Outlook

Wealth Management

Caution: Heavy Fog

You never realized how thick your fog was until it lifted.
– New York Times Bestselling Author J.R. Ward

Investment Strategy Group  |  January 2023

Sharmin Mossavar-Rahmani Additional contributors from the
Chief Investment Officer Investment Strategy Group:
Investment Strategy Group
Goldman Sachs
Matthew Weir
Managing Director

Venkatesh Balasubramanian
Managing Director

Oussama Fatri
Brett Nelson Managing Director
Head of Tactical Asset Allocation
Investment Strategy Group
Nicola Gifford
Goldman Sachs
Vice President

Arjun Menon
The co-authors give special thanks to: Vice President

Michael Murdoch
Vice President

Daniel Toro
Matheus Dibo Rob Hunter Vice President
Vice President Vice President

Fabian Mertes
Associate

Yousra Zerouali
Associate
Kelly Han Harm Zebregs
Vice President Vice President

This material represents the views of the Investment Strategy Group in Wealth Management at Goldman Sachs. It is not a
product of Goldman Sachs Global Investment Research. The views and opinions expressed herein may differ from those
expressed by other groups of Goldman Sachs.
2023 OUTLOOK

Dear Clients,

To say 2022 was a tumultuous year is an understatement.

Equity markets, which had peaked in January, dropped precipitously in less
than two months as investors reacted to higher inflation and Russia’s invasion of
Ukraine. Inflation in turn triggered the tightening of monetary policy. Central
bank policy rates and interest rates across maturities rose at the fastest pace in
decades, driving bond prices down by unprecedented amounts. Oil and natural
gas prices gyrated as the Nord Stream 2 project was halted and other energy
export sanctions were imposed on Russia. Financial markets were further roiled
by growing global geopolitical tensions following the invasion of Ukraine but
also aggressive posturing by China, including toward Taiwan.
This year is likely to be less tumultuous for markets. Inflation is already
trending lower. Central banks are expected to continue to tighten, but not to the
extent seen in 2022. As a result, bonds will come under less pressure. Oil and
natural gas prices are less likely to gyrate.
Still, we face great uncertainty. The US Federal Reserve may overtighten
monetary policy and create a recession in the United States. A recession in the
world’s largest economy would reverberate globally. The US Congress may repeat
the mistakes of 2011 in failing to raise the debt limit in a timely and orderly
manner. China’s disorderly abandonment of its “zero-COVID” policy may
unleash another wave of COVID-19 infections, including new variants, globally.
The geopolitical outlook for 2023, too, is foggy and fraught with risk. There is
no face-saving off-ramp for Russia from Ukraine. China is unlikely to reverse its
assertive and aggressive posture. North Korea is expected to continue, even step
up, its ballistic missile tests. Iran may proceed to enrich its uranium to weapons-
grade levels, which could elicit a military response by Israel.
We proceed with caution.
We start with a careful review of the turmoil in financial markets last year
because this backdrop is important in understanding the fog of uncertainty still
facing investors.

Outlook Investment Strategy Group 1

 Among financial assets, none were spared in 2022. US equities, as measured
by the S&P 500, had a maximum drawdown of 25% and ended the year with
a total return of -18% (in line with the bad case scenario, to which we had
assigned a 15% probability in last year’s Outlook). The basket of FANGMANT
stocks (Facebook/Meta, Apple, Netflix, Google/Alphabet, Microsoft, Amazon,
Nvidia and Tesla), with a maximum aggregate drawdown of 44%, were among
the worst-performing stocks in the S&P 500. Facebook/Meta and Tesla did
particularly poorly, experiencing maximum drawdowns of over 70%.
Outside the US, Russian equities had the largest drop, at 51%; China came
next, at 45%; they were followed by Italy at 28% and Germany at 26%—all in
local currency terms.
Also in 2022, bonds, which typically hedge portfolios against equity
drawdowns by rising in value, nose-dived in response to a steady stream of
rising inflation and interest rate hikes in the advanced economies. The maximum
drawdown in the price of 10-year US Treasuries was 22%. It seldom happens
that 10-year Treasuries—which have half the volatility of US equities—drop
nearly as much as these equities.
The maximum drawdown of 10-year German bunds was 21%, and that of
10-year UK gilts, 26%. This drop in the price of 10-year UK gilts stood in sharp
contrast to the 5% total return of UK equities, as measured by the FTSE 100.
The latter’s positive return was driven primarily by the energy sector and the
metals and mining sector.
Shorter-term bond benchmarks declined less but declined nonetheless: the
maximum drop was 11% for 1- to 10- year US Treasuries, 12% for 1- to 10-year
German bunds and 15% for UK gilts.
Oil and natural gas were thrown into turmoil with the invasion of Ukraine,
and energy security has been thrust back into the forefront after a long hiatus.
West Texas Intermediate (WTI) oil prices rose 62% between January and June
2022, only to fall 42% to their subsequent trough in early December; for the
year, WTI rose 7%. Similarly, Brent oil prices rose 59%, then fell 38%, ending
the year up 10%. Natural gas prices were even more volatile, with the biggest
moves seen in Europe, where prices shot up nearly fivefold by August before

2 Goldman Sachs january 2023

descending as storage facilities filled Exhibit 1: 10-Month Change in the Federal
Funds Rate
up given a milder start to the winter The fast pace of Federal Reserve rate hikes in 2022 has not
season. For the year, prices were up been seen since the early 1980s.
8%. Prices in Europe are still over Rolling 10-Month Change in Federal Funds Rate (%)
10
five times as high as those in the US, 8

where natural gas prices were also 6

4.3
volatile last year but much less so 4

2
than in Europe. US natural gas prices 0

increased by a cumulative 160% to -2

peak in August before dropping, and -4

now stand 20% above their levels at -6

-8
the start of 2022. -10

Global economic growth surprised 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Data as of December 2022.

to the downside; our forecast of Note: Shaded periods denote recessions. Effective federal funds rate used before February 1994.
Federal funds target rate used thereafter.
4.5% growth for 2022 made at the Source: Investment Strategy Group, Bloomberg, Haver Analytics.

beginning of the year is now 3.0%,

or 30% lower. US economic growth,
forecast last year to be 3.9%, is now estimated to be 50% lower, at 2.0%.
The US Consumer Price Index (CPI) reached a peak of 9.1% in June 2022.
Core CPI, which excludes food and energy prices, peaked at 6.6% in September
2022. The US Federal Reserve’s preferred measure, the Personal Consumption
Expenditures (PCE) price index, peaked at 7.0%, also in June, and the core PCE
price index peaked at 5.4% in February. Eurozone and UK inflation rates likely
peaked in October at 10.6% and 11.1%, respectively. We expect US inflation to
decline to 3.7%, as measured by headline CPI, by the end of 2023.
In 2022, central banks raised rates at one of the fastest paces on record to
combat inflation. As shown in Exhibit 1, such a pace has not been seen in the
US since the early 1980s, when the country faced inflation that peaked at nearly
14.8% in March 1980. The pace has also never been seen in the history of
the European Central Bank since its inception in 1998. Such a large and rapid
increase in policy rates contributed to the turmoil in financial markets; we do not
expect a repeat in 2023.

Outlook Investment Strategy Group 3

 Clients’ portfolios experienced more volatility in 2022 than usual because
equities and bonds declined at the same time in most markets. It is very rare to have
equities and bonds drop over the same period in the US; since 1926, i.e., across 96
years of data, a decline in both equities and bonds over a rolling 12-month window
has occurred only 5% of the time when using a 10-year benchmark for bonds,
and only 2% of the time when using a 1- to 10-year benchmark.

60/40 Stock/Bond Model Portfolios

Notwithstanding such rarity, reports issued last year by several financial

institutions challenged the 60/40 stock/bond model portfolios. Some
recommended adding real assets such as commodities, infrastructure and real

Exhibit 2: Pillars of the Investment Strategy Group’s Investment Philosophy

Investment Strategy Group

History Is a Appropriate Value Appropriate Consistency

Useful Guide Diversification Orientation Horizon

Analytical Rigor

Asset allocation process is client-tailored and independent of implementation vehicles

4 Goldman Sachs january 2023

estate. Others recommended diversifying portfolios by allocating more assets
to Asia ex-Japan. Still others recommended adding trading strategies, including
hedge funds and momentum- and volatility-based strategies.
The proliferation of such recommendations prompted some of our clients to
ask whether they should reevaluate their strategic asset allocation accordingly.
Our response is twofold.
First, appropriate, customized diversification for both institutional and private
wealth clients has been a key pillar of the Investment Strategy Group’s (ISG’s)
investment philosophy since its inception more than 20 years ago in 2001 (see
Exhibit 2). Such diversification around a core holding of equities and bonds
already includes asset classes and investment strategies that enhance risk/return
to preserve and then maximize risk-adjusted wealth, especially at times of
heightened uncertainty.
Second, nearly a hundred years of data demonstrates that a mixture of stocks
and bonds is an effective starting point for a portfolio, consistent with another
pillar of ISG’s investment philosophy that history is a useful guide. The 60/40
portfolio has generated positive returns on a rolling 12-month basis 80% of the
time since 1926.

Geopolitical Tumult

On the geopolitical front, the warning of the late Ash Carter, former US secretary
of defense, was realized. We regularly consulted with him on geopolitical issues,
and as was outlined in our 2022 Outlook: Piloting Through, he had asserted that
the Russian threat to Ukraine was “the most dangerous, dire, and imminent of
all the geopolitical risks.”1 So far, the Russia-Ukraine war has led to:

• About 100,000 casualties on each side, according to General Mark Milley,

chairman of the US Joint Chiefs of Staff2
• The exodus of 7.8 million Ukrainian refugees to other countries, particularly in
Europe, and another 6.5 million displaced from their homes within Ukraine3

Outlook Investment Strategy Group 5

• Over $100 billion in global military, financial and humanitarian aid to Ukraine
(about half from the US), with at least another $45 billion expected in 20234
• A World Bank estimate of $525 billion−$630 billion of reconstruction in
Ukraine as of December5

The war has also led to further deterioration in US-China relations, especially
when coupled with the joint China-Russia statement on February 4, 2022, that
the “friendship between the two States has no limits.”6 The US and its allies have
been changing their national security strategies toward China and imposing
import and export controls on a wide variety of products.
Turmoil in financial markets coupled with heightened geopolitical risks has
raised the risks, though not the certainty, of a recession. Historically, rapid
and extensive tightening by the Federal Reserve has led to recession in the US.
Many economists expect it. Bill Dudley, who served as president and CEO
of the Federal Reserve Bank of New York, vice chair of the Federal Reserve
Open Market Committee (FOMC) and Goldman Sachs partner, assigns a 70%
probability to a US recession in 2023—one of the highest probability forecasts in
the industry.
At the other extreme, Jan Hatzius, currently Goldman Sachs’ chief economist
and head of Global Investment Research, assigns a 35% probability to a US
recession—one of the lowest in the industry. Incidentally, Dudley and Hatzius
developed the Goldman Sachs Financial Conditions Index while they worked
together at Goldman Sachs. The index measures the impact of Federal Reserve
policy on the economy through the impact on the financial markets, specifically
on short- and intermediate-maturity interest rates, equity markets, incremental
yield of corporate bonds and the value of the trade-weighted dollar relative to
other currencies. The wide difference between the forecasts of these two former
colleagues is mirrored across the economic forecasting community.
Notably, in his latest press conference, on December 14, 2022, Jerome H.
Powell, chair of the Federal Reserve, said “I don’t think anyone knows whether
we’re going to have a recession or not … It’s just not knowable.”7

6 Goldman Sachs january 2023

 Similarly, a week later, Lawrence H. Summers, Harvard University professor
and former US Treasury secretary, wrote that “there is no basis for confident
economic prediction. Some of the most stridently made arguments are also the
silliest.”8
When Chair Powell says that “it’s just not knowable,” we take heed; we assign
a range of 45−55% to the probability of a US recession in 2023. To provide
context: over the last decade, the highest probability we assigned to a recession
was 30%. That was in our 2012 Outlook, after the European sovereign debt
crisis; the next-highest probability was 20−25%, in our 2020 Outlook.
Today, many leading indicators are pointing in opposite directions, and we
believe it is important to convey this uncertainty to our clients unequivocally.
In this uncertain environment, we believe portfolios should not be positioned
for the certainty of recession nor for the certainty of modest economic growth.
Instead, we recommend portfolios be positioned at their customized strategic
asset allocation, where they are designed to ride out volatility and provide staying
power in the event of geopolitical disruptions.
If a recession is averted, financial market returns in 2023 will be less volatile
than in 2022; we expect a moderate-risk diversified portfolio of stocks and bonds to
provide a total return of 9.0% for taxable clients and 9.8% for tax-exempt clients.
If a recession occurs early in the year, corporate earnings and equities will
decline—possibly beyond the maximum drawdown of 2022—but bonds will
hedge the portfolio by increasing in value, because the starting point of interest
rates is much higher than it was at the beginning of 2022. However, by the end
of 2023, as the recession recedes and the fog of uncertainty lifts, the equity
market will most likely rally. We would expect high-single-digit returns for
a moderate-risk diversified portfolio. If the recession lasts beyond year-end,
the equity market will most likely end the year near the lows we saw in 2022,
providing a total return of negative 4.4% from year-end 2022 and resulting in a
low- to mid-single-digit negative return for a moderate-risk portfolio.
Facing the fog of uncertainty in financial markets, economic growth and
geopolitics, we will on our side:

Outlook Investment Strategy Group 7

• Watch diligently for hazards and, if appropriate, pull into a safe location and
wait for the fog to clear.
• Use our fog lights to search for tactical strategies that can take advantage of
market volatility as opportunities present themselves.

On our clients’ side, we recommend that you:

• Avoid unnecessary lane changes; stay invested at your customized strategic

asset allocation.
• Allow extra time to reach your destination, as US equity markets will resume
their historical upward trajectory.

In Section I, we provide the rationale for assigning a 45−55% probability to

the risk of a US recession in 2023. We compare this tightening cycle to past
tightening cycles and explain that although a recession is possible, it is not
inevitable. We explain why staying invested in such an uncertain environment
is our recommended course of action. In a March 2009 Sunday Night Insight
titled Near-Term Pain, Long-Term Gain, we quoted the highly respected investor
Seth Klarman of Baupost, who wrote: “To maintain a truly long-term view,
investors must be willing to experience significant short-term losses; without
the possibility of near-term pain, there can be no long-term gain. The ability
to remain an investor (and not become a day-trader or a bystander) confers an
almost unprecedented advantage in this environment.”9
Next, we spell out our one- and five-year expected returns and review our
opportunistic tactical tilts coming into 2023. We currently have the lowest level
of risk allocated to tactical tilts of the last decade.
We conclude Section I with the key risks to our outlook beyond the recession
risks, primarily focused on geopolitical flare-ups and possible new COVID-19
waves originating from China.

8 Goldman Sachs january 2023

 In Section II, we provide a detailed review of our economic outlook for key
developed and emerging market countries. Section III details our financial market
outlook for these countries.
We present our annual Outlook and our investment recommendations with a
strong dose of humility, notwithstanding the considerable research that underpins
these reports, including consultation with leading experts. As always, these and
other insights and recommendations are based on rigorous analysis of a wealth of
data which we share with our clients.
We also take this opportunity to wish you a healthy, happy, prosperous and
calm 2023.

The Investment Strategy Group

Outlook Investment Strategy Group 9

2023 OUTLOOK

Contents

SECTION I

12 Assessing the Risk of a US Recession

We have assigned a probability range of Our One- and Five-Year Expected
26 
45–55% to the risk of a US recession in 2023. Total Returns

13 Key Arguments in Favor of a US Recession 32 Our Tactical Tilts

17 Key Arguments Against US Recession 42 Additional Risks to Our Outlook

17 Balanced Economy 48 Key Takeaways

18 Shorter Lag of Policy Tightening
19 Declining Inflation While we are facing a period of heightened
19 Less Tightening Than Expected uncertainty after a tumultuous 2022,
we believe our two primary investment
21 60/40 Stock/Bond Portfolios themes remain valid: US Preeminence and
Staying Invested.
22 Frequency of Negative Returns in
Stocks and Bonds
23 The Last Decade Does Not Imply a
Lost Decade
24 Diversified Model Portfolios Built Upon a
Reference Portfolio of Stocks and Bonds

10 Goldman Sachs january 2023

 S E C T I O N I I : A D I F F I C U LT B A L A N C I N G A C T SECTION III: LOOK ING FOR TR ACTION

50 2023 Global 66 2023 Financial

Economic Outlook Markets Outlook
Risks of a misstep remain, but global growth After hitting an icy patch last year, we see
should keep its stride this year. financial markets regaining traction in 2023.

52 United States 68 US Equities

58 Eurozone 74 Non-US Developed Market Equities

59 United Kingdom 74 Eurozone Equities

60 Japan 75 UK Equities

61 Emerging Markets 76 Japanese Equities

77 Emerging Market Equities

78 Global Currencies

83 Global Fixed Income

94 Global Commodities

Outlook Investment Strategy Group 11

SECTION I

Assessing the Risk

of a US Recession

we have assigned a probability range of 45–55% to

the risk of a US recession in 2023. A midpoint of 50% and
a 10-percentage-point range reflect the uncertainty of our
forecast. A recession is not our base case, and our investment
recommendations are based on this 45–55% probability. Since
we at ISG started publishing recession probabilities, we have
been quite unequivocal about our forecasts. As shown in

12 Goldman Sachs january 2023

Exhibit 3: ISG US Recession Probabilities Since 2012 it is just not knowable at this point whether we
Prior to 2023, our recession probabilities for the US have will have a recession or not. He also mentioned
ranged from 10% to 30%. that FOMC decisions will “depend on the totality
Recession Probability (%) of incoming data” and decisions will be made
60
55 “meeting by meeting.”10 As the FOMC members
react to incoming data, their responses will
50
increase or decrease the risks of recession.
40
45 Second is Canadian-American economist John
Kenneth Galbraith’s comment, “One of the greatest
30
30 pieces of economic wisdom is to know what you
25
do not know.”
20 20 20
20
15 15 15 20
We have also incorporated additional
10 15 10 10 noneconomic risks into our recession forecast.
10
They include a new wave of COVID-19 spreading
around the world as a result of China’s reopening,
0
2012 2013 2014 2015* 2016* 2017 2018 2019 2020 2021 2022 2023 heightened geopolitical risks emanating from
Russia and debt ceiling negotiations in the US
Data as of December 31, 2022.
Source: Investment Strategy Group. sometime in the second half of 2023. While each
* The ISG Outlook reports in 2015 and 2016 included descriptive assessments of recession
probabilities (“few signs of recession” (2015) and “low probability” (2016)).
of these risks individually may not throw a well-
balanced economy into recession, two or more
in conjunction with continued Federal Reserve
tightening of monetary policy are likely to do so.
Exhibit 3, our probabilities have ranged from a low We review those risks later in this report.
of 10% to a high of 30%. Our recession probability
for 2022 was 10%. Since the global financial crisis
(GFC), we have never forecast a recession, and Key Arguments in Favor of a
except for the brief pandemic-induced recession, the US Recession
US economy has not experienced one since then.
When we have felt more uncertainty about our The most compelling and most frequently cited
probabilities, we have used a five-percentage-point rationale for predicting a recession in 2023 is
range, as we did in our 2019 and 2020 Outlook the speed of tightening conducted by the Federal
reports. A midpoint of 50% and a 10-percentage- Reserve and the subsequent tightening of financial
point range, therefore, is unusual for us. conditions. As the Federal Reserve tightens
We have evaluated all our recession forecasting monetary policy by raising the federal funds rate
models, sought the input of best-in-class and reducing the size of its balance sheet, financial
economists, and concluded that the tools and conditions are tightened as:
analyses that favor a recession in 2023 are as
convincing as those that do not. We also have a • Interest rates rise across the Treasury yield curve.
wider probability range than usual because it has • The incremental cost of borrowing across
given us flexibility to adjust to incoming data. For businesses and households increases.
example, favorable economic data such as declining • Equity markets decline, creating a negative
inflation or declining job openings prompts us wealth effect in which consumers reduce
to lean toward the low end of our range, while consumption as they become less wealthy.
less favorable data that points to an
overheated economy and more aggressive
Federal Reserve tightening prompts us to
lean toward the high end of the range.
One of the greatest pieces of
Despite finding ourselves in this economic wisdom is to know what
difficult position, we are reassured by you do not know.
two observations.
First and foremost are Chair Powell’s – John Kenneth Galbraith
comments, noted earlier, indicating that

Outlook Investment Strategy Group 13

Exhibit 4: 10-Month Change in the Federal Exhibit 5: Goldman Sachs US Financial
Funds Rate Conditions Index
The fast pace of Federal Reserve rate hikes in 2022 has not Financial conditions tightened by 4% between November
been seen since the early 1980s. 2021 and October 2022.
Rolling 10-Month Change in Federal Funds Rate (%) Financial Conditions Index
10 105
Tighter Financial
8 104 Conditions
6
103
4 4.3
102 101.7
Oct
2 2022
101
0
100
-2
99
-4 +4.0%
-6 98

-8 97 Nov
2021
-10 96
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020

Data as of December 2022. Data as of December 31, 2022.

