“Fat and flat.”
That’s how Goldman Sachs’ Christian Mueller-Glissmann describes the current market, characterized by weaker returns and greater volatility.
“While momentum is positive, levels of growth remain weak and uncertainty is high,” Mueller-Glissmann said. “At least in the near term, equities are likely to be stuck in a ‘fat and flat’ range, i.e., below average returns with above average volatility.”
Since the bottom on March 23, stocks have rebounded to around where they were before the coronavirus pandemic sell-off. The S&P 500 is up nearly 50% since the bottom and is just 1% below its all-time high. The Dow has gained 47% since the bottom. And the Nasdaq just closed above 11,000 for the first time after rising 62% since March 23.
But even as the market surges higher, Mueller-Glissmann argues that in recent months, declining bond yields (bond yields minus inflation) have boosted equity valuations, which means flatter returns for investors.
“At the same time, you still have very high uncertainty on the growth outlook, both in the near term but also in the long term,” Mueller-Glissmann said. “And on top of that you have increasing uncertainty on inflation, so in all, that makes us, in the medium term, a bit less excited about risk-adjusted returns for equities.”
Mueller-Glissmann says that the key driver of markets in the last couple of months hasn’t been optimism on growth, but rather optimism on inflation. Given that, he says investors have a “tactical opportunity” in certain sectors.
“You have break-even inflation at incredibly depressed levels, to some extent giving a pretty high probability of deflation in the near term,” Mueller-Glissmann continued. “But even over a 10-year horizon, inflation expectations were low, and those have gotten repriced.”
“Together with the kind of aggressive central bank anchoring, you are pushed on real rates, and at the margin that is more supportive of growth stocks, because growth stocks have a lot of their cash flow in the future of course, you discount it less, valuations go up,” he said. “Anything that has a stable or reliable growth cash flow has benefited.”
According to Goldman Sachs strategists, there’s a recovery underway for growth stocks as earnings season continues to surprise on the upside.
But Mueller-Glissmann says there’s a more important driver: forward-looking macroeconomic data, including the purchasing managers’ index (PMI) and Institute for Supply Management index readings, which have been generally pointing up.
With that, Mueller-Glissmann says, “there is a window here, I think, for the market to probably get a bit more positive on cyclical assets” that perform better in macroeconomic cycles.