Monthly Market Pulse: July

Macro Views

China Growth

China’s post-reopening recovery slowed in 2Q 2023, and GIR now expects full-year GDP growth of 5.4%, from 6.0% earlier. Near-term headwinds from a property slowdown and confidence deficit may outweigh tailwinds from growth momentum. Still, strong excess savings and a services-led rebound may limit further growth weakening. Read More

DM Growth

Developed economies have shrugged off rapid hiking campaigns and credit tightening, and growth appears resilient enough to avoid officially-declared recessions. Strong consumer spending has propped up growth in the US, UK, and Euro area. Meanwhile, sticky services inflation and wage growth pose key risks to the Fed, BoE, and ECB, who each may extend their respective tightening campaigns. Read More

Monetary Policy

The Fed surprised investors by forecasting two additional 25 bp hikes in its dot plot, indicating a terminal rate of 5.50%-5.75%. After 500 bps of rate hikes and the prospect for more, messaging may be more impactful than the absolute rate. In Europe, GIR updated their terminal rate forecasts for the BoE and ECB to 5.75% and 4.00%, respectively, as inflation, not growth, poses the biggest threat. Read More

Diverging Data

Depressed sentiment and the “imminent recession” narrative have driven soft data to underperform hard data since October 2022. A possible culprit is less reliable business surveys due to lower response rates and higher measurement error. Improvements in soft data hinge on lower uncertainty in rate stabilization or inflation deceleration. Still, GIR places less emphasis on soft data, which may continue to underperform economic reality in 2023. Read More

Market Views

US Equities

GIR revised their year-end S&P 500 price target from 4000 to 4500 as resilient economic growth, slowing inflation, and mega-cap tech dominance drive valuation higher. Furthermore, the left-tail risks of a US recession and more aggressive Fed have diminished, while a right-tail risk has emerged from a potential AI profit boost. Still, we are near-term cautious as narrow market breadth represents increased drawdown risk, and investor equity positioning has now become stretched. Read More

Ex-US Equities

GIR upgraded their year-end STOXX 600 price target from 470 to 480 given moderating inflation, peaking interest rates, and positive real income growth. We also believe high dividends, robust EPS upgrades, and relatively cheap valuations are additional tailwinds. Elsewhere, GIR upgraded their year-end TOPIX price target from 2050 to 2400 following progress on favorable corporate governance reforms. Read More

EM Equities

EM has typically outperformed DM when 1) EM-DM growth differentials are rising, 2) the US dollar is weakening, 3) commodity prices are rising, 4) S&P 500 returns are low but positive, and 5) relative valuations start low. The latter three conditions have arguably been met, and we expect a resumption in US dollar weakness. Ultimately, durable consumer-led EPS growth has kept us favorable on EM equities. Read More

Yield Curve

The 2s10s US Treasury yield curve seems too inverted versus macro data. Still, we expect this US yield curve inversion to persist through the next year as markets appear anchored to equilibrium rates well-below potential GDP. We believe curve inversion will only resolve through front-end easing and longer-term real rate normalization, both of which may take longer than investors anticipate. Read More

High on Muni

When late cycle conditions prevail, the general rule of thumb for many investors has been to lean toward quality fixed income. However, we believe high yield muni is one area where the risk-return asymmetry is in an investor’s favor. With elevated tax-equivalent yields and low defaults, muni credit has become core to addressing many investor objectives. Furthermore, traditional summer technical tailwinds have historically unlocked further price upside amid already attractive coupons.

A BLEND OF ‘GOOD’ AND ‘GOOD’

The great yield reset has favored muni bonds over many other spread sectors, lifting muni yields across the credit spectrum to a two-decade high. On a tax-equivalent basis, muni bonds have outyielded their respective taxable counterparts by nearly 15%. With defaults historically low, one-off in nature, and unlikely to turn in the short term, we believe moving down in credit may unlock an incremental yield pick-up for investors without having to sacrifice on quality.

ADDRESSING MANY PORTFOLIO NEEDS

In our view, few asset classes may solve for as many investor needs as effectively as high yield muni. We observed that optimal muni bond portfolios prioritizing positive returns, risk reduction, or maximum Sharpe ratio all feature significant allocations to high yield muni. While the precise portfolio weight may likely differ across investor risk appetite, one general observation is the potential benefit and room to owning more.

HIGH TIME FOR HIGH YIELD MUNI

We believe considering high yield muni in portfolios is a year-round strategy, but low summer issuances have provided a seasonal kick that historically has enriched returns. With risk assets already at high valuations, investors seeking income may find high yield muni to be complementary in portfolios. The asset class has offered access to near double-digit tax-equivalent yields¹ today, favorable fundamentals (diversified revenues and elevated cash reserves), and a low correlation to the US equity market.

Top Section Notes: As of May 31, 2023, latest available. Cumulative default rate shows the empirical incidence of default for a credit from 1970 – 2021 which would have otherwise remained outstanding over a fixed time horizon. Middle Section Notes: As of May 31, 2023. Chart shows optimal muni bond portfolio weights for three illustrative portfolios using monthly data from June 2013 to May 2023. Bottom Section Notes: As of May 31, 2023. ¹ Yield of the Bloomberg Municipal High Yield Bond Index. Goldman Sachs does not provide accounting, tax, or legal advice. Please see additional disclosures at the end of this document. Please see additional disclosures at the end of this document. Past performance does not guarantee future results, which may vary.

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