Note: Shaded periods denote recessions. Effective federal funds rate used before February 1994. Source: Investment Strategy Group, Goldman Sachs Global Investment Research.
Federal funds target rate used thereafter.
Source: Investment Strategy Group, Bloomberg, Haver Analytics.

• The dollar appreciates relative to other was driven by the rapid increase in interest rates,
currencies, lowering exports as the cost of US the increase in the incremental yield (also known as
goods rises for non-US-dollar importers. the spread) in corporate bonds, the drop in equity
prices and the large appreciation of the dollar. The
As we discussed in last year’s Outlook report, best example of the impact of tighter financial
Piloting Through, not every Federal Reserve conditions is the change in residential mortgage
hiking cycle and subsequent tightening of financial rates. Mortgages rates increased from 3.11% at
conditions has resulted in a recession. Of 15 the beginning of the year to a peak of 7.08% in
hiking cycles in the post-WWII period, only nine, late October, reflecting the combined impact of an
or 60% of the cycles, did so. The cycles that led increase in Treasury interest rates and an increase
to recessions can be differentiated from those that in spreads. Such high mortgage rates lowered
did not by some combination of the magnitude of homeownership affordability to levels below those
tightening and the pace of tightening. of the GFC (see Exhibit 6). A decline in home
As shown in Exhibit 4, the magnitude of policy prices, as measured by the Case-Shiller national
tightening over the past 10 months has been the home price index, followed, as shown in Exhibit 7.
greatest and the pace has been the fastest on record As we noted earlier, history is a useful guide. It
since the stagflation of the 1970s and early 1980s. shows that since WWII, such significant tightening
That period was marked by a ninefold increase in in a short time has always led to a recession.
the price of oil from about $4 per barrel before the History, however, is less helpful in telling us when
Arab oil embargo to about $40 per barrel after the a recession might unfold. The number of months
Iranian Revolution and Iran-Iraq War. CPI reached from when a hiking cycle has begun to when a
14.8% in March 1980, and core CPI reached 13.6% recession has begun has ranged from 11 to 43,
in June of the same year.11 In the current cycle, CPI with an average of 30 months and a median of 31.
peaked at 9.1%; core CPI peaked at 6.6%. The tightening in this cycle started in March
The tightening of financial conditions was 2022. Taking the historical experience at face
equally severe in 2022. As shown in Exhibit 5, value, that start date implies a recession could
from its trough in November 2021, the Goldman start as early as the first quarter of 2023 or as
Sachs US Financial Conditions Index increased by late as the fourth quarter of 2025. With such a
more than four percentage points. This was the wide range of potential recession start dates—
biggest tightening in 11 months since the GFC. It and the fact that the historical average and median

14 Goldman Sachs january 2023

Exhibit 6: Goldman Sachs US Housing Exhibit 7: S&P CoreLogic Case-Shiller Home
Affordability Index Price Index
Homeownership affordability currently stands at levels Home price growth has slowed significantly.
below those of the GFC.
Goldman Sachs US Housing Affordability Index % MoM (Seasonally Adjusted)
150 2.5

140 2.0
Increasing
130 Affordability 1.5

120 1.0

110 0.5

100 0.0
-0.3
90 -0.5

80 -1.0

70 69.7 -1.5

60 -2.0
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022

Data through December 2022. Data through October 2022.

Source: Investment Strategy Group, Goldman Sachs Global Investment Research. Source: Investment Strategy Group, Haver Analytics.

would imply a recession does not begin until

sometime later in 2024—we recommend clients Exhibit 8: ISG Yield Curve Inversion Diffusion Index
stay invested. Recent index readings imply a rising risk of recession.
As we will discuss later in this section, our one- Yield Curve Inversion Diffusion Index (%)
and five-year expected returns result in attractive 100 100

portfolio returns. It is also not prudent to stay 90

on the sidelines by being invested in cash for 30 80

months or longer and risk forgoing those attractive 70

portfolio returns. 60
A model developed by Eric Engstrom and Steven 50
Sharpe, two economists at the Board of Governors 40
of the Federal Reserve System, referred to as the 30
Engstrom-Sharpe model, supports the view that 20
a recession is likely but not imminent. The model
10
looks at the spread between the interest rate on a
0
3-month Treasury bill in 18 months as priced by the 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
Treasury market, and the current interest rate for a Data through December 31, 2022.
3-month Treasury bill. That model assigns a 70% Note: Shaded periods denote recessions. The diffusion index is based on four yield curves selected
across different maturities and measured on a daily, weekly and monthly basis. The index measures
probability to a recession unfolding in 12 months— the percentage of yield curve measures inverted in the previous 6 months based on data available
so a recession is likely in 2024. The model assigned at each point in time. This index is tracked internally by ISG and is not publicly available.
Source: Investment Strategy Group, Bloomberg, Haver Analytics.
a 1% probability in early 2022.
Our ISG models also suggest a recession is
likely. Our most reliable—but not foolproof—
model is the ISG Yield Curve Inversion Diffusion Although this index has a reliable 89% hit ratio
Index, which looks at four yield curves over daily, (percentage of time it has been successful), the time
weekly and monthly frequencies. When the index to recession after the index was triggered has been
has reached 100%, meaning all the yield curve bimodal. As shown in Exhibit 9, the recession has
inversions have been triggered, a recession has typically started either about seven months or 1.5
followed all nine times except in 1965 (see Exhibit to two years after the trigger date. The likelihood
8). This index triggered a recession signal when it of a recession within seven months of the trigger
reached 100% on July 25, 2022. date, in this case by February 2023, is low. A more

Outlook Investment Strategy Group 15

Exhibit 9: ISG Yield Curve Inversion Diffusion Exhibit 10: ISG Recession Scorecard
Signal Time Length to Start of Recession Our scorecard stands at 62, close to the elevated recession
The time to recession after the diffusion index reached risk threshold of 65.
100% in the past has been bimodal.
Number of Occurrences Scorecard Recession Start (Weighted Average)
3.5 Above 65 = Elevated Recession Risk Recession Index
Above 40 = Moderate Recession Risk
3.0 100

2.5
80

2.0
65
60 62
1.5

1.0 40
40

0.5
20

0.0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 0
Number of Months 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Data through December 31, 2022. Data as of December 2022.

Note: The light blue area is stylized. Note: Shaded periods denote recessions.
Source: Investment Strategy Group, Bloomberg, Haver Analytics, NBER. Source: Investment Strategy Group, Haver Analytics.

likely scenario is a recession in 2024, according to and exposure to greater-than-expected risk.”12

this indicator. She recommends incorporating some judgment
Another ISG model, the ISG Recession into projections so that one can have “greater
Scorecard, has not yet breached the elevated confidence that those projections will prove
recession risk level of 65. As shown in Exhibit 10, trustworthy.”
the level stands at 62. The scorecard combines a Hence, we examine other factors that, in our
series of leading indicators such as the Conference judgment, point to a lower likelihood of recession
Board Leading Economic Index, the Institute than that shown by the models.
for Supply Management (ISM) Manufacturing
Index of new orders minus inventories, and initial
jobless claims, as well as a series of National
Bureau of Economic Research (NBER) recession
indicators such as the average of payroll and
household employment and industrial production.
In other words, this scorecard follows many of the
indicators that have prompted most economists to
forecast a recession.
One important consideration when using such
models is that no economic forecasting model has a
perfect track record that can predict the occurrence
and, more importantly, the timing of a recession.
In a recent book titled Escape from Model
Land: How Mathematical Models Can Lead Us
Astray and What We Can Do About It, Erica
Thompson, senior policy fellow at the London
School of Economics Data Science Institute and a
fellow of the London Mathematical Laboratory,
warns that too great a reliance on models “can Escape from Model Land: How Mathematical Models Can Lead Us Astray
have catastrophic effects because it invariably and What We Can Do About It by Erica Thompson (Basic Books 2022),
results in an underestimation of uncertainties Cover photograph @Shutterstock.com

16 Goldman Sachs january 2023

Exhibit 11: Global Investment Research Financial Excess Monitor
The types of imbalances that preceded the dot-com bubble and GFC are notably absent today.
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Overall

Housing
Commercial
Real Estate
Consumer Credit

Business Credit

Equity Market
Households/
Consumers
Non-Financial
Business
Financial
Business
Government

Data through Q4 2022.

Note: Red shading indicates periods of financial excess; blue shading indicates periods of benign conditions.
Source: Investment Strategy Group, Goldman Sachs Global Investment Research.

Key Arguments Against a US Recession

Exhibit 12: Non-Financial Corporate Debt to GDP
We now consider four factors suggesting the US Corporate debt stands at elevated levels.
economy may be able to avoid a recession: a % of GDP
balanced economy, a shorter lag of policy tightening, 65

declining inflation and the possibility of fewer 60

Federal Reserve hikes than are currently expected.
55

Balanced Economy 50 49.7

The US economy is even more balanced today 45

than it was at the end of 2021. A more balanced
40
economy is likely to absorb shocks much better
than an imbalanced economy. 35

Exhibit 11 is a Financial Excess Monitor 30

produced by our colleagues on the Goldman Sachs
25
US Economics Research team. We have been using 80-Q1 83-Q3 87-Q1 90-Q3 94-Q1 97-Q3 01-Q1 04-Q3 08-Q1 11-Q3 15-Q1 18-Q3 22-Q1
this tool since David Mericle, chief Goldman Sachs Data through Q3 2022.
US economist, and the US Economics Research Source: Investment Strategy Group, Haver Analytics.

team created it in March 2018. It comprises 46

different measures, such as the housing-price-
to-rent ratio, commercial real estate price index, deterioration. In aggregate, the US economy is
credit card interest rates relative to the risk- more balanced today than it was a year ago: the
free rate, incremental yield of corporate bonds, total line is a light shade of blue rather than white.
equity market valuations, personal savings rate, Importantly, both the financial sector and the
corporate debt-to-GDP growth rate, leverage in the non-financial business sector improved—captured
financial sector, and federal and state government by the darker shades of blue. Some observers have
debt. The monitor highlights pockets of risks expressed concern about the increase in debt levels
in the US economy and financial markets. Red in the non-financial corporate sector. As shown in
signifies excesses; blue signifies a well-balanced Exhibit 12, non-financial corporate debt as a share
sector or metric. The monitor shows that all of GDP stands at 49.7%, the highest it’s been since
sectors improved in 2022 except for households/ 1980 except for the pandemic-related spike. While
consumers and housing, which showed a slight this level may appear alarming, it does not seem

Outlook Investment Strategy Group 17

Exhibit 13: Non-Financial Corporate Debt Exhibit 15: Contributions to Year-on-Year Core PCE
Service Ratio Inflation from Core Goods Categories
The cost of servicing debt as a share of income stands at its Core goods inflation is expected to turn negative in 2023.
lowest since 1980.
% of Income Debt Service Ratio +200 bps Rate Shock Basis Points
53 250 New Cars
Used Cars
GIR Forecast
48 Furniture & Appliances
200
Video/Audio/Photo &
43 Information Equipment
150 Clothing & Footwear
38 33.4 Pharma & Medical
Q4 08 Other Core Goods
33 100
Total

28 50

23
0
18
14.7 -50
13
10.3
8 -100
1980 1985 1990 1995 2000 2005 2010 2015 2020 Jan-19 Sep-19 May-20 Jan-21 Sep-21 May-22 Jan-23 Sep-23 May-24

Data as of Q3 2022. Data through November 2022, Global Inverstment Research Estimates through December 2024.
Note: Shaded areas denote recessions. Source: Investment Strategy Group, Goldman Sachs Global Investment Research.
Source: Investment Strategy Group, Haver Analytics.

ratio (the ratio of earnings before interest and

Exhibit 14: Impulse to US GDP Growth from Fiscal tax payments to interest expense) for investment
Policy and Financial Conditions grade borrowers is at 7.0x, which is the highest
The drag on GDP growth from monetary and fiscal policy since 1999.
tightening will abate in 2023. As shown in Exhibit 13, the cost of servicing
% the debt as a share of income is the lowest since
8 Fiscal Impulse
Financial Conditions Impulse*
1980, at 10.3%. Because most of the debt is fixed-
6 Total rate and generally of longer maturity, an increase
4
in interest rates does not have a material impact on
the cost of servicing the debt. An increase of two
2
percentage points in interest rates raises the cost
0
of servicing the debt to 14.7%, still very low by
-2 historical standards.
-4 We should note that while the level of
imbalance in the households/consumer sector
-6
has deteriorated relative to the end of 2021,
-8
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
households still have significant excess savings,
2021 2022 2023 estimated at over $1.5 trillion. According to Bank
of America data, households have savings and
Data through Q4 2022; Global Inverstment Research Estimates through Q4 2023.
Source: Investment Strategy Group, Goldman Sachs Global Investment Research. checking account balances that are still above
* The impulse estimate assumes that financial conditions remain at their current level.
pre-pandemic levels across all income cohorts,
including lower-income and younger households.13

so upon further examination. Most of the increase Shorter Lag of Policy Tightening
was driven by high-quality investment grade bond According to a Financial Conditions Index growth
issuers that issued debt in order to take advantage impulse model developed by Mericle and his
of the low level of interest rates. The average team, the drag on GDP growth from tightening of
coupon level of investment grade corporate debt financial conditions occurs sooner than is typically
is 3.7%, which is close to the lowest level since thought by most market participants.14 As a result,
1973. The median level of the interest coverage Mericle and his team estimate that the drag from

18 Goldman Sachs january 2023

Exhibit 16: Goldman Sachs Supply Chain Exhibit 17: Rental Inflation Measures
Congestion Scale The pace of rent increases has moderated since the spike
The scale has reached its lowest level since the start of in mid-2021.
the pandemic. Monthly Annual Rate (%)
50 Zillow: Observed Rent Index*
CPI: Rent of Primary Residence
Apartment List: Asking Rents*
40

30

20
2
10

0
1 10
Fully Open Fully Bottlenecked -10

Data as of December 31, 2022. -20

Source: Investment Strategy Group, Goldman Sachs Global Investment Research. Jan-2019 Jul-2019 Jan-2020 Jul-2020 Jan-2021 Jul-2021 Jan-2022 Jul-2022

Data through October 2022.

Source: Investment Strategy Group, Goldman Sachs Global Investment Research, Apartment List,
Haver Analytics, Oxford Economics.
the tightening of financial conditions will abate in * Seasonally adjusted.
2023, as shown in Exhibit 14.

