwan’s Leader, an Affront
to China,” New York Times,
December 2, 2016.
98. Kate O’Keeffe and Damian
Paletta, “Tensions Linger Over
Seizure of Survey Drone in
South China Sea,” Wall Street
Journal, December 18, 2016.
99. Based on aggregated balance
sheet data for the Federal
Reserve, European Central
Bank, Bank of Japan, Bank
of England, Swiss National
Bank and People’s Bank of
China. Source: Bloomberg,
Datastream.
100. Federal Reserve Board Chair
Janet Yellen, exchange with
ABC News reporter Rebecca
Jarvis, December 2015.
101. Federal Reserve Chair Janet
Yellen, ”The Economic Outlook
and Monetary Policy,” speech
delivered at the Economic Club
of Washington, December 2,
2015.
102. Based on Goldman Sachs
Global Investment Research
estimates.
103. Based on the European
Commission investment survey.
104. Arnold Palmer, www.
arnoldpalmer.com/bio.
105. Beginning in September 1945.
106. Elroy Dimson, Paul Marsh and
Mike Staunton, Triumph of the
Optimists: 101 Years of Global
Investment Returns, Princeton
University Press, 2002. © 2013
Elroy Dimson, Paul Marsh and
Mike Staunton. As cited in
Credit Suisse Global Investment
Returns Yearbook 2013,
February 2013.
107. December 2016 FOMC
Statement of Economic
Projections.
108. Peter Oppenheimer, “‘Fat &
Flat’ with a Resurgence of
Divergence,” Goldman Sachs
Global Investment Research,
December 5, 2015.
109. Anna Kitanaka, Yuji Nakamura
and Toshiro Hasegawa, “The
Bank of Japan’s Unstoppable
Rise to Shareholder No. 1,”
Bloomberg, August 14, 2016.
110. As evidenced by SoftBank’s
recent pledge to invest $50
billion in the US. Michael J.
de la Merced, “After Meeting
Trump, Japanese Mogul
Pledges $50 Billion Investment
in the U.S.,” New York Times,
December 6, 2016.
111. The Plaza Accord was an
agreement between the
governments of France, West
Germany, Japan, the United
States and the United Kingdom
to depreciate the US dollar in
relation to the Japanese yen
and German Deutsche Mark
by intervening in currency
markets. Source: Jeffrey
Frankel, “The Plaza Accord, 30
Years Later,” Harvard Kennedy
School, December 10, 2015.
112. Stu Wood, Rick Carew and Eva
Dou, “SoftBank to Buy ARM
Holdings for $32 Billion,” Wall
Street Journal, July 18, 2016.
113. Since April 1946.
114. Karen Reichgott, “Fiscal Policy:
A Modest Boost to Global
Growth in 2017,” Goldman
Sachs Global Investment
Research, December 8, 2016.
115. Sources: Citi, Barclays, Morgan
Stanley, JP Morgan.
116. Bank of America, “2016
Outlook: May the Odds Be Ever
in Your Favor,” November 24,
2015.
117. Matthew Jozoff and Alex
Roever, “US Fixed Income
Markets – 2017 Outlook,” JP
Morgan, November 23, 2016.
118. Lofti Karoui, “Credit Notes:
2016: The Year of Extremes
in 20 Charts,” Goldman Sachs
Global Investment Research,
December 20, 2016.
119. Rating agencies referenced are
Moody’s, Standard & Poor’s
and Fitch Ratings.
120. Yang-Myung Hong, Alisa
Meyers and Zubair K. Syed,
“2017 Outlook – Clouds of
Uncertainty Shroud the Outlook
in Fat Tails,” JP Morgan,
November 2016.
121. Standard & Poor’s,“Rising
Interest Spreads, US
Corporates Would Fare Better
than Others,” December 2016.
122. Data is from Baker Hughes rig
counts.
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© 2017 Goldman Sachs. All rights reserved.
The co-authors give special thanks to:
Paul Swartz
Vice President
Amneh AlQasimi
Associate
Michael Murdoch
Associate
David Hulme
Analyst
Additional contributors from the
Investment Strategy Group include:
Venkatesh Balasubramanian
Vice President
Thomas Devos
Vice President
Andrew Dubinsky
Vice President
Oussama Fatri
Vice President
Howard Spector
Vice President
Giuseppe Vera
Vice President
Harm Zebregs
Vice President
Lili Zhu
Vice President
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