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    Investment Ideas 2022

    LOOKING BEYOND US EQUITIES

    It may be time to diversify into other regions and global thematic strategies.

    The S&P 500 rose 28% in 2021, once again outperforming non-US markets. In fact, annualized returns for the S&P 500 over the past 10 years are more than double the MSCI Europe Index and three times the MSCI Emerging Markets Index.

     

    We think US equities could still generate strong returns but the balance of risk and reward points to diversifying into other regions, global thematic strategies and sub asset classes, such as small caps. We highlight three key reasons: unique risks to US equities, weaker drivers of recent US equity returns and the potential opportunity cost of not investing in other markets.

     

    US equities have two particular vulnerabilities versus other regions: valuations and concentration. Valuations for US stocks are high relative to their own history and relative to other regions the S&P 500 still trades at a premium even after adjusting for its larger weightings to higher valued sectors, such as technology (Exhibit 6). 

     

    Exhibit 6: US equities are at a premium to the rest of the world also when controlling for sector composition

     

    Source: FactSet, Goldman Sachs Global Investment Research. As of September 30, 2021.

     

    The US equity market is also exceptionally concentrated—which is not the case in most other major equity markets. Roughly 20% of the market capitalization of the S&P 500 is in just five stocks1, leaving investors overexposed to these companies, some of which may also be subject to increasing regulation and taxes. 

     

    Some of the key drivers of recent US equity outperformance may not be as pronounced going forward. The US equity market benefitted from the extraordinary growth and performance of the technology sector over the past decade (Exhibit 7). We believe technological innovation will continue to drive growth in the US tech sector, but we don t expect the same rate of growth and multiple expansion in the coming decade as technological innovation spreads across sectors and around the world. As a result, US earnings forecasts for the next couple of years look more in line with other regions, suggesting more similar equity market performance.

     

    Exhibit 7: Net Income contribution by sector to S&P 500, 1976-2021

    Source: Compustat, FactSet, Goldman Sachs Global Investment Research. As of September 30, 2021.

     

    Record-low interest rates over much of the last decade also helped fuel both corporate growth and the equity rally in the US, but rates are now set to rise. For active investors, US equities can still offer exposure to secular growth trends and companies that can benefit in an environment of rising inflation and interest rates. But the cost of missing out on strong secular growth opportunities in other regions could be high. As alpha becomes more important in a lower return environment, investors may benefit from having the widest opportunity set possible and not limiting investments to the US. 

          

    Investment Ideas to Consider

    Thematic Investing

    Global thematic strategies that transcend traditional classifications based on region, market capitalization or sector are more targeted ways to capture secular growth driven by innovation, sustainability or changing consumer trends. These portfolios seek to take advantage of alpha opportunities across all sectors, market caps and regions­—including the US to maximize returns.

     

    Opportunities in EM, Euro Equities

    Non-US equities, such as EMs, Europe and Japan, may be attractive complements to US equities, and are currently trading at lower valuations for potentially similar levels of earnings growth. EM are highly exposed to secular growth trends such as increased spending from millennials: for example, Chinese millennials are expected to overtake US millennials in aggregate income over the coming decade fueling a consumption boom. EM also have sizeable exposure to commodities, which may be helpful in an inflationary environment. The MSCI Europe Index has more cyclical exposure than the S&P 500, offers higher-dividend yields and is home to leaders in sustainable investing: eight out of the 102 of biggest clean energy companies are in Europe. Valuations and earnings growth for Japanese companies also look compelling in a Covid-recovery catch-up economy. Within the US, we see potential opportunities in small-cap stocks.

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