Declining Inflation
Inflation has peaked and is declining across Exhibit 18: Wage Growth Indicators
many drivers: Forward-looking indicators of wage growth point to a
meaningful deceleration in 2023.
• As shown in Exhibit 15, core goods inflation Annual Rate (%) % YoY
is expected to turn negative by the middle of 10 Monthly Wage Surveys* (Left)
Indeed Job Postings Wage Tracker (Right)
10

2023, and the GS Supply Chain Congestion 9 9

Scale has reached its lowest level since the start 8 8

of the pandemic (see Exhibit 16). 7 7

• With respect to shelter inflation, which is 6

6.3
6
about 40% of core CPI, both the Case-Shiller 5 5
national home price index and the alternative 4 4.1 4
measures of rent inflation have been declining, 3 3
as shown in Exhibits 7 (referenced earlier) 2 2
and 17. Due to the mechanics of how housing
1 1
inflation is calculated, the current decline
0 0
impacts official shelter inflation with a lag 2006 2008 2010 2012 2014 2016 2018 2020 2022
of as long as a year. Since policymakers are Data through November 2022.
aware of this mechanical delay, they are Source: Investment Strategy Group, Goldman Sachs Global Investment Research, Department of
Labor, Indeed.
likely to incorporate these contemporaneous * Average of NFIB, Dallas Federal Reserve manufacturing, Dallas Federal Reserve services,
measures of shelter inflation into their decision- Richmond Federal Reserve Manufacturing, Richmond Fed services, NY Federal Reserve services
and Kansas City Federal Reserve services, scaled to 6-month annualized average hourly earnings.
making process.
• Wages have been the most persistent source of
inflation in 2022. However, we expect wage
pressures to abate slowly as the number of Indeed Wage Tracker (for job postings)—shown
job openings declines, the unemployment rate in Exhibit 18—as support for diminishing wage
increases and lower headline inflation reduces pressures.
the bargaining power for wage negotiations.
Our colleagues in US Economics Research Less Tightening Than Expected
point to forward-looking indicators of wage Although our base case scenario includes the
growth such as monthly wage surveys and the expectation that the Federal Reserve will raise

Outlook Investment Strategy Group 19

Exhibit 19: 1-Year Treasury Bills 1 Year Forward Exhibit 21: US Recession Probabilities
(1y1y) and Policy Rate Experts have differing views on the probability of recession
Policy rates have typically peaked below the peak 1y1y rate in the US.
priced by the market.
Probability of Recession Within:
% 11.75%
20 ~3 Months 1 year 2 years
20.0% 19.1 William C. Dudley 70% 90%
18
13.0%
9.75%
ISG Jason Furman 55% 75%
16 ~2 Months Base Case:
~4 Months 6.0%
5.25% Mark Zandi 50% 60%
14 14.1 ~5 Months
>7 Months Investment Strategy Group 45–55% 65–75%
12 6.50% GS Global Investment Research
~8 Months 5.25%
35% N/A
10.0 Jan Hatzius & David Mericle
10 ~15 Months
8.3
8 2.50% As of December 31, 2022.
7.5
~7 Months Source: Investment Strategy Group, GS Global Investment Research, William C. Dudley, Mark
6 5.3 Zandi, Jason Furman.
4.7
4 3.2
1y1y Proxy
2
Policy Rate 1974 and 1980. In all other cases, the Federal
0
1972 1977 1982 1987 1992 1997 2002 2007 2012 2017 2022 Reserve hiked rates to a peak below the peak
market pricing of 1y1y. In this tightening cycle,
Data through December 31, 2022.
Note: Based on the 6m6m prior to 1976 and interpolating the 1y1y based on the 6-month and the peak to date for the 1y1y was 4.7% in early
2-year yields during the 2001–08 period when 52-week bills were discontinued.
Source: Investment Strategy Group, Bloomberg.
November. It stood at 4.2% at year-end. If this
historical pattern repeats itself, the Federal Reserve
may hike only one more time. Given that most
of the impact of tighter financial conditions has
Exhibit 20: Federal Funds Rate Path Through already occurred, as shown earlier in Exhibit 14, it
December 2023 is possible that a recession will be averted.
Forecasts for the path of policy rates have changed Of course, there is a chance of further
dramatically since the end of 2021. tightening beyond our expectations. Note in
Federal Funds Rate (%) Exhibit 20 that the FOMC’s estimate for the
6 Market Implied (12/31/2021)
Market Implied (12/30/2022)
FOMC (Dec-2022 SEP)
FOMC (Dec-2021 SEP)
federal funds rate in the December 2021 Summary
5.1
of Economic Projections was materially below
5
4.4
4.6
its most recent projections in December 2022.
4
Even FOMC members do not have the proverbial
crystal ball.
3 In summary, we think the probability of a
recession in 2023 ranges from 45% to 55%.
2 1.6 In Exhibit 21, we share the views of a panel of
0.9 1.4 experts whom we have hosted on client calls; the
1
lowest probability is from our colleagues on the
0.1
GS US Economics Research team and the highest
0
Dec-2021 Jun-2022 Dec-2022 Jun-2023 Dec-2023 probability is from Bill Dudley. Jason Furman,
professor of practice of economic policy jointly at
Data as of December 31, 2022.
Note: Market implied path is based on federal funds futures. Harvard Kennedy School and the Department of
Source: Investment Strategy Group, Bloomberg, Federal Reserve.
Economics at Harvard University and former chair
of the Council of Economic Advisers, is at 55%,
and Mark Zandi, chief economist at Moody’s
policy rates to 5−5.25%, we also recognize that Analytics, is at 50%.
there is a chance it will not raise rates as much as We have also provided probabilities for 2024.
we expect. As shown in Exhibit 19, policy rates By definition, expanding the horizon to two
have typically peaked below the peak of where the years to estimate the probability of recession
market expects the yield on 1-year Treasury bills increases the probability. As shown in Exhibit
to be one year from now (1y1y). In the nine hiking 22, the cumulative probability of a recession if
cycles since 1972, there have been two exceptions: the economy is still in an expansion increases

20 Goldman Sachs january 2023

Exhibit 22: Percentage of Time Recession Occured largesse correlating the entire market.”15 Some
by End of Period asset management firms have suggested rethinking
The cumulative probability of a recession from 1981 to 2022 traditional stock/bond portfolios or having a
has been 12% in one year and 24% in two years. “makeover.” Quite a few firms warn of a lost
% decade for 60/40 portfolios. Most recommend
60 1946–2022
1946–1980
adding asset classes such as commodities and hedge
1981–2022 50 funds to hedge against the positive correlation
50
between stocks and bonds seen in 2022. Others
40
have recommended adding factor-based investment
36
strategies and active equity managers to improve
30 performance.
26
24 This range of suggestions has prompted some
20 18 clients to ask us whether they should change their
12 strategic asset allocation. We do recommend clients
10
reevaluate their strategic asset allocation on a
regular basis, especially after a tumultuous year, to
0
Next 12M Next 24M make sure that their portfolios are tailored to their
risk tolerance, tax status and preferences. However,
Data through December 2022.
Source: Investment Strategy Group, Haver Analytics. clients should not alter their strategic asset
allocation simply in response to the noise around
60/40 portfolios.
from 12% in one year to 24% in two years, a Our reasoning is twofold:
12-percentage-point increase. Given the tightening
of policy rates to date and the expected increases in • What transpired in 2022 in terms of negative
2023, we believe the probability of recession will returns for both bonds and stocks is a rare
still be elevated in 2024, and we therefore expect occurrence, and clients should not adjust
the cumulative probability to rise by 20 percentage portfolios solely because of a rare occurrence.
points from 2023 to 2024. We also find that positive correlations
We now turn to our analysis of 60/40 between stocks and bonds are common, and
portfolios. We show why a stock/bond portfolio such correlations alone do not invalidate the
is still a compelling starting point and how value of 60/40 portfolios. There is no need
diversifying the portfolio by adding certain asset to change asset allocation because of market
classes and strategies provides the optimal strategic performance in 2022.
asset allocation. • ISG’s strategic asset allocation process uses a
mix of stock/bond portfolios (60/40 or other
mixes of stocks and bonds) as a launching
60/40 Stock/Bond Portfolios pad. The 60/40 portfolio merely provides a
reference benchmark: many asset classes are
Following the negative returns of both stocks and added to a client’s portfolio to improve the
bonds in 2022, several institutions have questioned risk/return profile relative to a portfolio of only
the viability of 60/40 stock/bond portfolios. We stocks and bonds. Of course, while we refer
should note that the term “60/40 stock/
bond portfolio” is used generically by the
financial industry to mean a portfolio of
stocks and bonds; it does not imply that What transpired in 2022 in terms
a 60/40 mix is the right allocation for
every client.
of negative returns for both bonds
The Financial Times reports that and stocks is a rare occurrence, and
“private capital titans insist that the
traditional 60/40 investor allocation
clients should not adjust portfolios
between listed stocks and bonds has solely because of a rare occurrence.
been rendered useless by central bank

Outlook Investment Strategy Group 21

 Exhibit 23: Frequency of Observation of Positive/ Exhibit 25: Returns for 60/40 Portfolio Since 1926
Negative Returns in US Stocks and Bonds A 60/40 portfolio produced a positive 12-month return 80%
The occurence of negative returns in both US stocks and of the time.
bonds over any 12-month window is rare.
Stock Returns Average Cumulative Nominal Returns (%) % of Positive Returns
30 Following Negative % of Positive Returns (Right) 100
Negative Positive 12-Month Returns (Left) % of Positive Returns, Unconditional (Right)
Unconditional (Left) 90
25 86 87 80
80 21.6
Positive

70
23% 67% 20 73 19.2
60
Bond Returns

15 50

10.2 40
10 9.2
30
Negative

2% 8% 5
20

10

0 0
Subsequent 12 Months Subsequent 24 Months

Data through December 2022. Data as of December 31, 2022.

Note: US intermediate bonds are modeled using Bloomberg Barclays US Intermediate Treasuries Note: 60/40 portfolio refers to 60% US equity/40% US intermediate bonds. US intermediate
(with Ibbotson backfill). US equity is modeled by the S&P 500. Based on data since 1926. bonds are modeled using Bloomberg Barclays US Intermediate Treasuries (with Ibbotson backfill).
Source: Investment Strategy Group, Datastream. US equity is modeled by the S&P 500.
Source: Investment Strategy Group, Datastream, Ibbotson.

Frequency of Negative Returns in Stocks and Bonds

Exhibit 24: Rolling 12-Month Nominal Total Return Negative returns in both stocks and bonds over
for a 60/40 Portfolio any 12-month window have occurred only 2% of
A 60/40 portfolio has produced a positive 12-month return the time since 1926, as shown in Exhibit 23. We
80% of the time since 1926. used the S&P 500 Index to represent stocks and the
Rolling 12-Month Total Return (%) Bloomberg Barclays US intermediate 1- to 10-year
100 Treasury index for bonds. About 67% of the time,
80 both stocks and bonds provided positive returns;
Frequency of Positive Returns: 80%
23% of the time, stocks had a negative return
60
partially offset by positive bond returns; and 8%
40 of the time, stocks had a positive return partially
20 offset by negative bond returns. In aggregate, the
data covers 96 years of 12-month windows. A 60/40
0
portfolio produced a positive 12-month return 80%
-20 of the time, as shown in Exhibits 24 and 25.
-40 Another challenge put forth by the naysayers
to the viability of 60/40 portfolios has been the
-60
1926 1932 1938 1944 1950 1956 1962 1968 1974 1980 1986 1992 1998 2004 2010 2016 recent positive correlation between stocks and
bonds. The correlation between stocks and bonds
Data through December 2022.
Note: 60/40 portfolio refers to 60% US equity/40% US intermediate bonds. US intermediate has been positive since August 2022. As shown in
bonds are modeled using Bloomberg Barclays US Intermediate Treasuries (with Ibbotson backfill).
US equity is modeled by the S&P 500.
Exhibit 26, this correlation has varied over time.
Source: Investment Strategy Group, Datastream, Ibbotson. We have looked at both three-year and 10-year
rolling windows. While the long-term average for
both series is 0.04, there have been periods such
to 60/40 portfolios generically, every reference as the 25-year window between 1975 and 2000 in
benchmark and the corresponding diversified which the average of three-year rolling correlations
portfolio must be customized for each client. has been positive at 0.33, and periods such as the
22-year window between 2000 and 2022 when

22 Goldman Sachs january 2023

Exhibit 26: Rolling 3-Year and 10-Year Correlation of Bonds and Equities
The correlation between stocks and bonds has varied over time.
3-Year Rolling Correlation
0.8 Correlation Average While Positive Average While Negative Overall Average

0.6

0.4
0.33
0.2

0.04
0.0

-0.2
-0.33
-0.4

-0.6

-0.8
1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013 2018

10-Year Rolling Correlation

0.6 Correlation Average While Positive Average While Negative Overall Average

0.4

0.26
0.2

0.04
0.0

-0.2
-0.29

-0.4

-0.6
1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Data through December 31, 2022.

Note: US intermediate bonds are modeled using Bloomberg Barclays US Intermediate Treasuries (with Ibbotson backfill). US equity is modeled by the S&P 500.
Source: Investment Strategy Group, Datastream, Ibbotson, Global Financial Data.

the average correlation has been negative at -0.33. do not undermine the viability of 60/40 portfolios
The correlations over 10-year rolling windows and should not deter clients from the use of stock/
exhibit the same pattern of positive and negative bond benchmarks as a launching pad for strategic
correlations. asset allocation.
The changing correlation between stocks and
bonds, however, has no bearing on the viability of The Last Decade Does Not Imply a Lost Decade
60/40 portfolios. A 60/40 portfolio comprising the S&P 500 and
Typically, investors expect bonds to provide the Bloomberg Barclays Intermediate Treasury
some downside protection during large declines in Index generated an annualized return of 8.0% on
equity prices. Bonds have done so even when the a nominal basis and 5.3% on a real basis (adjusted
correlation between stocks and bonds has been for inflation) over the decade ending in 2022.
positive. Exhibit 27 shows how bonds have had This compares to an annualized portfolio return
positive returns—albeit small returns at times— of 8.8% in nominal terms and 5.4% in real terms
during equity market downdrafts, in effect partly since 1926. What differentiates the returns of the
hedging the returns of the portfolio even when the past decade is that they were produced with a
correlations were positive. low annualized volatility of 8.8%, compared to
We conclude that negative returns for stocks volatility of 10.1% since 1926. As a result, the
and bonds and positive correlations between them Sharpe ratio (a measure of the excess return above

Outlook Investment Strategy Group 23

Exhibit 27: Performance of Bonds and Equities During US Equity Drawdowns
Bonds have typically provided downside protection during equity market downdrafts.
Cumulative Return (%)
40 US Equities Intermediate Treasuries
25 23
20 12 12
8 6 5
0 2 1 3 3 2 5 2 2
0
-8
-20 -15 -16 -14 -17 -15 -15 -14
-20 -18
-22 -22
-29 -30
-40
-43 -45
-51
-60

-80
-83
-100
Aug 29– May 46– Jul 57– Dec 61– Jan 66– Nov 68– Dec 72– Dec 76– Nov 80– Aug 87– May 90– Jun 98– Aug 00– Oct 07– Sep 18– Dec 19– Dec 21–
Jun 32 Nov 46 Dec 57 Jun 62 Sep 66 Jun 70 Sep 74 Feb 78 Jul 82 Nov 87 Oct 90 Aug 98 Sep 02 Feb 09 Dec 18 Mar 20 Dec 22

Data through December 2022.

Source: Investment Strategy Group, Datastream, Ibbotson, Global Financial Data.

on long-term returns driven by its multi-factor

Exhibit 28: 60/40 Portfolio Reference vs. Matched- model, a 6.2% annualized total return over the
Volatility Optimized Diversified Portfolio next decade.
An optimized diversified portfolio is expected to have higher Building a diversified portfolio based on the
return and Sharpe ratio than the 60/40 reference. reference portfolio is expected to add another
0.75 to 1.0 percentage point to returns, as we
60% Equities / 40% Bonds Allocations discuss below.
Optimized
Reference Diversified
Investment Grade Fixed Income 40.0% 26.6% Diversified Model Portfolios Built Upon a
Other Fixed Income 0.0% 5.0% Reference Portfolio of Stocks and Bonds
Public Equity 60.0% 42.1% Appropriate diversification is another pillar of
Hedge Funds 0.0% 2.3% ISG’s investment philosophy. We recommend
Private Equity 0.0% 17.9% diversifying assets away from generic stocks and
Other Private Assets 0.0% 6.1% bonds into other assets, but only if those assets
Total 100.0% 100.0%
improve the risk/return profile of a portfolio.
After-Tax Estimated Mean Return
Assuming 2.50% Risk-Free Rate 5.3% 6.0% For example, one can improve the return and
Sharpe Ratio 0.43 0.51 Sharpe ratio of a portfolio by adding high yield
Volatility 8.9% 8.9% securities and illiquid assets such as private equity,
real estate and infrastructure to it. We recommend
Data of December 31, 2022.
Note: Equities are represented by the MSCI All Country World Index and bonds by Barclays a very limited allocation to hedge funds. As shown
Capital US Municipal 1-10 Index.
Source: Investment Strategy Group, Datastream.
in Exhibit 28, diversification into these other assets
is expected to add about 0.7 percentage point to
annualized returns and improve the Sharpe ratio of
an optimized portfolio from 0.43 to 0.51 relative
a risk-free rate per unit of risk) was particularly to a 60/40 reference benchmark.
attractive. We believe that one can add value to portfolios
We expect benchmark returns to be lower over by introducing certain long-term investment
the next five and 10 years. ISG’s Tactical Asset themes. For example, US Preeminence has been
Allocation team expects, based on fundamental an investment theme since the inception of ISG.
analysis, a 6.3% annualized total return for a We recommend overweighting US equities and
60/40 portfolio over the next five years. The team meaningfully underweighting emerging market
does not provide 10-year portfolio forecasts. The assets. In a December 2022 Insight on China titled
Strategic Asset Allocation team expects, based Middle Kingdom: Middle Income, we restated our

24 Goldman Sachs january 2023

Exhibit 29: Total Return Since the ISG Exhibit 30: Frequency of Outperforming Inflation
Commodities Insight Publication Over a Given Investment Horizon
Commodities have meaningfully lagged US equities since Equities have consistently outperformed inflation compared
January 2010. to other asset classes.
Total Return (%) Historical Frequency of Outperforming Inflation (%)
400 120 T-Bills Home Prices
345 Intermediate Treasuries Commodity Prices
350 Long Treasuries Gold Prices
100 US Equity 100
300
91
250
80
77
200
67
150 60 56
55
100

50 38 40
32
0
20
-50 -29

-100 -74
0
-150 1 5 10 15 20
S&P 500 S&P GSCI Index Gold Oil Investment Horizon (Years)

Data through December 31, 2022. Data as of Q3 2022.

Source: Investment Strategy Group, Bloomberg. Note: Calculated using headline inflation.
Source: Investment Strategy Group, Bureau of Labor Statistics, The Economist, Datastream,
Bloomberg, Ibbotson, Robert Shiller (Yale University).

view that diversified portfolios should overweight While we do not recommend commodities as part
US assets and underweight emerging market assets of a client’s strategic asset allocation, we have
and assets with significant exposure to China. In tactically allocated assets to commodities and
the interest of brevity, we refer you to that Insight commodity-related sectors and will continue to do
for details. so in the future.
We also recommend avoiding certain asset US equities, in fact, are the most effective hedge
classes that do not improve the risk/return profile against inflation relative to other asset classes.
of a portfolio. Among certain strategic asset This asset class has had the highest frequency of
allocation advisors, commodities—especially oil,
natural gas and gold—have become a frequently
recommended asset to add to a portfolio given the
increase in inflation as well as the strong returns of
the energy sector in 2022.
We strongly advise against such a strategic
allocation. As explained in our January 2010
Insight report, Commodities: A Solution in
Search of a Strategy, neither gold, nor oil, nor
commodities in aggregate improve the risk/return
profile of a portfolio. At the time, the prevailing
recommendation was to add commodities to
portfolios. We did not agree. As shown in Exhibit
29, US equities have outperformed all key
commodities since we published that report. We
still do not recommend commodities, because
they do not improve the risk/return profile of a
portfolio and, notably, they are among the worst
asset classes in outperforming inflation, as shown
in Exhibit 30.
It is important to note that we differentiate
between strategic and tactical asset allocation.

