(Un)Steady as She Goes: 2018 Investment Outlook

Episode Summary

Executive Summary: Goldman Sachs’ 2018 outlook argues the bull market and economic recovery still have room to run, supported by steady growth, low/stable inflation, strong earnings, and synchronized global expansion. Risks remain—geopolitics, trade tensions, cyber threats, and crypto speculation—but they are framed as potential sources of short-term volatility, not reasons to abandon equities.

Main Topics: Steady recovery and continued bull market (Priority: 5/5): Mosavar-Rahmani says the central thesis remains that the U.S. and global recovery still have “more innings left,” with growth, earnings, and market appreciation continuing despite rising concern about the cycle’s age. Why the bull market has lasted (Priority: 5/5): The long run-up is attributed to the slow but durable post-crisis recovery, steady earnings growth, low inflation, and low inflation volatility, all of which support higher market multiples. Market fatigue and recent correction risk (Priority: 4/5): The market is not viewed as exhausted because investor flows have favored bonds over equities for years. Recent investor euphoria in late 2017/early 2018 made a 5%–10% correction likely, but not a structural reversal. Valuation and the limits of mean reversion (Priority: 4/5): High valuations alone are not a reliable signal to underweight equities over a 1–3 year horizon. The team argues valuation is more useful for identifying when to overweight equities, especially when cheap. Broad market participation beyond tech (Priority: 4/5): The rally is not solely a FANG-driven story; broad earnings strength and modest sector dispersion indicate the advance has been wider than many headlines suggest. Low volatility and policy stability (Priority: 4/5): Low equity volatility is linked to low/stable inflation, stable rates, synchronized global growth, and predictable central-bank communication. The firm expects easy monetary conditions to persist for at least another year. Risks: geopolitics, trade, and cryptocurrencies (Priority: 5/5): North Korea, U.S.-China trade tensions, terrorism, cyberattacks, and crypto mania are identified as sources of downside volatility. These could cause pullbacks, but are not expected to derail the broader expansion.

Key Arguments: The 2018 outlook remains constructive: economic growth, earnings growth, and market appreciation are still on track, so investors should stay invested in equities. The bull market has persisted because the recovery has been slow but steady, with low inflation and low inflation volatility supporting stronger valuations. Investor behavior does not show classic late-cycle euphoria; instead, funds have flowed heavily into bonds, while equities have seen net outflows, suggesting limited fatigue. A short-term correction was expected after a surge in optimism in late 2017, with the firm assigning a very high probability to a 5% decline and meaningful odds of a 10% decline. Valuation should not be used as a stand-alone timing tool to exit equities because historical episodes show investors can miss large gains by relying on mean reversion assumptions. The apparent dominance of tech stocks is overstated; removing FANG returns barely changes the S&P 500’s overall performance, indicating broad market strength. Low volatility reflects a combination of stable inflation, stable interest rates, synchronized global growth, and consistent central-bank communication. U.S. assets remain the preferred strategic overweight because of strong institutions, innovation, earnings quality, and corporate management, reinforcing a long-term theme of U.S. preeminence. Geopolitical and policy risks are real but mostly hard to predict; the recommendation is not to position portfolios around unknown unknowns. Cryptocurrencies are judged as highly speculative and not suitable as money because they lack stability as a medium of exchange, store of value, or unit of account.

Data Points: S&P 500 January 2018 performance: Best January since 1997 - Used to frame the strong start to 2018 before early-February volatility U.S. bull market length: Almost 9 years - Described as the second-longest bull market in the post-World War II era U.S. economic recovery growth rate: About 2.2% - Characterized as the slowest post-World War II recovery but still steady ETF and mutual fund flows into bond funds: About $1.8 trillion - U.S. investor flows since the trough of the financial crisis Cumulative outflow from U.S. equities: $185 billion - Excluding dividend reinvestments, through end-2017 Bond returns since crisis trough: About 4% - Characterized as one of the lowest-returning major asset classes U.S. equity returns since crisis trough: About 19% - Highest among compared major asset classes Expected probability of a 5% correction: Close to 95% - Firm warned clients a correction was highly likely after 2017 euphoria Expected probability of a 10% correction: Close to two-thirds - Second correction estimate provided to clients 2017 S&P 500 return: About 21% to 21.8% - Referenced as strong market performance S&P 500 return excluding FANGs: About 19% - Used to argue the rally was broader than just tech FANG returns in 2017: Well over 40% - Used as a comparison to the broader market Cryptocurrencies’ market cap vs global GDP: 0.8% - Used to argue crypto is too small to be a systemic global-economic risk Probability of significant military engagement with North Korea: Average/median around 25% - Based on consultations with geopolitical and military experts ECB/BOJ policy outlook: Easing likely to continue for about another year - Central banks seen as not abruptly tightening despite market fears

Pivotal Quotes: "Steady as She Goes and Unsteady as She Goes." — Charmine Mosavar-Romani: Her description of the 2018 outlook title, capturing the balance between supportive fundamentals and external risks "there's no long-term mean reversion" — Charmine Mosavar-Romani: Her key point on why valuation alone should not drive investors out of equities "if you hear the phrase, this time is different, they should have their antenna up and be incredibly cautious" — Charmine Mosavar-Romani: Her warning against assuming history no longer applies to markets and policy cycles

Implications: Investors should remain in equities, favor U.S. assets strategically, and expect periodic pullbacks rather than a cycle-ending crash. The bigger risks are geopolitical and speculative excess, not valuations alone.