Half Full: The Case for Remaining Invested in US Equities

Episode Summary

Executive Summary: Goldman Sachs’ Charmaine Mosevara-Romani argues for staying overweight U.S. equities in 2017 despite high valuations, citing a favorable economic and policy backdrop, low recession odds, and the enduring gap in U.S. preeminence versus other countries. She also highlights China as the main global risk, while viewing Europe’s populism, inflation, and short-term volatility as less threatening to the U.S. outlook.

Main Topics: Case for U.S. Equity Preeminence (Priority: 5/5): The CIO argues that U.S. equities remain the best core asset because the U.S. has stronger growth, innovation, and structural advantages than other developed markets. Favorable Global and U.S. Policy Backdrop (Priority: 5/5): Low real rates, continued central bank support, and anticipated fiscal stimulus in the U.S., Europe, and Japan are presented as powerful tailwinds for equities. Why the Slow Recovery Is Still 'Half Full' (Priority: 4/5): The recovery is slow by historical standards, but balance-sheet repair, household deleveraging, and resilience to shocks make the expansion healthier than it appears. Productivity, Demographics, and Mismeasurement (Priority: 4/5): Weak productivity and aging demographics are acknowledged, but the discussion emphasizes historical cycles and possible GDP undercounting from technology-related mismeasurement. Inflation and Interest Rate Outlook (Priority: 3/5): Despite fiscal stimulus concerns, the view is that global excess capacity and weak demand will keep inflation subdued and rate hikes gradual. Major Global Risks: China, Populism, Geopolitics (Priority: 5/5): China is framed as the key high-risk, high-impact threat due to debt and capital outflows, while European populism and geopolitical tensions are seen as more manageable. Why Stay Invested Despite Lower Return Expectations (Priority: 4/5): Even with muted expected returns, U.S. equities are preferred over cash and bonds, and tax costs make selling unattractive for taxable investors.

Key Arguments: U.S. equities remain attractive because the economic backdrop is favorable: U.S. growth should improve in 2017, developed markets broadly are strengthening, and emerging markets are recovering modestly. Policy support is unusually strong: real rates remain negative in major developed economies, central bank balance sheets are still supportive, and fiscal policy is shifting from austerity to stimulus. Valuation alone is not a good timing signal; history shows investors who exited too early missed substantial upside, including nearly 200% returns in the mid-1990s example. The recovery has been slower than average, but household and corporate deleveraging has reduced vulnerability and should support future consumption. Concerns about demographics are valid, but labor-force participation and recovery per worker can be viewed in context, and some participation issues are addressable. Weak productivity may be overstated because technology and digital services are difficult to measure accurately in GDP statistics. Inflation is unlikely to accelerate sharply because global excess capacity remains large and demand is weak in many major economies. China is the largest risk because its credit boom, debt burden, and capital outflows resemble conditions that have preceded crises elsewhere. The direct U.S. exposure to China is limited, but market sentiment could transmit shocks indirectly through financial conditions and confidence. Even with lower forward returns, U.S. equities are still the best core asset versus cash or bonds, and selling would trigger taxes and reinvestment risk.

Data Points: U.S. equity valuation rarity: More expensive only 10% of the time since World War II - Used to argue that high valuations alone are not a reason to leave U.S. equities Probability of U.S. recession: 15% - Goldman Sachs’ view of recession odds in the U.S. for the year ahead Probability of positive equity returns during expansion: 86% - Supports staying invested when the economy is expanding Historical downside of exiting in mid-1990s: Just under 200% returns left on the table - Example showing the cost of leaving equities too early U.S. growth rate: Better in 2017 than 2016 - Part of the favorable economic backdrop for U.S. equities Fed rate hikes expected: 2 to 3 times - Expected U.S. monetary tightening, though still leaving real rates negative Real rates in major developed economies: Negative - Indicates continued easy monetary policy U.S. recovery growth rate: Just over 2% - Recovery since the trough of the financial crisis Average post-World War II recovery growth: About 4% - Shows this recovery has been slower than historical averages Prime-age male labor-force participation: Worse than most OECD countries; only Italy and Israel are worse - Illustrates U.S. labor-market weakness in participation Productivity growth in weak period: Just over 1% - Recent 10-year window of low productivity growth Productivity growth in strong periods: About 3% - Illustrates that productivity moves in cycles Mismeasurement estimate: About 0.7% - Jan Hatsius’ estimate of GDP undercounting from tech-related measurement issues China credit-to-GDP gap: 30% in Q2 2016 - Goldman Sachs cites this as a high-risk signal for potential crisis U.S. credit-to-GDP gap at financial crisis: 12.4% in 2009 - Reference point showing that China’s credit gap is far higher Threshold for elevated credit risk: Above 10 - BIS benchmark cited for crisis risk China capital outflows: About $1.3 trillion - Evidence of stress and contrast with U.S. inflows Direct U.S. bank exposure to China: Less than 1% of bank assets - Shows limited direct financial exposure Corporate profits exposure to China: Less than 1% - Used to argue direct earnings impact is limited U.S. exports to China: Less than 1% of GDP; 6% to be more precise - Illustrates limited direct trade dependence U.S. oil output: 9 to 10 million barrels a day - Example of U.S. energy strength supporting preeminence Cash return expectation: Less than 1% - Reason to prefer equities over cash Bond return expectation: 0% to 1% - Reason to prefer equities over bonds

Pivotal Quotes: "Austerity is out, and fiscal stimulus is in." — Charmaine Mosevara-Romani: Summarizing why policy should support equities in 2017 "the gap between the U.S. and the rest of the world is actually widening." — Charmaine Mosevara-Romani: Core thesis behind U.S. preeminence "China is going to have a problem." — Charmaine Mosevara-Romani: Her strongest warning about the main high-risk global issue

Implications: Listeners should expect Goldman to favor U.S. risk assets, especially equities, while treating China as the main macro tail risk. Near-term volatility may rise, but the base case remains constructive for U.S. markets and cautious on cash, bonds, and China exposure.