Outlook Investment Strategy Group 25

outperforming inflation over any period between Exhibit 31: Base and Bear Case Probabilities for
one and 20 years, as shown in Exhibit 30. S&P 500 Year-End Price Scenarios in ISG Outlooks
We conclude that a 60/40 portfolio is still a Our base case probability for the S&P 500 is the lowest
good starting point upon which to build a fully since the GFC while that of our bear case is the highest.
diversified portfolio. A year of negative returns in Scenario Probability (%)
both asset classes, positive correlations and lower 70 Bear Case
Base Case
forward returns compared to returns in the prior 60
decade do not negate the benefits of a portfolio
that is composed primarily of stocks and bonds 50 50

and has been supplemented by other asset classes. 40

As Sir John Templeton, American-British
30
investor, wrote, “the four most expensive words in 30
25
the English language are ‘This time it’s different.’”16 20 20 20 20 20
20
When market participants say this time is different 15 15 15 15 15 15 15
10
and suggest that we are entering a new regime 10

in which 60/40 stock/bond portfolios no longer

0
work, we are reminded of Templeton’s comment 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
and remain confident that history is a useful guide: Data as of December 31, 2022.
this time is not that different from past periods of Source: Investment Strategy Group.

underperformance of stock/bond portfolios and

positive correlations.
Since we expect returns for the next one, five, and a recession in Russia because of the war
and 10 years to be attractive, we recommend in Ukraine. While our base case for China is a
clients stay invested at a well-diversified strategic post-COVID economic recovery of 4.9%, the
asset allocation that is in line with their risk risks are tilted to the downside if the disorderly
tolerance. We now turn to our one- and five-year exit from COVID—which The Economist has
expected returns across publicly traded asset referred to as “China’s COVID failure”—saps
classes and make the case for staying invested consumer and business confidence.
despite the heavy fog ahead. • Mid-single-digit earnings growth in the US; flat
earnings in Japan; and declining earnings in the
Eurozone, the UK and emerging markets.
Our One- and Five-Year Expected • Slightly lower interest rates in the US, Europe and
Total Returns the UK; a modest increase in rates in Japan; and
a very small decline in rates in emerging markets.
Given the probability of 45−55% that we have
assigned to a US recession, with a midpoint at 50%,
we are also assigning a 50% probability to the base
case scenario of our expected returns across the
major publicly traded asset classes. We are assigning
a higher probability to the downside scenarios, given
the combined risks of recession and geopolitical
flare-ups around the world. This is the lowest
probability we have given our base case scenario
and the highest probability we have given our
downside scenario since the GFC (see Exhibit 31).
Our expected returns are driven by our
estimates of:

• Below-trend global growth of 2.4% in 2023,

consisting of 1.2% growth in the US, mild
recessions in the Eurozone and the UK, anemic
growth in Brazil, below-trend growth in India

26 Goldman Sachs january 2023

Exhibit 32: ISG Prospective Total Returns
%
14 2023 Prospective Return 5-Year Prospective Annualized Return 13 13
12 12
12 11
10 10
10 9 9 9
8 8 8 8 8 8
8 7 7
6 6 6 6 6
5 6 5 5
6 5 4 5 5 4
4 4 4
4 3 4
4
2
2
0
-2 -1
DXY (9%)

Muni 1-10 (3%)

Bank Loans (8%)

Muni HY (6%)

US Cash (0%)

EM Local Debt (13%)

US Corporate HY (12%)

5-Year Treasury (5%)

Hedge Funds (6%)

10-Year Treasury (7%)

EM Equity (US$) (22%)

UK Equity (15%)

Japan Equity (17%)

Non-US Developed
Equity (Local) (15%)

MSCI All Country

World (15%)

S&P 500 (15%)

Eurozone Equity (18%)

EUR Moderate
Portfolio (8%)

US Taxable Moderate
Portfolio (8%)

US Tax-Exempt
Moderate Portfolio (8%)
Asset Class (Volatility)

Data as of December 31, 2022.

Source: Investment Strategy Group. See endnote 17 for list of indices used.
Note: Forecasts have been generated by ISG for informational purposes as of the date of this publication. There can be no assurance the forecasts will
be achieved.

• A negligible increase in the US dollar of 1−2%,

and modest decreases in emerging market Exhibit 33: ISG S&P 500 Total Return Forecast
currencies. Scenarios—Year-End 2023
In our upside scenario, we expect US equities to increase as
As shown in Exhibit 32, we expect US and much as 27%.
Eurozone equities to be the best-performing
asset classes in 2023, with total returns in local Total Return (%)
currency of about 13% in our base case scenario. 35

We expect returns of 12% for the MSCI All 30

27
Country World Index. Such strong equity returns, 25

if realized, will result in moderate-risk model 20

portfolio returns of 9.0% for taxable clients and 15 13

9.8% for tax-exempt clients. As mentioned earlier, 10
we assign a probability of 50% to our base case 5
scenario. 0
We assign a probability of 30%, much higher -5
-4
than usual, to our downside scenario across all -10
equity markets. However, in the US, the full-year Good Case Central Case Bad Case
(4,800 Price) (4,200–4,300 Price) (3,600 Price)
returns in our downside scenario are relatively (20% Probability) (50% Probability) (30% Probability)
muted, at -4%, because US equities already Data as of December 31, 2022.
declined 18% in 2022. Valuations declined from Source: Investment Strategy Group, Bloomberg.

21.4x consensus earnings at the beginning of 2022 Note: Forecasts are estimated, based on assumptions, are subject to
revision and may change as economic and market conditions change.
to 17.4x by the end of the year.
There can be no assurance the forecasts will be achieved. Indices are
In our upside scenario, we expect equities to gross of fees and returns can be significantly varied. Please see additional
increase by as much as 27% due to lower inflation, disclosures at the end of this Outlook.
above-trend growth in the US and higher multiples
as investors are relieved that recession risks have
abated. We assign a 20% probability to that case, The most important question to address for
as shown in Exhibit 33. clients is why we recommend they stay invested at
We estimate that our one- and five-year return their strategic asset allocation given the 45−55%
expectations will be realized even if we have a mild probability of recession and 30% probability of
US recession that ends this year. our downside scenario.

Outlook Investment Strategy Group 27

 Exhibit 34: ISG Decision Matrix for Exhibit 35: S&P 500 Drawdown Prior to Yield
Underweighting Equities Curve Diffusion Inversion Index Trigger
We believe investors are better off staying the course and The equity market had already declined by 17% when the
even looking for opportunities to overweight stocks. index triggered a recession signal last year.
Drawdown from 1Y High (%) 0.0
0
-0.7 -0.3
-2 -1.2 -1.4
Small

-2.2
Stay Invested Potential Underweight -4
Equity Drawdown

-6
-6.2 -6.3
-8

-10 -9.5

Stay Invested Stay Invested -12

Large

-14

Potential Overweight Potential Overweight -16

-18 -17.3
-20
Low High Dec-56 Sep-59 Dec-65 Dec-67 Mar-73 Sep-78 Feb-89 Apr-00 Feb-06 Jul-22
Imminent Recession Risk Date of 100% Yield Curve Inversion Diffusion Index Value

Data as of December 31, 2022. Data as of July 2022.

Source: Investment Strategy Group. Source: Investment Strategy Group, Bloomberg.

First and foremost, while we have assigned a equities have declined by low- to mid-single digits at
30% probability to a muted -4% return for the the time of past signals, allowing time for defensive
full year, we have assigned a 70% probability portfolio adjustments (see Exhibit 35). The largest
of S&P 500 returns of 13% or higher. The skew decline prior to 2022 was 9%. So underweighting
of expected returns by the end of 2023 is to the equities after a decline of 18% in 2022 is not
upside, based on our analysis. prudent given our view that a recession is not a
Second, ISG’s framework for underweighting certainty and the fact that a significant market
equities in the face of a high probability of decline preceded the recession signal in this cycle.
recession requires that equity markets have not Similarly, the equity market has rallied after the
declined more than 10%. As shown in Exhibit start of every Federal Reserve tightening cycle that
34, if the probability of recession is high—which led to a recession. As shown in Exhibit 36, the S&P
it is currently—but the equity market has already 500 has rallied after the beginning of all tightening
declined significantly, it is too late to underweight cycles by anywhere from 4% to 85%, with an
equities; in fact, we look for opportunities average of 40% and a median of 34%. (We have
to overweight equities, either directly or included the tightening cycle that started in 2015,
through options. even though the pandemic triggered the following
Our framework to underweight equities in recession.) Therefore, the beginning of a tightening
anticipation of a recession is based on post-WWII cycle is not reason enough to underweight equities.
history showing equity markets do not typically In 2022, the equity market had already declined
discount recessions more than six months in 10% by the time of the first hike by the Federal
advance. What transpired in 2022 was unusual on Reserve in March.
multiple fronts—not just because having a year It is very unusual for financial conditions to
with negative returns for both stocks and bonds tighten as much as they did in 2022 before the
has occurred only 2% of the time since 1926. Federal Reserve raises rates.
Other rare occurrences also materialized last The third reason we recommend clients stay
year. As mentioned earlier, our most historically invested at their strategic asset allocation is that
reliable leading indicator for detecting a future portfolio returns after a year of negative returns—
recession, our Yield Curve Inversion Diffusion such as we had in 2022—tend to be higher than
Index, triggered a recession signal on July 25, 2022. long-term averages in the following 12 and 24
At that time, US equities had already declined months. We shared some of this analysis in defense
17% from peak levels earlier in the year. Typically, of 60/40 portfolios. Here we examine the data for

28 Goldman Sachs january 2023

Exhibit 36: S&P 500 Returns From Start of Federal Exhibit 37: Rolling 12-Month Nominal Total Return
Reserve Tightening to Market Peak for the 50/50 Portfolio
US equities have rallied after the beginning of all tightening A 50/50 portfolio produced a negative 12-month return only
cycles that led to recessions. 18% of the time since 1926.
Total Return (%) Rolling 12-Month Total Return (%)
90 80
85
80 75 60
Frequency of Positive Returns: 82%
70 68
40
60

50 48
20
40
40 35
32 34 0
30

20 18 18 -20
15
10
4 -40
0
Apr-46 Jul-54 Aug-58 Aug-67 Mar-72 Feb-77 Aug-80 Dec-86 Jun-04 Dec-15 Avg. Med. -60
Federal Reserve Tightening Start Date 1926 1933 1940 1947 1954 1961 1968 1975 1982 1989 1996 2003 2010 2017

Data as of December 31, 2022. Data through December 2022.

Source: Investment Strategy Group, Bloomberg. Note: 50/50 portfolio refers to 50% US equity/50% US intermediate bonds. Bonds are
represented by US intermediate treasuries and equities by the S&P 500 Index.
Source: Investment Strategy Group, Datastream, Ibbotson.

moderate-risk portfolios that are benchmarked

against 50/50 stock/bond portfolios because that Exhibit 38: Total 12-Month Returns for the 50/50
benchmark is more commonly used by our clients. Portfolio Following Negative Returns
We note the following: Typically, the markets outperform long-term averages after
a big decline.
• As shown in Exhibit 37, negative returns for Average Cumulative Nominal Returns (%) % of Positive Returns
a moderate-risk portfolio occur only 18% of 20 Following Negative
12-Month Returns (Left)
% of Positive Returns (Right)
% of Positive Returns, Unconditional (Right)
100

the time. 18 Unconditional (Left) 90

• Typically, as shown in Exhibit 38, the market’s 16

82
85 83 80

subsequent returns outperform long-term 14 75 70

averages after a big decline. For example, in 12

10.6
60

the post-WWII period, the total return of a 10 9.0 8.9 50

8.5
50/50 portfolio was 10.6% in the 12 months 8 40
following a negative return, compared to the 6 30
average annual return of 8.9%. The returns are 4 20
even more compelling over 24 months. 2 10
• Of course, positive returns do not always
0 0
follow 12 or 24 months later. During the Great 1926–2022 1945–2022
Depression, a moderate-risk portfolio would Data as of December 31, 2022.
have experienced a cumulative drawdown of Note: 50/50 portfolio refers to 50% US equity/50% US intermediate bonds. Bonds are
represented by US intermediate treasuries and equities by the S&P 500 Index.
53% for 2.8 years. A moderate-risk portfolio Source: Investment Strategy Group, Datastream, Ibbotson.
took 3.6 years to recover to prior peak levels,
as shown in Exhibit 39.
• In the post-WWII period, there have been three – Monetary policy discipline was very different
periods in which above-average returns have in the early 1970s, oil prices increased by
not followed a year of negative returns in a nearly 2.5 times and inflation expectations
moderate-risk portfolio: the 1973−74 Arab- became unanchored.
Israeli War and Arab oil embargo, the dot-com – In the dot-com bubble period, equity valuations
bubble, and the GFC. We do not believe those were significantly higher. The red diamonds
periods are likely to be repeated: in Exhibit 40 indicate valuations at the peak

Outlook Investment Strategy Group 29

Exhibit 39: Peak-to-Trough Drawdowns and Recovery During the Great Depression
Downdrafts pass and portfolios recover.
% US Equity 50/50 Portfolio
0

-20

-40

-53.0
-60

-80
-83.4
Peak Date Trough Date June 1932 Portfolio Recovery Date January 1936 Equities Recovery Date January 1945
August 1929 Drawdown Duration: 34 Months Recovery Duration: 43 Months Recovery Duration: 151 Months
-100
Aug-1929 Jul-1931 Jun-1933 May-1935 Apr-1937 Mar-1939 Feb-1941 Jan-1943 Dec-1944

Data through January 31, 1945.

Note: 50/50 portfolio refers to 50% US equity/50% US intermediate bonds. Bonds are represented by US intermediate treasuries and equities by the S&P 500 Index.
Source: Investment Strategy Group, Datastream, Ibbotson.

of the dot-com bubble. These valuation levels 2.5x equity capital relative to risk-weighted
were higher than levels in December 2021 assets compared to levels that existed
and December 2022. And as shown in Exhibit during the GFC.
41, the equity risk premium—the incremental
premium investors earn to hold equities instead As shown in Exhibit 43, the 12-month returns of
of bonds—was negative! a moderate-risk portfolio have averaged 13.3%
– During the GFC, aggregate leverage for following a negative 12-month return if we remove
households and non-financial corporations the three episodes that we think are highly unlikely
was 143% of GDP, as shown in Exhibit 42. to be repeated in this environment.
It is now 123%, and the economy is very There are some additional factors that support
well balanced, as discussed earlier. Large, staying invested:
systematically important US banks have

Exhibit 40: S&P 500 Valuation Multiples

Valuations were significantly higher in the dot-com bubble period than today.
Multiple (x)
60 Long-Term Median (Post-World War II)
Median Over the Low and Stable Inflation Regime (Since April 1996)
Current Level
50 Peak of Dot-Com Bubble
End of 2021
40

29.7
30 26.7
22.2 21.5 22.4
20 19.4 18.7 19.2
15.8 16.5 17.1
15.5

10

0
P/Trend Reported Earnings P/10Y Avg Reported Earnings P/Peak Reported Earnings Shiller CAPE P/TTM Operating Earnings P/TTM Reported Earnings
Based on Earnings Over a Cycle Based on Earnings in the Last 12 Months

Data through December 31, 2022.

Source: Investment Strategy Group, Bloomberg, S&P Global, Robert Shiller.

30 Goldman Sachs january 2023

Exhibit 41: S&P 500 Equity Risk Premium Proxy Exhibit 43: Total Returns for the 50/50 Portfolio
During the dot-com bubble, the equity risk premium Following Negative 12-Month Returns
was negative. The 12-month returns have averaged 13.3% excluding
1973–74, the tech bubble and GFC.
ERP (%) Average Cumulative Nominal Returns (%) % of Positive Returns
8 30 100
Cheaper 85 83
82 96 90
Equity
25 75
Valuations 80
6
70
20
60
4 13.3
15 50
10.6 40
10 8.5 9.0 8.9
2 2.0 2.0 30
20
5
10
0
0 0
1926–2022 1945–2022
-1.4 S&P 500 ERP (Earnings
-2 Following Negative % of Positive Returns (Right)
Yield Less 10Y Treasury)
12-Month Returns (Left) % of Positive Returns, Unconditional (Right)
1999–2000 (dot-com bubble)
Unconditional (Left) % of Positive Returns, Excluding 1973–74,
2005–2007 (Pre- GFC)
-4 Excluding 1973–74, Tech Bubble and GFC (Right)
1980 1985 1990 1995 2000 2005 2010 2015 2020 Tech Bubble and GFC (Left)

Data through December 31, 2022. Data as of December 31, 2022.

Note: Equity risk premium is approximated by forward earnings yield minus US 10-year Treasury yield. Note: 50/50 portfolio refers to 50% US equity/50% US intermediate bonds. Bonds are
Source: Investment Strategy Group, Goldman Sachs Global Investment Research, Bloomberg represented by US intermediate treasuries and equities by the S&P 500 Index.
FactSet, Compustat. Source: Investment Strategy Group, Datastream, Ibbotson.

Exhibit 42: Debt-to-GDP for Households, Exhibit 44: S&P 500 Returns in Each Year of the
Nonprofits and Non-Financial Corporates Presidential Cycle
Aggregate leverage was 143% of GDP during the GFC, The third year in the presidential cycle has historically had
compared to 123% at the end of 2022. the highest returns and 84% odds of a gain.
Debt-to-GDP (%) % %
165 25 Average Return (Left) 100
% Time Higher (Right)
84
143 79
145
20 80

125 123 63 16
15 55 60
105

85 10 40
8
7
65
5 4 20

45
0 0
25 Year 1 Year 2 Year 3 Year 4
80-Q1 86-Q1 92-Q1 98-Q1 04-Q1 10-Q1 16-Q1 22-Q1 Year of Presidential Cycle

Data through Q3 2022. Data through December 31, 2022.

Note: GDP is seasonally adjusted annual rate (SAAR). Note: Based on data since 1946.
Source: Investment Strategy Group, Haver Analytics. Source: Investment Strategy Group, Bloomberg.

• Technical signals related to market breadth at likelihood of a positive price return in the post-
various points last year, such as the number of WWII period, as shown in Exhibit 44.
S&P 500 companies above their 200- and 50- • For investors who pay taxes, it is important
day moving averages, point to positive returns to factor in the cost of taxes incurred when
well above our base case target for the S&P 500. realizing capital gains of assets. As shown in
• The third year of a presidential term has Exhibit 45, the market must decline significantly
typically had the highest return and the highest to make up for the cost of taxes, and the timing

Outlook Investment Strategy Group 31

Exhibit 45: Required Decline in US Equities to Exhibit 46: S&P 500 Price Index vs. Earnings
Offset Tax Consequences of Selling Prices of US equities follow the path of corporate earnings
Capital gains taxes increase the hurdle to exit the equity in the long run.
market for tax-paying investors.
% Invested at Trough Invested Midway Through Bull Market* Indexed Value in Log Scale (1945 = 100)
0 S&P 500 Trailing-12-Month Reported Earnings
S&P 500 Price Index
-5

-10 6250
-11
-15
-16
-17
-20 -18
-20 1250

-25

-30 -29 250

-31
-32
-35

Hypothetical Hypothetical Hypothetical Hypothetical 50

California Taxpayer New York City Taxpayer New York Taxpayer Florida Taxpayer 1945 1955 1965 1975 1985 1995 2005 2015

Data as of December 31, 2022. Data through Q3 2022.

Source: Investment Strategy Group, Datastream. Source: Investment Strategy Group, Bloomberg, S&P Global.
* Invested at an S&P 500 level of 2,031, which is the midpoint between the GFC trough level of
677 and the peak level of 3,386 before the COVID-19 drawdown.

for exiting and then reentering the market must our recommendation to stay invested will have
be excellent. For example, if a hypothetical New served our clients well. Interestingly, even if we had
York City taxpayer sold equities at the beginning exited equities early in January 2022 and stayed
of 2022 and remained out of the market, the in cash waiting for the fog of recession risk and
taxes paid on a dollar invested in 2009 would other geopolitical risks to lift, our taxpaying clients
necessitate a market decline of 32% from the might not have broken even. They would have paid
beginning of 2022 just to break even. Taxes paid more in taxes than they would have saved in the
on a dollar invested midway between 2009 and market decline.
the pre-COVID market peak would require a We now turn to our tactical tilts, which
market decline of 18% just to break even. provided some incremental portfolio return to
clients that used them in 2022, and review our tilts
Finally, our recommendation to stay invested is in place at the beginning of 2023.
also driven by the general upward trend of US
equities. As shown in Exhibit 46—an exhibit
that is familiar to our long-standing clients—US Our Tactical Tilts
equities are driven by earnings in the US economy,
which are upward-trending except for recessions. A tumultuous year in financial and commodity
Downdrafts pass and portfolios recover. On markets presented the tactical asset allocation team
average, it has taken 10 months for moderate-risk with significant opportunities to add value to clients’
portfolios to recover; the median time to recovery portfolios. Volatility was nearly double that of
is eight months, as shown in Exhibit 47. We 2021 as measured by the S&P 500, and about 80%
recommend staying invested because the risk of higher as measured by the MSCI ACWI. At peak
missing out on an increase in equities is far greater levels, we had 22 individual tactical tilts in 2022,
than a short-term mark-to-market risk that will compared to a long-term average of 10 tilts a year.
eventually dissipate. Typically, these tactical tilts have been funded
We recommend clients stay invested at their from fixed income assets and driven by attractive
full strategic asset allocation. We acknowledge that valuations and market dislocations. Volatile
we made the same recommendation in our 2022 markets tend to provide more market dislocations,
Outlook report, Piloting Through. We believe which, in turn, provide more opportunities for
that if our 2023 expected returns are realized, tactical asset allocation.

32 Goldman Sachs january 2023

Exhibit 47: Time to Recovery for 50/50 Portfolios During Past Equity Drawdowns
It has taken 10 months on average for moderate-risk portfolios to recover.

S&P 500 50% Equities/50% Bonds

Peak-to-Trough Drawdown Duration Time to Recovery Time to Recovery
Drawdown (Months) (Months) Portfolio Drawdown (Months)
May 1946–Nov 1946 -21.8% 6 35 -11.0% 18
Dec 1961–Jun 1962 -22.3% 6 10 -10.1% 7
Nov 1968–Jun 1970 -29.3% 19 9 -14.3% 6
Dec 1972–Sep 1974 -42.6% 21 21 -20.6% 8
Aug 1987–Nov 1987 -29.5% 3 18 -13.7% 14
Aug 2000–Sep 2002 -44.7% 25 49 -15.7% 15
Oct 2007–Feb 2009 -50.9% 16 37 -24.2% 19
Sep 20–Dec 24, 2018 -19.4% 3 4 -8.7% 2
Feb 19–Mar 23, 2020 -33.8% 1 5 -15.4% 3
Average -32.7% 11 21 -14.9% 10
2022 Peak-to-Trough -24.5% - - -16.9% -

Data as of December 31, 2022.

Note: 50/50 portfolio refers to 50% US equity/50% US intermediate bonds. Bonds are represented by US intermediate treasuries and equities by the S&P 500 Index. Episodes correspond to historical monthly
drawdowns of more than -20% during the post-war era. Monthly data used with the exception of the Q4 2018 drawdown, COVID drawdown and 2022 peak-to-trough performance, which use daily data.
Source: Investment Strategy Group, Datastream, Ibbotson.

We estimate that these tilts added about 50

basis points to a taxable moderate-risk portfolio Exhibit 48: Daily Implied S&P 500 Volatility
in 2022, outperforming intermediate Treasury Extreme levels of volatility increase attractiveness of option
and municipal bonds. The overall volatility of the strategies.
tilts was 5.1%, and the beta to the S&P 500 was Volatility Index (VIX)
0.18. Despite the positive beta to the S&P 500— 45
39
which dropped about 18% for the year—the tilts 40
Intraday High
(1/24)
produced a positive total return.
35

S&P 500 Option Strategies: One of the most 30

effective strategies in 2022 for taking advantage of
increased volatility was using options to augment 25

the returns of a fully invested portfolio. 22

20
The strategy is based on two tenets:
15

• Volatility tends to revert to its long-term

10
average over time. If volatility spikes because Dec-21 Feb-22 Apr-22 Jun-22 Aug-22 Oct-22
of events such as the GFC, the pandemic or Data through December 31, 2022.
the Russian invasion of Ukraine, it eventually Source: Investment Strategy Group, Bloomberg.

comes back toward its long-term average of

about 20 as measured by the VIX. During the
early months of the pandemic, for example, a riskier strategy. For example, if volatility is
volatility reached 85. In 2022, it peaked at 39 high and we can collect an attractive premium
intraday and ended the year at 22, as shown by selling a put option, that may be more
in Exhibit 48. When volatility is high, options attractive than buying the asset outright.
increase in value, and that may be an opportune Sometimes, we use a combination of options,
time to sell options. When volatility is low, that as we did in 2022.
may be an opportune time to buy options.
• We tend to use options to enhance the risk/ In 2022, we had a total of nine put and call option
return profile of a portfolio when we believe tactical tilts on the S&P 500. In aggregate, they
that buying or selling the underlying asset is produced a total return of 3.2% net of transaction

Outlook Investment Strategy Group 33

costs, with a volatility of 6%, compared to the Exhibit 49: MLP Enterprise Value to EBITDA
total return of the S&P 500 of -18%, total return MLP valuations are still attractive even after strong returns
of intermediate Treasuries of -8% and total return over the least 2 years.
of intermediate municipal bonds of -5%. Multiple (x)
While we do not have any such S&P 500 18 Historical Median Multiple
Median Since Q1 2003
options as a tactical tilt in early 2023, we expect Median Excluding 2010–15 (High-Inflow Years)
16
this to be an effective tactical asset allocation
strategy this year, as spikes in volatility are likely 14
given the uncertainty ahead with respect to the US
economy and geopolitical tensions. 12
11.3
As of year-end 2022, we had six tactical tilts,
which is below our average number of tilts and is 10
9.7
the lowest level of risk allocated to such tilts over 8.6
the last decade. 8

6
Overweight 2-Year Treasuries: We initiated a 1Q03 1Q05 1Q07 1Q09 1Q11 1Q13 1Q15 1Q17 1Q19 1Q21
tactical tilt to a constant-maturity 2-year Treasury Data through Q4 2022.
early in 2022. At the time, our view was that 2-year Source: Investment Strategy Group, Bloomberg.

Treasury rates were already discounting Federal

Reserve tightening to such an extent that the tilt was
likely to provide a positive return. We still expect the • The tax-advantaged distribution yield of 8% is
tilt to provide a positive return, especially as 2-year attractive compared to fixed income and high
Treasury rates ended 2022 at 4.4%. Given our view yield rates. The companies in the Alerian MLP
of economic growth at 1.2% and the federal funds Infrastructure Index generate 1.8x free cash
rate peaking at 5−5.25%, we expect this tilt to flow relative to distributions, so the distribution
provide a mid-single-digit return in 2023.18 yield appears secure.
• We expect returns in the low 20s in 2023.
Overweight US Energy Infrastructure Master
Limited Partnerships: The allocation to master We note that we removed our S&P 500 energy
limited partnerships (MLPs) has been one of our sector tilt in October 2022 as the sector had rallied
longest-standing tactical tilts. It was initiated 63%, following a 55% total return in 2021. The
as an option tilt in 2015 and changed to a long energy sector had outperformed the S&P 500 by
sector position in January 2016. This tilt has an 83 percentage points when we removed the tilt. We
inception-to-date return of 37% and has been one removed the tilt because it had reached fair value
of our most volatile tilts. The MLP sector was up on a normalized price-to-earnings basis, given oil
nearly 30% in 2022, compared to the S&P 500 prices in the futures market.
at -18%. While we have reduced the allocation
to this tilt given its strong performance over the Overweight Eurozone Banks: We have maintained
last two years, we still retain an allocation, for the our tactical tilt to Eurozone banks at a reduced
following reasons: allocation. This is also among our longest-standing
tilts, initiated in June 2018. And very much like our
• Valuations are still attractive even after such MLP tilt, it has been very volatile. It outperformed
strong returns. Valuations as measured by the European markets in both 2021, with a total
the ratio of enterprise value to EBITDA are return of 42%, and 2022, with a total return of 2%.
one standard deviation below their long-term We retain this allocation for the following reasons:
average due to continued strong earnings (see
Exhibit 49). • Rising rates will improve the banks’ net interest
• Corporate management has continued to margins and overall profitability.
be disciplined about capital expenditures, • We expect only a moderate rise in provisions
with 2022 levels about 3.9% below 2021 despite our recession forecast for the Eurozone.
levels. 2023 levels are expected to be flat to Leverage has remained low, and two-thirds of
slightly lower. the post-COVID increase in lending is covered

34 Goldman Sachs january 2023

Exhibit 50: Eurozone Banks’ Nonperforming Exhibit 51: Eurozone Banks’ Return on Equity vs.
Loan Ratio Price/Book Ratio
There are no signs of deterioration in asset quality. Eurozone banks’ valuation is lower than what is implied by
their profitability.
Nonperforming Loan Ratio (%) Trailing Price/Book (x)
8 3.0

7
2.5

6
R 2 = 80%
2.0
5
1.5
4 2023
Estimate
3 1.0

2 0.5
1.8

1 Current
0.0
0 0 2 4 6 8 10 12 14 16 18
2014 2015 2016 2017 2018 2019 2020 2021 Trailing Return on Equity (%)

Data through Q2 2022. Data through December 31, 2022.

Source: Investment Strategy Group, European Central Bank. Source: Investment Strategy Group, Datastream.

by government guarantees. There are currently

no signs of deterioration in asset quality, as Exhibit 52: Rolling March-April Henry Hub Natural
shown in Exhibit 50. Gas Spread
• The banks’ capital ratio is near record highs. March 2023 contracts became very expensive relative to
• We expect a total return in the low 20s, April and traded at a historically high premium.
composed of 6% dividend yield and multiple US$ per MMBtu
expansion as the price-to-book ratio increases 5 Spread
Spread at Tilt Inception ($1.08)
from its current low level of 0.60x to 0.69x. 4
As shown by the red triangle in Exhibit 51,
3
that increase in price-to-book is a reasonable
assumption. 2

1
Allocation to US Natural Gas Calendar Spread: 0.19
0
As noted earlier, both European and US natural
gas prices gyrated following the halting of the -1

Nord Stream 2 pipeline and the Russian invasion -2

of Ukraine. Fears of winter shortages of natural
-3
gas led US March 2023 contracts to become 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022
very expensive relative to April and trade at a Data through December 31, 2022.
historically high premium of over $1 per million Source: Investment Strategy Group, Bloomberg.

BTU (see Exhibit 52)—a spread that had been

wider only 9% of the time. This spread has
typically contracted to $0.5 or less 95% of the time reliable, carbon-free and secure sources of energy.
as the winter ends. The base case expected return Some view nuclear energy as a permanent solution
on this trade was in the mid- to high teens, and we and others as a transition source of energy
are rapidly approaching those levels. away from hydrocarbons while waiting for the
development of more renewable energy sources.
Allocation to Physical Uranium: We initiated a Nuclear energy has supplied about 20% of
small allocation to physical uranium in 2022. total annual US electricity since 1990. In 2020,
Nuclear energy is becoming an increasingly nuclear energy supplied 69% of France’s electricity
attractive source of electricity as countries seek generation.

Outlook Investment Strategy Group 35

Exhibit 53: Annual Uranium Mine Production and Exhibit 54: FANGMANT Weight Over Time
Nuclear Reactor Requirements The FANGMANT stocks represent 20% of the
The current trajectory of mine production is projected to overall S&P 500.
remain below annual reactor requirements.
Million Pounds U3O8 Weight of FANGMANT in the S&P 500 (%) 29
300 Mine Production 30 Nov 2021
Reactor Requirements

250 255 25

200 20 20

150 15

100 10
93

Projections
50 5

0 0
2008 2012 2016 2020 2024 2028 2032 2036 2040 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022

Data through 2022; projected through 2040. Data through December 31, 2022.
Source: Investment Strategy Group, UxC LLC. Note: FANGMANT = Facebook/Meta, Apple, Netflix, Google/Alphabet, Microsoft, Amazon,
Nvidia and Tesla.
Source: Investment Strategy Group, Bloomberg.

There has been a sharp decrease in uranium it has become extended. The strategy is based on
exploration activity and in production from the momentum factor and is a diversified strategy
existing mines. Since 2018, mined supply has been for ISG’s more value-oriented tactical tilts. We
insufficient to meet annual reactor requirements generally expect the strategy to deliver a high-
(see Exhibit 53), and utilities have accessed single-digit return.
inventories and extended the enrichment process to
extract more yield per unit of raw uranium. Role of Growth Stocks in Driving Equity Returns:
As of December 31, 2022, the price for Our tactical tilts generally have had a value
uranium was $48/lb. We estimate that prices need orientation. Since the inception of ISG, we have
to reach $70 or higher to incentivize adequate had only a handful of growth-oriented tactical tilts.
future production. While we do not anticipate In total, our tactical tilts have provided incremental
those levels in the near term, we think this tilt will return to the strategic asset allocation process.
have long-term attractive returns. Avoiding growth-oriented sectors did not hamper
our performance, or that of the S&P 500.
Allocation to Systematic Strategies: We deploy One of the questions clients most frequently ask
three systematic strategies to provide uncorrelated us concerns the role of a limited basket of stocks
sources of incremental return to a portfolio: like the FANGMANT stocks, or the technology
Systematic Upside Improvement Tilt (SUIT); or communication sector stocks, in driving equity
Systematic Downside Mitigation Tilt (SDMT); and returns since the GFC. When we share our view
Trend-Based Rotation (TBR). that the return of the S&P 500 has been broad-
All three strategies were deployed at the based, clients are often surprised. As shown in
beginning of 2022. We removed the first two Exhibit 54, the FANGMANT stocks represent
strategies after high-single-digit returns but have 20% of the weight in the S&P 500 Index, down
left the TBR strategy as a tactical tilt for 2023. from a peak of 29% in November 2021.
This strategy was introduced in 2021. The goal The most straightforward way to show that a
is to rotate among 10 asset classes: US and non- handful of growth stocks with large weights in the
US equity indices, gold, US corporate bonds, US S&P 500 have not driven the index returns is to
Treasury bonds and US cash. The strategy is driven compare these returns using market capitalization
by the trend in each asset class, its volatility and weights to those of an equal-weighted index
the likelihood the trend will reverse course once of stocks, where value stocks like Exxon, with

36 Goldman Sachs january 2023

Exhibit 55: Performance of Equal- and Exhibit 56: Performance of S&P 500 Sectors
Market Cap-Weighted S&P 500 Financials and industrials are among the sectors that
The equal-weighted S&P 500 index has outperformed the outperformed the S&P 500 since the trough of the GFC.
market cap-weighted index across prior historical windows.
Annualized Total Return (%) Annualized Total Return Since March 2009 (%)
25 Market Cap-Weighted Equal-Weighted Difference 25
(Equal Less Market Cap)
20.4
19.7 20
20 18.8 18.4 17.8 17.0 16.6 16.3
16.5 15.6
15.6 15.7 14.4 13.9
15 13.6 12.8
15

9.0 8.5
9.6 10
10
7.4
5
5
2.2
0.9 0

Info Tech

Consumer Disc.

Financials

Industrials

Health Care

Real Estate

Materials

Consumer Staples

Utilities

Energy

Comm Services

S&P 500
0
-0.9
-2.7
-5
Since Mar 24, 2000 Since Mar 9, 2009 2011–2021 2016–2021

Data through December 31, 2021. Data through December 31, 2022.
Source: Investment Strategy Group, Bloomberg. Source: Investment Strategy Group, Bloomberg.

a 1.4% weight, and Coca-Cola, with a 0.8% the equal-weighted index would have lagged the
weight, are given the same weight as Apple Inc., market capitalization-weighted index significantly
which has a 6.0% weight, and Microsoft, which over all periods.
has a 5.6% weight in the market capitalization- An alternative approach is to look at the
weighted index. total return across all S&P 500 Index sectors. As
We have analyzed the data through the end shown in Exhibit 56, the information technology
of 2021 and end of 2022. We present below the sector outperformed after the trough of the GFC.
returns of the two benchmarks for four periods: However, financials, industrials and health care all
since March 2000, the peak of the dot-com bubble; outperformed the broader market.
since the trough of the GFC; and over the last five While our US Preeminence theme is not
and the last 10 years. We focus on the data ending reflected in a tactical asset allocation tilt, it is a
in 2021 because these stocks did extremely poorly strategic asset allocation overweight. As shown in
in 2022 and we do not want clients to discount the Exhibits 57–72, the US is preeminent across most
analysis because of that poor performance. Late metrics that underpin economic growth, superior
2021 also marks the peak weight of the basket of earnings growth and greater resilience. Should
FANGMANT stocks in the S&P 500 Index. This some of the risks other than recession that we
basket of stocks declined 40% in 2022. have outlined in the next section materialize, this
Since 2000 and since the trough of the GFC, resilience will be paramount. Even so, these risks
the equal-weighted index outperformed the could derail our 2023 outlook.
market capitalization index by 2.21 and 0.94
percentage points, respectively, on an annualized
basis. Over the decade ending in 2021,
the market capitalization-weighted
index outperformed by 0.92 percentage
point. The outperformance increased
to 2.75 percentage points over the five
The US is preeminent across most
years ending in 2021, and that includes metrics that underpin economic
the strong outperformance during the
pandemic (see Exhibit 55).
growth, superior earnings growth and
If the returns had been driven by a greater resilience.
basket of growth-oriented stocks alone,

Outlook Investment Strategy Group 37

US Preeminence by the Data

Exhibit 57: Nominal GDP per Country Exhibit 59: Annualized and Cumulative Equity
The US has the highest GDP in the world. Returns Since the Trough of the GFC
US equities have outperformed equities in other regions
over the past 13 years.
Nominal GDP (US$ Billions) Annualized Total Return (%)
30,000 20

25,035 Cumulative:
Cumulative: 267% 15.7
25,000 16 Cumulative: Cumulative: Cumulative:
Cumulative: 235%
Cumulative: 210% 216% Total Value:
189% 204% Total Value:
20,256 157% Total Value: $367
Total Value: Total Value: Total Value: $335 Cumulative:
20,000 12 Total Value: $310 $316 647%
$289 $304
$257 9.9 Total Value:
9.2
8.4 8.5 $747
8.0 8.0
15,000 8 7.1

10,000 4

5,000 4,031 4,301 0

2,778 3,198 3,469
1,997 2,133 2,200 Chinese EM German UK Eurozone Non-US French US
Equities Equities Equities Equities
Equities Developed Equities Equities
0 Equities
Italy Russia Canada France UK India Germany Japan China US Total Value of US$100 Invested on Trough of GFC.

Data as of 2022. Data as of December 31, 2022.

Source: Investment Strategy Group, IMF World Economic Outlook. Note: All non-US equities returns are calculated in US$.
Source: Investment Strategy Group, Datastream, Bloomberg.

Exhibit 58: Nominal GDP per Capita Exhibit 60: Total Equity Market Capitalization
The US also has the highest GDP per capita in the world.* per Country
US market capitalization is the largest in the world.
Nominal GDP per Capita (US$) US$ Billions
80,000 75,180 45,000

40,000 41,062
70,000 66,408
35,000
60,000 56,794
30,000

50,000 47,318 48,398 25,000

42,330
20,000
40,000 15,361
33,592 33,740 34,358 15,000
29,198
30,000 10,000
5,457
20,000 5,000 2,875 2,912 3,331
391 397 566 618 739 2,130
0
10,000
South Africa

Mexico

Italy

Spain

Brazil

Germany

France

UK

India

Japan

China + HK

US

0
Spain Korea Italy Japan France UK Germany Canada Australia US

Data as of 2022. Data as of December 31, 2022.

Source: Investment Strategy Group, IMF World Economic Outlook. Source: Investment Strategy Group, Bloomberg.
* The US has the largest GDP per capita among countries with populations over 25 milion.

38 Goldman Sachs january 2023

Exhibit 61: Equity Market Capitalization as a Share Exhibit 63: Share of Working-Age Population With
of GDP per Country Completed Tertiary Education
The US equity market stands at 164% of GDP. The working-age population in the US has a high level of
completed tertiary education relative to other regions.
% of GDP Share of Working-Age Population (%)
180 35 32.1
164
160
30 28.6 29.3
27.7
140 127
25 24.0
120 20.9
104
100 95 96 20
91
16.4
76 15.1 15.3
80 15
53 11.0
60 9.5
44 10 8.8 8.9
39
40 28 28 5.8 6.0
4.7
5
20

0 0

South Korea
South Africa

China

India

Turkey

Brazil

Taiwan

Italy

France

Mexico

Germany

Spain

UK

Japan

Russia

US
Mexico

Italy

Brazil

Spain

Germany

China + HK

UK

South Africa

India

France

Japan

US

Data as of December 31, 2022. Data as of 2020.

Source: Investment Strategy Group, Bloomberg. Note: Fraction of population that has completed tertiary education is estimated using original
growth assumptions between 2015 and 2020 from Barro-Lee (2015) and the most recent
completion rate data for 2015 as reported by Barro-Lee (2021).
Source: Investment Strategy Group, UNESCO, United Nations World, Barro-Lee.

Exhibit 62: Average Years of Schooling Exhibit 64: Human Capital Index
The US has the highest average years of schooling among The quality of the US labor force is higher than that in most
comparable countries. peer countries.
Years Human Capital Index
14 13.1 13.1 13.2 13.3 4 3.7 3.8 3.8
12.5 12.7 3.6 3.7
12.1 3.4
3.4
12 11.2 11.4 3.2 3.2
10.5 10.6 3.1
2.9 3.0
9.7 3 2.8
10 9.2 2.7
9.0 2.5
7.8 8.2
8 2.2
2
6

4
1
2

0 0
India

Turkey

Mexico

South Africa
China

Spain

Brazil

Italy

France

Taiwan

Russia

Japan

Germany

US

South Korea

UK
South Africa
India

Turkey

Brazil

Mexico
China

France

Spain

Italy

Russia

Germany

Taiwan

Japan

UK

South Korea

US

Data as of 2020. Data as of 2019.

Note: Average years of schooling data is estimated using original growth assumptions between Source: Investment Strategy Group, Penn World Table 10.0.
2015 and 2020 from Barro-Lee (2015) and the most recent years of schooling data for 2015 as
reported by Barro-Lee (2021).
Source: Investment Strategy Group, Barro-Lee.

Outlook Investment Strategy Group 39

Exhibit 65: Total Factor Productivity (TFP) Relative Exhibit 67: Average Management Scores
to US levels The US has the highest rank.
There are not many countries that exceed US total factor
productivity.
TFP (% of US) Average Management Score
120 3.5 3.3
3.1 3.2 3.2 3.2
3.0 3.0 3.0
100
103 3.0 2.9 2.9 2.9 3.0
2.7 2.8
100 2.6 2.7 2.7 2.7 2.7 2.7
91 2.5 2.6
89 2.5

80 77
2.0
63
1.5
60 55
51
44 1.0
40
40
0.5

20 0.0
India
Colombia
China
Brazil
Argentina
Greece
Chile
Turkey
Spain
Portugal
Poland
Mexico
Italy
Singapore
UK
Australia
France
Canada
Japan
Sweden
Germany
US
0
China India Brazil Russia Japan UK France Germany US Norway

Data as of 2019. Data as of 2015.

Source: Investment Strategy Group, Penn World Table. Source: Investment Strategy Group, World Management Survey.

Exhibit 66: Labor Productivity Exhibit 68: Triadic Patent Families Registered
The US has high levels of labor productivity. The US ranks high in terms of the number of triadic patent
families filed.
Labor Productivity (2021 PPP,* Thousands) Triadic Patent Families Registered
160 20,000
147
140 18,000 17,469
127
117 16,000
120 109
105 108
99
100 92 14,000 13,040
82
80 12,000
59 63
60 10,000
48
37 38 8,000
40
19 5,897
20 6,000
4,381
4,000 3,244
0
1,708 1,880
India

China

Brazil

Mexico

South Africa

Russia

Japan

Korea

Spain

UK

Germany

Italy

France

Taiwan

US

2,000 910
394 662
0
India Canada Italy UK France Korea Germany China US Japan

Data as of 2021. Data as of 2020.

Source: Investment Strategy Group, Conference Board. Note: Measures the number of patents filed at the European Patent Office, the United States
* Purchasing power parity. Patent and Trademark Office, and the Japan Patent Office.
Source: Investment Strategy Group, OECD.

40 Goldman Sachs january 2023

Exhibit 69: Modern Innovation System Exhibit 71: Worldwide Governance Indicators
Composite Index The US ranks highly among major economies on worldwide
The US has a higher ranking than the average governance.
open economy.
Modern Innovation System Composite Index Worldwide Governance Indicator (US = 100)
8 120
110 113
6.9 108
7 102
100
6.0 6.0 100
6 5.5
5 80
4.3 4.4
4 3.5
3.3 63
58 59
3 60
2.3 2.4
1.7 1.8 44
2
40
1

0 20
Italy

Spain

Canada

China

Australia

France

Avg Open
Economy

UK

Germany

US

South Korea

Japan

0
Russia Brazil China India US France UK Japan Germany

Data as of 2021. Data as of 2021.

Source: Investment Strategy Group, China Pathfinder, Atlantic Council, Rhodium Group. Source: Investment Strategy Group, World Bank.

Exhibit 70: Index of Economic Freedom Exhibit 72: GDP, Nobel Laureates and
There are not many large economies that surpass the US. Universities in Top 50
The US is stronger because of its alliances.
Index of Economic Freedom (US = 100)
120 GDP GDP per Nobel Universities
106
(US$billion) Capita (US$) Laureates in Top 50
100 101 United States 22,996 69,227 403 23
100 97
91 Europe 22,044 37,060 579 15
80 78 France 2,957 45,188 72 1
74 75
67 Germany 4,263 51,238 113 3
60 Italy 2,101 35,473 21 0
Spain 1,426 30,090 8 0
40 United Kingdom 3,188 47,329 137 7
Australia 1,635 63,464 12 2
20 Canada 1,988 52,015 28 3
Japan 4,933 39,301 29 1
0 Korea 1,811 35,004 1 0
China Brazil India Russia France Japan US UK Germany
New Zealand 247 48,317 3 0
Data as of 2022. West 55,654 47,432 1,055 44
Source: Investment Strategy Group, The Heritage Foundation. China 17,745 12,562 10 4
Russia 1,779 12,219 32 0
East 19,523 12,530 42 4

Data as 2021.
Source: Investment Strategy Group, IMF, Nobel Prize website, Times Higher Education.

Outlook Investment Strategy Group 41

Additional Risks to Our Outlook

We face significantly greater risks in 2023 than we

did in 2022:

• In 2022, we assigned a 10% probability of

recession in the US; we have increased that
probability to 45−55% for 2023.
• We wrote that the late Ash Carter, former
US secretary of defense, had assigned a 50%
probability to the risk of a Russian invasion
of Ukraine in 2022. Now, not only has that The geopolitical advisors we have consulted with expect the Ukraine-
happened, but we are facing risk of escalation, Russia war to last well beyond 2023.
including attacks on infrastructure beyond
Ukraine’s borders and a nonzero probability of consulted on these risks with Andrew Bishop,
tactical nuclear weapon deployment. senior partner and global head of policy research
• We wrote that US-China relations were going at Signum Global Advisors; Ian Bremmer, president
to be a source of uncertainty and volatility and founder of Eurasia Group; General Sir Nick
for the indefinite future; China became more Carter, former chief of the Defence Staff in the UK;
aggressive in both its policy statements and its Bernie Haykel, professor of Near Eastern studies at
military activities in 2022. Princeton University; and Sir Alex Younger, former
• With respect to North Korea, we wrote that chief of the Secret Intelligence Service in the UK
we were least worried about rising tensions in and regional advisor at Goldman Sachs.
2022, but now we are worried about Kim Jong
Un’s more aggressive posture toward missile Ukraine-Russia War
testing and North Korea’s nuclear capabilities. The base case for most of the geopolitical advisors
• We wrote about two risks with respect to we have consulted with is a war that will last well
Iran: continued development of its nuclear beyond 2023. There is no face-saving off-ramp
program and its extensive missile program. The for President Vladimir Putin, and Ukraine cannot
risks are even greater now given Iran’s further readily come to the negotiating table after the war
enrichment of its uranium and its new military crimes committed by the Russians against men,
partnership with Russia. women and children, and the extensive damage to
• On COVID, we highlighted the risks of a more civilian structures and infrastructure.
transmissible variant and risks to supply chains The greatest risk is escalation by the Russians:
from China’s “zero-COVID” policy. The risks
from COVID are unchanged. The new XBB.1.5 • Russian could become more aggressive,
omicron subvariant has become the dominant targeting infrastructure such as undersea cables
variant in parts of the US, and China’s disorderly and pipelines outside Ukraine.
abandonment of its “zero-COVID” policy may • Russia could launch cyberattacks globally.
create another surge of infections in other parts • Russia, most importantly, could use its nuclear
of the world. capabilities.
• We did not cite US midterm elections as a risk – Russia has the ability to use the ruse of a
in 2022. However, the US will be a source of “dirty bomb” as a false flag somewhere
volatility in the second half of 2023: US debt near the Russian border to undermine
ceiling negotiations are likely to be contentious Ukraine’s position, according to General Sir
and lead to market volatility, as they have in Nick Carter.19
the past. – It could use a small-scale tactical nuclear
weapon with limited explosive yield in Ukraine.
In aggregate, we think the risks to our economic and – It could use a nuclear weapon to generate
financial market outlook are greater than in 2022. a high-altitude electromagnetic pulse
We begin with the geopolitical risks, since the that would damage electronics and
recession risks were discussed earlier. We have communication systems.

42 Goldman Sachs january 2023

Exhibit 73: Annual LNG Shipments
The US is fast becoming the largest exporter of LNG.
Million Tonnes
90 Qatar US

80 81

70

60

50

40

30

20

10
Germany inaugurated its first floating LNG terminal in December 2022.
0
2010 2013 2016 2019 2022
munitions,”22 and US officials have made similar
Data through 2022.
Note: 2022 figures are according to ship-tracking data compiled by Bloomberg. statements. The Wagner Group, a Russian
Source: Investment Strategy Group, Bloomberg New Energy Finance.
mercenary company, has also complained about
the lack of ammunition.23 Others have countered
that Russia can tap into Soviet-era stockpiles and
According to Bremmer, the US has told Russia import ammunition from North Korea.
that if it were to deploy a nuclear weapon, Finally, a cutoff of the West’s military, financial
the US would directly target Russian forces.20 and humanitarian support to Ukraine would
Theoretically, that warning should be a sufficient increase the likelihood that Ukraine would be
deterrent to President Putin. However, Sir Alex forced to negotiate a settlement of some kind.
warns that “we cannot rely on Putin to act While some have questioned the resolve of the
rationally. He has a higher readiness to accept US and Europe, it appears that their resolve has
risk.”21 Bremmer has assigned a 5% probability to only strengthened. Ukraine has received increasing
use of nuclear weapons. funds, more sophisticated military equipment
Financially, Russia can afford to prolong and stronger statements of support from most
this war through 2023 and possibly through Western leaders.
2024. We base this assessment on a series of Europe is also under limited pressure to resume
assumptions, such as: imports of natural gas from Russia. Germany, in
less than a year from the start of construction,
• A modest GDP decline in Russia of 3% in 2022 inaugurated its first floating liquefied natural gas
relative to high-single-digit drop expectations (LNG) terminal in Wilhelmshaven, and accepted its
• Equally modest GDP decline of 2.6% in 2023 first shipment of LNG from the US. The terminal
• Oil and gas exports continuing at year-end can process close to 6% of Germany’s 2021
2022 levels consumption level. Coincidentally, the US is fast
• China and India continuing to import 24% and becoming the largest exporter of LNG, as shown
11%, respectively, of Russia’s export of crude in Exhibit 73. In 2022, it matched Qatar’s exports,
oil and refined products and it is expected to exceed Qatar’s level once
• Russia’s ability to issue bonds domestically the Freeport export plant in Texas returns to full
and tap oligarchs, their companies and the production after a June 2022 fire.
sovereign wealth fund, which has an
estimated $186 billion in assets

One factor constraining how long In aggregate, we think the risks to

Russia can continue the war is its supply
of artillery ammunition. Admiral Sir
our economic and financial market
Tony Radakin has said that “Russia outlook are greater than in 2022.
faces critical shortages of artillery

Outlook Investment Strategy Group 43

 The Ukraine-Russia war is likely to continue,
and risks of escalation will contribute to market
volatility.

US-China Tensions
As discussed extensively in our China Insight
report, Middle Kingdom: Middle Income, China
has become more aggressive and assertive in its
foreign policy toward the West. The US and its
allies have responded by changing their national
security strategies; they have introduced export and
The Chinese aircraft carrier Liaoning sailed to within 400 miles of the US
import controls such as the US Bureau of Industry territory of Guam in December 2022.
and Security’s revision of export controls of high-
end semiconductors and enhanced cybersecurity
measures. Please see the report for a detailed
discussion on this topic.
We think financial market volatility emanating
from US-China tensions will ebb and flow. The
meeting between Presidents Biden and Xi on
November 14, 2022, in Bali, Indonesia, and the
appointment of the Chinese ambassador to the US
as foreign minister on December 30, 2022, have
been interpreted as an improvement in US-China
relations. On the other hand, a series of military
activities in December 2022 have been interpreted
as a more aggressive approach:
Taiwan reported that several Chinese aircraft crossed into its air defense
• The Japanese Ministry of Defense reported identification zone in December 2022. (Credit: Taiwan Ministry of National
that between December 17 and December Defense)
27, the Chinese aircraft carrier Liaoning
and its accompanying vessels sailed near the
southernmost part of Japan and that there were
numerous aircraft takeoffs that prompted Japan
to scramble military aircraft and vessels.24 The
Lianoning and its task force also proceeded
to within 400 miles of the US territory of
Guam during this period, and Chinese media
highlighted that Guam would be a target in a
conflict scenario.
• On December 21, the US Indo-Pacific
Command reported that a People’s Liberation
Army Navy fighter pilot “performed an unsafe The US military said a Chinese Navy J-11 fighter jet flew close to a U.S. Air
Force RC-135 aircraft in December 2022.
maneuver during an intercept of a U.S. Air
Force RC-135 aircraft … in international
airspace … forcing the RC-135 to take evasive
maneuvers to avoid a collision.”25 While US-China tensions and increased risks
• On December 25, China sent 71 warplanes into of military accidents in the air and the seas
the vicinity of Taiwan, of which 47 crossed into may contribute to market volatility, our panel
Taiwan’s southwest air defense identification of geopolitical advisors believe that the risk of
zone, prompting Taiwan’s military to respond a Chinese invasion of Taiwan is low in 2023.
with aircraft and navy vessels. The level of such Most think it is unlikely over the next five years.
incursions doubled in 2022 relative to 2021.26 However, Bishop from Signum Global Advisors

44 Goldman Sachs january 2023

Exhibit 74: North Korean Missile Launches China and Russia would have been the countries to
North Korea has launched more missiles in 2022 than in the place some guardrails on North Korea, but given
prior five years combined. the Ukraine-Russia war and rising geopolitical
Number of Launches tensions between the US and China, those
100 Short-Range Ballistic Missile
Taepodong-2/Unha-3
guardrails have been removed.
Cruise Missile While risks of incidents between South Korea
Nuclear Test
Medium-Range Ballistic Missile and North Korea are non-negligible in 2023, and
Submarine-Launched Ballistic Missile
Intermediate-Range Ballistic Missile
missile tests could lead to interim volatility in
Unknown the financial markets, the risk of serious military
Hwasong-14
50 Hwasong-15 engagement with North Korea is low in the
Hypersonic Glide Vehicle near term.
Unknown ICBM
Hwasong-17

Iran
Iran poses two threats in 2023: producing weapons-
grade uranium and making other irreversible
0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 advances in its nuclear program and expanding its
weapons sales to Russia from drones to missiles.
Data as of 2022.
Source: Investment Strategy Group, Center for Strategic and International Studies.

Nuclear Concerns. According to data from

the International Atomic Energy Agency and
assigns a 35% probability of a Chinese attack on the analysis from the Institute for Science and
Taiwan over the next two years. International Security (ISIS), Iran already has
highly enriched uranium (HEU) at 60% sufficient
North Korea to be used for a nuclear weapon.29 However, ISIS
While we were not worried about North Korea’s thinks Iran may prefer to enrich its 60% HEU
activities spilling into financial markets in 2022, to 90%, which is considered weapons-grade and
we think North Korea poses greater risks in 2023. more suited to Iran’s nuclear weapons designs.
As shown in Exhibit 74, North Korea has launched General Sir Nick has suggested Iran will very
more missiles in 2022 than in the prior five years likely have reinforced its view from observing
combined. The missiles have varied from short- the Ukraine war that there is merit is possessing
range ballistic missiles to intercontinental ones. a nuclear deterrent.30 Sir Alex suggests that Iran’s
CIA Director William Burns has referred to it as leaders will not weaponize because their progress
“quite troubling,” and Bremmer has warned that on enrichment “gives them enough leverage.”31
“they’re going to test a nuke.”27 Eurasia Group writes that Iran might decide
Eurasia Group has also written that “the to enrich to 90% when the Joint Comprehensive
chances of conflict on the Korean peninsula are at Plan of Action (JCPOA) restrictions on Iran’s
their highest level since at least 2017 with fewer development program of ballistic missiles designed
guardrails in place to promote de-escalation.”28 to carry nuclear weapons expire in October 2023.32

Missile tests by North Korea could lead to interim market volatility. Headlines from Iran on its nuclear program will be a source of volatility in
2023.

Outlook Investment Strategy Group 45

 Headlines from Iran on its nuclear program The Office of the Director of National Intelligence
and responses from Israel will be a source of considers Russia a significant threat given its focus
volatility in 2023. on critical infrastructure, including underwater
cables and industrial control systems, in the US and
Transferring Drones and Missiles to Russia. The in allies and partner countries.36
new military relationship between Russia and Use of ransomware is on the rise as well and
Iran has been troubling to the West. Burns has will continue increasing in 2023. Australia will
said that “what’s beginning to emerge is at least lead a global ransomware task force starting in
the beginning of a full-fledged defense partnership January 2023 to develop safeguards for advanced
between Russia and Iran, with the Iranians economies, but the benefits of such a task force will
supplying drones to the Russians, which are not be immediate.
killing Ukrainian civilians.”33 In a joint statement
after a United Nations Security Council meeting, Terrorism
France, Germany and the UK warned Iran “against Our panel of experts believe that the risk of
any further deliveries of weapons to Russia, in terrorism is unchanged from 2022. They cite the
particular of any short-range ballistic missiles, absence of charismatic leaders and the lack of
which would constitute a serious escalation.”34 command and control under which terror groups
In our 2022 Outlook, we quoted Kenneth could operate from the Middle East, including in
“Frank” McKenzie Jr., Marine general and Afghanistan. With limited state sponsorship, terror
commander of the US Central Command covering groups cannot get adequate funding to organize
the Middle East and South Asia; he said that Iran and pull off major terrorist acts in the West.
had reached “overmatch” where its “strategic General Sir Nick has warned that there is a real
capacity is now enormous” and it has “the ability possibility of terrorism being exported on the back
to overwhelm.” Its missiles “can strike effectively of migration from Africa. The assessment of the
across the breadth and depth of the Middle East … Combating Terrorism Center at West Point is that
with accuracy and volume.”35 The joint statement the threat of terrorism from Africa and the Middle
warned that transferring such missiles to Russia East is more local and cross-border within the
would constitute an escalation. Escalation would region than global, with “Africa emerging as the
lead to market volatility. world’s leading terrorism hotspot.”37

Cybersecurity COVID-19
Cyberattacks remain a major threat from state and COVID-19 risks in advanced economies are
non-state actors, with the biggest threats emanating unchanged from last year. A new omicron
from China, Russia, Iran and North Korea. subvariant, XBB1.5, has become the dominant
US intelligence and national security agencies variant in the US Northeast and could be
assess China’s state-sponsored cyber activities as responsible for the current surge. However, holiday
presenting one of the largest and most dynamic travel and the winter may also be contributing
threats to US government and civilian networks. to the surge. This variant appeared in Singapore
in the fall.
The new variant has been described as
immune-evasive: the virus is less likely to be
neutralized by antibodies from prior infection or
vaccines. According to Dr. David Ho, professor
of microbiology and immunology at Columbia
University, the level of immune evasion is
“alarming.”38 Our COVID-19 advisor, Dr. Luciana
Borio, former director for medical and biodefense
preparedness at the US National Security Council,
believes that the new variant will cause many more
infections, but that T cells from prior infections
and vaccinations will limit serious disease and
Cyberattacks remain a major threat from state and non-state actors. hospitalizations for most people.

46 Goldman Sachs january 2023

 Mericle and Phillips suggest that the political
and fiscal conditions this year will be similar to the
conditions in 1995 and 2011, when the US had to
raise the debt limit and the process was “extremely
disruptive.”42 In both those periods, a sitting
Democratic president faced a Republican House
which had won the majority after the midterm
election, and federal debt as a share of GDP had
increased at a more rapid pace. The “debt limit
standoffs” between Republicans and Democrats
led to increased market volatility in both periods.
China is going through its massive first wave of COVID since the initial Prices of Treasury securities with maturities around
controlled surge in Wuhan in 2020. the date of the debt ceiling dropped, and worries
about a default increased.
China is going through its massive first wave of Mericle and Phillips point out that the process
COVID since the initial controlled surge in Wuhan to elect a speaker of the House provides some
in 2020. According to reports in the Financial insight into how the debt ceiling negotiations may
Times, Sun Yang, a deputy director at the Chinese transpire.
Center for Disease Control and Prevention (CDC), We conclude that there is no shortage of risks
estimated that about 250 million people—or that could derail our economic and financial
18% of China’s population—were infected by market outlook.
COVID-19 in the first 20 days of December 2022.39
Wu Zunyou, chief epidemiologist at the
Chinese CDC, has suggested China will face three
waves: the present one, a second one following
the travel of hundreds of millions of people for
the Lunar New Year starting on January 21, 2023,
and a third one from late February to mid-March
when people return to work from the New Year
holidays.40 The University of Washington’s Institute
for Health Metrics and Evaluation has estimated
that China could see as many as 1 million COVID-
related deaths.41
Dr. Borio believes that the focus on variants
emerging from China’s abandonment of its “zero-
COVID” policy is understandable but not fully
justified. While China’s removal of all COVID
restrictions, including travel restrictions inside and
outside China, may increase COVID infections
outside China, we do not expect the risks to
meaningfully affect the financial markets.

US Debt Ceiling
David Mericle and Alec Phillips, our colleagues in
Goldman Sachs Global Investment Research, have
highlighted raising the debt ceiling in 2023 as a
significant risk to equity and bond markets. The
debt ceiling limits how much debt the Treasury
can issue to fund the US government and meet its
coupon and principal payment obligations. The US
is expected to reach its debt limit by August 2023,
but it may be as late as October.

Outlook Investment Strategy Group 47

 Key Takeaways

While we are facing a period of heightened uncertainty after a

tumultuous 2022, we believe our two primary investment themes
remain valid: US Preeminence and Staying Invested. US Preeminence
leads us to overweight US assets in our strategic asset allocation. Staying
Invested drives our recommendation that clients maintain their strategic
asset allocation; that recommendation will change if we develop high
conviction that a recession is imminent and not already discounted by
the market. Currently, we do not have high conviction that a recession
is imminent and one has already been partially discounted by the equity
market decline.

The key takeaways from our 2023 Outlook are as follows:

• Below-Trend Growth: We expect global economic growth to slow to

below-trend levels. We believe the US will have modest growth; the
Eurozone, the UK and Russia will be in recession; and that Japan will be
an exception with above-trend growth. Large emerging market countries
will grow below trend at mid-single-digit growth levels, in our view. We
estimate China’s post-COVID recovery will reach 4.9%, just above trend
levels of 4−4.5%.
• Monetary Policy Tightening: We believe that most major central banks
will continue tightening monetary policy but at a more modest pace than
in 2022. China will be a key exception as the leadership tries to stem the
declines in the property sector.
• Recession Risk in the US: We have assigned a 45−55% range to the risk
of recession in 2023. We believe the fog of uncertainty is too great to have
much conviction on the direction of the US economy, and we therefore
recommend clients position their portfolios neither for the certainty

48 Goldman Sachs january 2023

 of recession nor for the
certainty of modest growth Exhibit 75: ISG Decision Matrix for
Underweighting Equities
in the US. The framework
We believe investors are better off staying the course and
for staying invested is best even looking for opportunities to overweight stocks.
captured by Exhibit 75.
If the equity market has
already largely discounted Small
Stay Invested Potential Underweight
Equity Drawdown

a recession, history has

repeatedly shown that
investors are better off Stay Invested Stay Invested
staying the course given
Large

forward returns have Potential Overweight Potential Overweight

typically been attractive.

Low High
• Attractive High-Single- Imminent Recession Risk
Digit Portfolio Returns: Data as of December 31, 2022.

We expect high-single-digit Source: Investment Strategy Group.

returns on a well-diversified
moderate-risk portfolio.
The returns are driven by equity returns of over 10% in developed markets
and 9% in emerging markets. We expect mid-single-digit returns in fixed
income assets.
• Significant Geopolitical Risks: We face a much longer litany of geopolitical
risks this year, including an escalation of the Russia-Ukraine war, high US-
China tensions, more ballistic missile testing by North Korea, a growing
partnership between Iran and Russia, continued nuclear enrichment in Iran
and debt ceiling negotiations in the US.
• Vigilance: In the face of fog, we diligently watch for hazards and will
remain tactical to take advantage of market opportunities.

Outlook Investment Strategy Group 49

SECTION II

2023 Global
Economic Outlook:
A Difficult Balancing Act

around the world, policymakers are attempting to cross

a tightrope. For global central banks, the challenge is to lift
interest rates high enough to dampen growth and bring down
inflation, but not so high that they cause undue economic
fallout. Similarly, governments are seeking to administer enough
fiscal stimulus to help consumers cope with high prices but not
so much that they stoke even worse inflation in the process. In
both cases, leaning too far in either direction could be harmful.
To be sure, the risk of a misstep is high. Global central
banks collectively delivered more than 280 interest rate hikes
last year in response to inflation that was both higher and more
persistent than expected.43 Such forceful tightening of monetary
policy clearly raises the risk of recession. At the same time,
already stretched fiscal finances and fragile bond markets limit

50 Goldman Sachs january 2023

Outlook Investment Strategy Group 51
the scope for additional fiscal stimulus, as the Exhibit 77: Headline CPI Inflation
negative reaction of the UK gilt market to the Headline inflation exceeded 9% at its apex last year, the
government’s expansionary budget last year highest reading in four decades.
reminds us. Additional stimulus is particularly % YoY
constrained today because countries representing 20

almost three-quarters of the world’s GDP have 15 June

annual budget deficits greater than 4%. Europe 2022:
9.1
and the UK alone have deployed more than $750 10

billion of fiscal stimulus to offset the impacts of the 5

7.1

war in Ukraine.44
Still, a sure-footed crossing can’t be ruled 0

out. We place even odds on the US avoiding a

-5
recession this year, as households still have a
savings cushion, and the US economy lacks the -10

obvious cyclical excesses seen on the eve of past

-15
economic downturns. In Japan, the economy should 1923 1932 1941 1950 1959 1968 1977 1986 1995 2004 2013 2022
continue to expand at an above-trend pace given Data through November 2022.
still-accommodative policy, as well as considerable Source: Investment Strategy Group, Haver Analytics.

excess savings. Meanwhile, emerging markets as a

group are likely to grow slightly faster than they
did in 2022 as they benefit from China’s uneven United States:
reopening. A Thorny Problem, Year Two
The Eurozone’s outlook, on the other hand,
is shaky. Russia’s invasion of Ukraine put acute Inflation remains a thorn in the side of the US
pressure on the region’s energy supplies and economy. As seen in Exhibit 77, headline CPI
growth last year, likely causing a recession in the exceeded 9% at its apex last year, the highest level
final months of 2022. The same could be said for in four decades. That increase surpassed consensus
the UK. But we expect relatively shallow recessions forecasts by a wide margin for a second year in a
in both regions, as the economic slowdown thus row. But unlike 2021’s spike in goods prices, last
far has been better than expected and a mild winter year saw inflation expand to services as well (see
has helped cool energy prices. Exhibit 78).
Taken together, these factors support our While external factors like the war in Ukraine
forecast for a year of below-trend yet still positive and ongoing supply disruptions from China’s
global GDP growth (see Exhibit 76). “zero-COVID” policy have put upward pressure

Exhibit 76: ISG Outlook for Developed Economies

Real GDP Growth Headline Inflation* Core Inflation* Policy Rate** 10-Year Bond Yield***
Annual Average (%) Annual Average (%) Annual Average (%) End of Year (%) End of Year (%)

2023 2023 2023

2022 2022 2023 2022 2023 2022 2023 2022 2023
Base Case Good Case Bad Case
United States 2.0 0.9–1.5 2.6 -0.3 8.0 3.9–4.5 6.1 4.3–4.7 4.375 5.1 3.9 3.15–3.65
Eurozone 3.3 -0.6–0.0 0.6 -1.2 8.6 6.7–7.3 4.0 4.0–4.4 2.0 3.5 2.6 1.75–2.25
United Kingdom 4.4 -1.3–-0.7 0.0 -2.0 9.0 7.2–7.8 6.0 4.3–4.7 3.5 4.5 3.7 3.0–3.5
Japan 1.5 1.0–1.6 2.0 0.3 2.4 1.6–2.0 2.2 1.7–2.1 -0.1 0.0 0.4 0.5–1.0

Data as of December 31, 2022.

Source: Investment Strategy Group, Haver Analytics, Bloomberg.
* Inflation refers to CPI inflation. Japan core inflation excludes fresh food, but includes energy.
** The US policy rate refers to the midpoint of the Federal Reserve’s target range. The Eurozone policy rate refers to the ECB deposit facility. The Japan policy rate refers to the BOJ deposit rate.
*** For Eurozone bond yield, we show the 10-year German bund yield.
Note: Forecasts are estimated, are based on assumptions, are subject to revision, and may change as economic and market conditions change. There can
be no assurance the forecasts will be achieved.

52 Goldman Sachs january 2023

Exhibit 78: Core CPI Inflation Exhibit 80: Atlanta Fed Wage Tracker and San
In contrast to 2021’s spike in goods prices, last year saw Francisco Fed Cyclical Core PCE Inflation
inflation expand to services as well. Labor demand and a shrinking labor force have pushed wage
growth above levels consistent with 2% inflation.
% YoY % YoY
14 Core Goods 8 Atlanta Fed Wage Tracker, 3-Month Moving Average
Core Services San Francisco Fed Cyclical Core PCE Inflation
7.4
12 7

10 6.4
6
8
6.8 5
6
4
4 3.7
3
2
2
0

-2 1

-4 0
2008 2010 2012 2014 2016 2018 2020 2022 1998 2001 2004 2007 2010 2013 2016 2019 2022

Data through November 2022. Data through November 2022.

Source: Investment Strategy Group, Haver Analytics. Source: Investment Strategy Group, Haver Analytics.

Exhibit 79: Core and Trimmed Mean PCE Inflation Exhibit 81: Labor Productivity Growth
Various measures of the underlying trend of inflation remain Productivity gains have been insufficient to counter strong
well above the Federal Reserve’s 2% target. labor demand.
% Annualized % YoY
6 Trimmed Mean PCE (6-Month Change) Nonfarm Business (GDP-based) Non-financial Corporate (GDI-based)
Trimmed Mean PCE (12-Month Change) 10
Core PCE (12-Month Change)
5 5.0 8
4.7
4.6
4 6

4
3

2
2
0

1 -1.3
-2
-2.7
0 -4
1990 1995 2000 2005 2010 2015 2020 1990 1994 1998 2002 2006 2010 2014 2018 2022

Data through November 2022. Data through Q3 2022.

Source: Investment Strategy Group, Haver Analytics. Note: Shaded periods denote recessions. Gross domestic income (GDI) is a measure of the
incomes earned and the costs incurred in the production of gross domestic product. It’s another
way of measuring US economic activity.
Source: Investment Strategy Group, Federal Reserve, Haver Analytics.

on prices, inflation has emanated from within the greater risk that wage gains are directly fueling
US economy as well. As seen in Exhibit 79, various inflation in shelter and other cyclically sensitive
measures of the underlying trend of inflation sectors (see Exhibits 80 and 81).
remain well above the Federal Reserve’s 2% target. Such persistently high inflation is a significant
The same is true for wages, where demand for headwind to the US economy in at least three ways.
workers and a sluggish recovery in the labor force First, it acts as a tax on consumers and erodes their
are stoking pay increases that are far outpacing real earnings. Second, it raises the hurdle for capital
productivity gains. As a result, there is much investment given a more uncertain future and higher

Outlook Investment Strategy Group 53

Exhibit 82: Real and Nominal Disposable Personal Exhibit 84: Regular US Gasoline Prices
Income (DPI) The drag on disposable income from high gas prices should
Real DPI was reduced by elevated inflation, the withdrawal abate this year.
of COVID-19 stimulus payments and higher taxes.
% YoY $/Gallon
40 Disposable Personal Income 5.5
Real Disposable Personal Income
30 5.0

4.5
20

4.0
10
3.5
2.9
0 3.2
-2.5 3.0

-10
2.5

-20 2.0

-30 1.5
2014 2015 2016 2017 2018 2019 2020 2021 2022 2016 2017 2018 2019 2020 2021 2022

Data through November 2022. Data through December 31, 2022.

Source: Investment Strategy Group, Haver Analytics. Source: Investment Strategy Group, American Automobile Association (AAA), Bloomberg.

Exhibit 83: Goldman Sachs US Financial Exhibit 85: Consensus US Real GDP
Conditions Index Growth in 2022
Financial conditions tightened substantially last year. Tighter financial conditions and higher energy prices
weighed on expected 2022 US GDP growth.
Index % YoY
102 101.7 4.5
4.3
Tighter Financial
101 Conditions 4.0

100.2
100 3.5

99 3.0

+3.3
98 2.5

97 2.0
1.9

96 1.5
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Jan-21 Apr-21 Jul-21 Oct-21 Jan-22 Apr-22 Jul-22 Oct-22

Data through December 31, 2022. Data through December 31, 2022.
Source: Investment Strategy Group, Goldman Sachs Global Investment Research. Source: Investment Strategy Group, Bloomberg.

funding costs. Lastly, it is incompatible with the payments and higher taxes. At the same time,
Federal Reserve’s price stability mandate, obliging financial conditions tightened substantially (see
the bank to tighten monetary policy to dampen Exhibit 83) in response to the Federal Reserve’s
demand. Taken together, these effects slow economic steepest hiking cycle since the early 1980s. The
growth and raise the risk of a recession. war-driven spike in energy prices only exacerbated
These effects were clearly visible last year. these economic drags, which collectively took
As seen in Exhibit 82, real disposable personal expected 2022 US GDP growth from around 4%
income (DPI) was reduced by elevated inflation at the start of the year to less than 2% by year-end
as well as the withdrawal of COVID stimulus (see Exhibits 84 and 85).

54 Goldman Sachs january 2023

Exhibit 86: Net Worth of US Households and Exhibit 87: US Household Sector Debt
Nonprofit Organizations Service Ratio
We expect last year’s drop in net worth to dampen Households’ debt service ratio would remain low even with
household spending in 2023. higher rates.
% of GDP % of Disposable Income
650 Q2 2021: Debt Service Ratio +200 bps Rate Shock +300 bps Rate Shock
617 14
13.2
600
13
Q4
550 2019: 557
537 12

500
11
10.2
10.1
450 10
9.6
400 9

350 8

300 7
1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 2017 2022 1980 1985 1990 1995 2000 2005 2010 2015 2020

Data through Q3 2022. Data through Q3 2022.

Source: Investment Strategy Group, Haver Analytics. Note: Shaded periods denote recessions.
Source: Investment Strategy Group, Federal Reserve, Haver Analytics.

This abrupt economic slowdown comports

with the Federal Reserve’s desire to bring inflation Exhibit 88: US Homeowner Vacancy Rate
back to its target by engineering a period of Residential investment will likely decline this year despite
below-trend growth. Our 2023 forecast of 1.2% low homeowner vacancy rates.
real GDP growth—below the 1.5−2.0% estimates %
of trend growth—is consistent with that objective. 3.5

We expect last year’s drop in net worth will 3.0

dampen household spending (see Exhibit 86), as
will a modest rise in unemployment. The same 2.5

could be said for higher debt service payments, 2.0

but still-healthy household balance sheets and the
high proportion of fixed-rate debt are likely to 1.5

keep those costs below their pre-pandemic levels

1.0 0.9
(see Exhibit 87). Slower consumer spending is
also expected to weigh on nonresidential business 0.5

investment, while last year’s surge in mortgage

0.0
rates should further reduce residential investment 1955 1965 1975 1985 1995 2005 2015
despite low homeowner vacancy rates (see Data through Q3 2022.
Exhibit 88). Note: Shaded periods denote recessions.
Source: Investment Strategy Group, Haver Analytics.
Although inflation has likely peaked, the pace
of its descent remains a key source of debate.
Of the three component categories on which the
Federal Reserve focuses—goods, housing and likely to look through them, especially since recent
services other than housing—we expect goods to weakness in house prices and lease rates on new
exert the largest drag on core inflation this year, rentals imply a decline in housing inflation later
given already visible progress and improvements in this year (see Exhibit 91).
supply chain bottlenecks (see Exhibits 89 and 90). The trajectory of the third and largest
Housing will take longer to adjust given the slow category—services other than housing, which
rate at which the stock of rental leases turns over. represent more than half of the core PCE index—
Yet the Federal Reserve is aware of these lags and is also the most uncertain. Wages represent the

Outlook Investment Strategy Group 55

Exhibit 89: Components of US Core PCE Inflation Exhibit 91: US Market Rents and PCE Housing
We expect a continued moderation in core goods inflation Services Inflation
this year. Recent weakness in lease rates on new rentals suggests
housing inflation should moderate later this year.
% YoY % YoY
10 Core Goods 20 PCE Housing Services
Housing Services Zillow (National)
Core Services Less Housing ApartmentList (National)
8
CoreLogic Single-Family Detached (National)
7.1 15
RealPage (National)
6

4.6 9.8
4.6 10 9.7
4 9.3
7.1
2 5.8
5

0
0
-2

-4 -5
2014 2015 2016 2017 2018 2019 2020 2021 2022 2014 2015 2016 2017 2018 2019 2020 2021 2022

Data through October 2022. Data through October 2022.

Note: October data is estimated based on October data from the Consumer Price Index and the Note: ApartmentList, CoreLogic, RealPage and Zillow measure rents for a new lease by a new
Producer Price Index. tenant. October PCE (Personal Consumption Expenditures) data is estimated on the basis of
Source: Investment Strategy Group, Bureau of Economic Analysis, Bureau of Labor Statistics, October data from the Consumer Price Index and the Producer Price Index.
Federal Reserve staff estimates. Source: Investment Strategy Group, ApartmentList, Bureau of Economic Analysis, Bureau of
Labor Statistics, CoreLogic, RealPage, Zillow, Federal Reserve staff estimates.

Exhibit 90: Markit Global Purchasing Managers’ Exhibit 92: US Job Openings and Unemployed
Indices (PMIs) Individuals
PMIs reflect improvements in supply chain bottlenecks. Total job vacancies still far exceed the number of
unemployed workers.
Index Index Millions
60 Backlogs of Work (Left) 30 25 Unemployed
Supplier Delivery Times (Right, Inverted) Job Openings

55 35
20

50 40
15

45 45

10 10.5
40 50

6.0
5
35 55

30 60 0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022

Data through November 2022. Data through November 2022.

Source: Investment Strategy Group, Haver Analytics. Source: Investment Strategy Group, Haver Analytics.

largest costs in delivering these services, and the enough above the Federal Reserve’s target to keep
labor market remains tight, with about 1.7 job policy rates within 0.25% of 5% throughout 2023.
openings for every person looking for work (see Of course, the tighter monetary policy and
Exhibit 92). We expect only a modest increase in below-trend growth necessary to bring inflation
the unemployment rate, from 3.7% to 4.1%; hence down also raise the risk of recession. That is
we also forecast a more measured decline in core particularly true today, given many of the most
PCE inflation, to 3.6% by year-end. This is still far reliable long-leading recession indicators—

56 Goldman Sachs january 2023

Exhibit 93: ISG Yield Curve Inversion Exhibit 94: Household Sector Cash and
Diffusion Index Equivalents
Recent index readings imply a rising risk of recession. Households still have substantial excess savings.
% % of GDP
100 100 90

90
80
80

70 71
70
60

50 60

40
50
30

20
40
10

0 30
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 2017 2022

Data through December 31, 2022. Data through Q3 2022.

Note: Shaded periods denote recessions. The diffusion index is based on four yield curves selected Note: Includes currency, checkable, time and savings deposits, and money market shares.
across different maturities and measured on a daily, weekly and monthly basis. The index measures Source: Investment Strategy Group, Haver Analytics.
the percentage of yield curve measures inverted in the previous 6 months based on data available
at each point in time. This index is tracked internally by ISG and is not publicly available.
Source: Investment Strategy Group, Bloomberg, Haver Analytics.

including our own Yield Curve Inversion Diffusion

Index—have already triggered (see Exhibit 93). Exhibit 95: Atlanta Federal Reserve Wage Tracker
Moreover, most economists surveyed by Bloomberg by Wage Quartile
expect a recession in 2023.45 Broad-based wage gains enabled even the most
We certainly acknowledge this risk and economically vulnerable to amass a savings buffer.
place elevated 45−55% odds on a recession % YoY
this year. But there are several reasons that 8 Bottom Quartile
2nd Quartile 7.4
recession is not our base case. First, we estimate 7 3rd Quartile 7.2
Top Quartile
households have around $1.5 trillion in excess
6
savings after the largest increase in their holdings 5.7

of cash and cash equivalents on record (see 5

4.8

Exhibit 94). Even households in the bottom of 4

the income distribution—which tend to be the
3
most economically vulnerable—are benefiting
from disproportionately strong wage gains (see 2

Exhibit 95) that have enabled them to amass a 1

savings buffer. As recent Federal Reserve research
0
highlights, these “households in the bottom half 2007 2010 2013 2016 2019 2022
of the income distribution still held (as of mid- Data through November 2022.
2022) roughly $350 billion in excess savings— Source: Investment Strategy Group, Haver Analytics.

about $5,500 per household on average,” which

is sufficient to fully pay off “their ‘liquid debt’
with room to spare.”46 Second, real DPI is set unemployment, reflecting the still large number
to rebound this year as many of the drags from of job vacancies per unemployed worker. Without
2022—including higher gas prices, higher capital a strong negative feedback loop between job
gains tax payments and lower transfer payments— losses and reduced spending, it will be difficult
abate (see Exhibit 96). Our GIR colleagues forecast for recession dynamics to take hold. However,
real DPI will rise a solid 3.5% in 2023. Finally, recession risk may rise as we move through 2023,
as noted earlier, we expect only a modest rise in since these buffers are likely to erode over time.

Outlook Investment Strategy Group 57

Exhibit 96: Social Security Cost-of-Living Exhibit 98: Eurozone Headline Inflation by Major
Adjustments (COLAs) Price Categories
Increased payments to Social Security beneficiaries should Headline inflation reached a record high in 2022.
support overall US real disposable income this year.
% YoY % YoY
10 12 Services
Nonenergy Industrial Goods 11.0
9 8.7 Energy
10
Food
8
Headline
7 8

6 6
5
4
4

3 2

2
0
1

0 -2
1990 1994 1998 2002 2006 2010 2014 2018 2022 2017 2018 2019 2020 2021 2022

Data through 2023. Data through November 2022.

Source: Investment Strategy Group, Social Security Administration. Source: Investment Strategy Group, Haver Analytics.

The Eurozone: About-Face

Exhibit 97: Eurozone Household Real Disposable
Income Growth Russia’s invasion of Ukraine caused an abrupt
Energy prices caused a sharp drop in household real decline in the Eurozone’s expected growth last year.
disposable income last year. Not only did the resulting surge in energy prices
% YoY cause a sharp drop in real household disposable
10 income (see Exhibit 97), but it also forced
GIR Forecast
8
production cutbacks in energy-intensive industries,
6
which hurt output. Although fiscal support helped
4
to mitigate the economic impact of spiraling energy
2 1.8
prices, central bank policy eroded that cushion
0
as the ECB accelerated its hiking cycle to contain
-2
record-high inflation (see Exhibit 98).
-4
While the economy held up better than feared,
-6
Income we think the combination of these headwinds likely
-8 Inflation
Transfers + Taxes
pushed the Eurozone into recession in the final
-10
Real Disposable Income months of 2022. We expect a relatively shallow
-12
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 economic contraction barring a colder than normal
winter, with a peak-to-trough real GDP decline
Data through Q4 2024.
Source: Investment Strategy Group, Goldman Sachs Global Investment Research. of about 0.8%, but the recovery is likely to be
Note: Forecasts are estimated, are based on assumptions, are subject sluggish. Several headwinds—including weak
to revision, and may change as economic and market conditions change.
external demand, elevated energy prices and tight
There can be no assurance the forecasts will be achieved.
financial conditions—are set to constrain growth
in the second half of this year. The same can be
said for fiscal policy, which is expected to flip to a
As was the case in 2022, the interplays between slight drag this year as COVID-related programs
inflation, Federal Reserve policy and economic expire. All told, we expect the Eurozone economy
growth will remain the key macroeconomic to contract by 0.3% in 2023.
influences in the year ahead. While this slowdown in economic activity—
along with the easing of supply constraints and
some moderation in food and energy prices—will

58 Goldman Sachs january 2023

Exhibit 99: Eurozone Negotiated Wage Growth Exhibit 100: Eurozone Real GDP—Realized and ISG
Wage growth in the Eurozone remains elevated, exerting Baseline Forecast
upward pressure on services inflation. We expect Eurozone GDP to remain below its pre-pandemic
growth path.
% YoY Index (Dec-19 = 100)
3.5 110 GDP
Trend GDP
Forecast
105 105.3
3.0
2.9 101.5
100

2.5 95

90
2.0

85

1.5
80

1.0 75
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Dec-19 Jun-20 Dec-20 Jun-21 Dec-21 Jun-22 Dec-22 Jun-23 Dec-23

Data through Q3 2022. Data through Q3 2022, forecasts through Q4 2023.

Source: Investment Strategy Group, European Commission. Source: Investment Strategy Group, Haver Analytics.
Note: Trend GDP is based on an estimated pre-pandemic trend.
Forecasts are estimated, are based on assumptions, are subject to
revision, and may change as economic and market conditions change.
There can be no assurance the forecasts will be achieved.

reduce pricing pressures, we see several reasons replenished over the course of the summer and
inflation is likely to remain above the ECB’s 2% fall. Significant investment is needed to hasten the
target this year. First, last year’s spike in energy region’s energy transition, as failure to do so could
prices will lift 2023 goods and services inflation, leave the Eurozone economy permanently below its
given the typical lags. Second, euro weakness pre-COVID growth path (see Exhibit 100).
implies higher costs for imported products. Lastly,
the still tight labor market increases the risk that
higher wage growth will be sustained long enough United Kingdom: Mind the Gap
to foster persistent services inflation (see Exhibit
99). Against this backdrop, we expect headline A cursory glance at the UK’s 4.4% growth last year
and core inflation to rise by 7.0% and 4.2%, would imply a booming economy. But the full year
respectively, in 2023. result belies a sharp deceleration in activity over
In turn, we see the ECB hiking its policy rate the course of 2022 that culminated in a recession
to 3.5% and beginning quantitative tightening starting in the third quarter. While surging
through passive runoff of its asset purchase energy prices were a key driver of the slowdown,
program in the first half of 2023. Although we heightened policy uncertainty also had a material
do not expect policy rates to remain at peak impact (see Exhibit 101).
levels for an extended period given that
supply disruptions are the main driver
of the region’s inflation, we also think
rate cuts are unlikely this year absent a As was the case in 2022, the
significantly deeper recession.
Clearly, the events of last year have
interplays between inflation, Federal
revealed vulnerabilities in the Eurozone’s Reserve policy and economic growth
energy supply, which adds tremendous
uncertainty to the economic outlook. The
will remain the key macroeconomic
energy crisis could even resurface next influences in the year ahead.
winter if gas storage is not adequately

Outlook Investment Strategy Group 59

Exhibit 101: UK Economic Policy Uncertainty Index Exhibit 102: UK Real GDP—Realized and ISG
Heightened policy uncertainty was a key driver of the recent Baseline Forecast
slowdown in UK economic growth. The gap between the UK’s current and pre-pandemic growth
path is widening.
Index Index (Dec-19 = 100)
600 Brexit 110 GDP
Referendum
Trend GDP
Forecast
106.0
105
500
Announcement
of Mini-Budget 100
400 98.7

95
300
90
228
200
85

100 80

0 75
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Dec-19 Jun-20 Dec-20 Jun-21 Dec-21 Jun-22 Dec-22 Jun-23 Dec-23

Data through November 2022. Data through Q3 2022, forecasts through Q4 2023.
Source: Investment Strategy Group, PolicyUncertainty, Haver Analytics. Source: Investment Strategy Group, Haver Analytics.
Note: Trend GDP is based on an estimated pre-pandemic trend.
Forecasts are estimated, are based on assumptions, are subject to
revision, and may change as economic and market conditions change.
There can be no assurance the forecasts will be achieved.

We expect the downturn to be relatively shallow, Although price pressures are likely to moderate
with a 1.5% peak-to-trough decline in real GDP this year, several factors are apt to keep inflation
and a recovery beginning in the summer. But that well above the BOE’s 2% inflation target, including
recovery is likely to be feeble given the continued sustained wage pressures, the lagged pass-through
squeeze on household budgets from higher energy from higher energy prices and the depreciation of
costs and elevated mortgage interest rates. Similarly, sterling. As a result, the BOE will hike rates further
business confidence and fixed investment will into restrictive territory and continue reducing its
remain fragile in the face of higher corporate taxes balance sheet. We project rates reaching a terminal
and tight financial conditions. As a result, we see the level of 4.5% in the first half of this year.
economy contracting 1% for the full year. More broadly, we think the medium-term
Unfortunately, it will be difficult for economic outlook for the UK has weakened
policymakers to lend support. The limits of significantly. Aside from the current recession, the
deficit spending came sharply into focus when economy continues to face important structural
the gilt market revolted in reaction to the Liz challenges arising from Brexit and the need to put
Truss government’s so-called mini-budget, which public finances on a sustainable path. These issues
proposed large unfunded tax cuts to boost growth. are not only aggravating the current economic
To regain credibility with the financial markets, backdrop, but also widening the gap between the
the Rishi Sunak government was forced to propose UK’s current and pre-COVID growth path. As seen
a new budget that was the exact opposite of its in Exhibit 102, that gap is set to widen from 5.1%
predecessor, featuring tax increases and spending to 6.9% of GDP by the end of this year.
cuts. In fact, this new plan is set to improve
public finances by around 2.5% of GDP by 2027.
Although many of these measures are backend- Japan: Surprisingly Resilient
loaded, they nonetheless leave less room for fiscal
stimulus in 2023. Japan’s economic recovery slowed in 2022 in the
Monetary policy is equally constrained face of new waves of COVID and rising energy
considering inflation stands at 40-year highs. prices. Even so, we estimate the economy expanded

60 Goldman Sachs january 2023

Exhibit 103: Japanese Consumer Confidence With inflation expected to finish this year
Across Categories below the BOJ’s 2% target, markets were caught
Japanese household sentiment has weakened amid off guard by the timing of the bank’s hawkish
declining real disposable incomes. decision to widen the band around its 10-year
Index JGB target from ±25 bps to ±50 bps. Governor
60 Haruhiko Kuroda had dismissed a wider band
on several occasions, while research by BOJ staff
50
found that a wider band could be detrimental
40
to capital spending. Kuroda explained the move
34.4 as a necessary technical adjustment to the yield
34.3
30 29.4
curve control (YCC) policy that would improve
bond market functioning and the transmission of
22.0
20 monetary policy to the real economy. We interpret
Consumer Confidence the move as a small first step toward normalizing
10 Income Growth
Employment
the bank’s highly accommodative policy stance.
Willingness to Buy Durable Goods Additional steps in that direction are likely this
0
2006 2008 2010 2012 2014 2016 2018 2020 2022 year, ultimately culminating in the removal of
the YCC policy and possible exit from the bank’s
Data through November 2022.
Source: Investment Strategy Group, Haver Analytics. negative interest rate policy (NIRP). Several factors
will determine the timing of these steps, including
the path of inflation, the outcome of the shunto
1.5% last year, well above trend growth of wage negotiations in March-April, and the views
around 0.8%. of the yet-to-be-selected next governor who will
The outlook for 2023 is more nuanced. On succeed Kuroda in April. Even with these potential
the one hand, several factors support a further adjustments, however, the BOJ will remain among
recovery, including households’ considerable the most accommodative large central banks.
excess savings, improved business sentiment,
robust profit growth and the reopening of the
economy to foreign tourists. On the other hand, Emerging Markets: Reversal of Fortune
new headwinds have arisen. As seen in Exhibit
103, household sentiment has weakened amid Emerging market economies were hard hit by
declining real disposable incomes. At the same last year’s macroeconomic developments. Not
time, rising cost pressures and the weaker global only did Russia’s invasion of Ukraine result
economic outlook cast a cloud over firms’ capital in surging food and energy prices, but it also
spending plans. Yet despite these challenges, we tightened global financial conditions, significantly
anticipate the Japanese economy will expand 1.3% raising the cost of borrowing for these countries.
this year—its third consecutive year of above- The resulting slowdown in both domestic
trend growth. consumption and external demand was made
It is tempting to blame this string of stronger worse by multiple COVID lockdowns in China,
economic reports for Japan’s surging headline which further disrupted already fragile supply
inflation, which at 3.8% late last year stood chains and hampered commodity demand from
near the highest level in three decades. But the Chinese importers.
rise in inflation has largely been driven
by higher energy prices and the sharp
depreciation of the yen. Wage pressures,
in contrast, have been limited thus
far. Given this mix of factors and the
We anticipate the Japanese economy
forthcoming government subsidies will expand 1.3% this year—its third
on electricity and gas, we expect both
headline and core inflation to moderate
consecutive year of above-trend
this year, reaching 1.8% and 1.9%, growth.
respectively.

Outlook Investment Strategy Group 61

Exhibit 104: Emerging Markets Headline and Exhibit 106: Emerging Markets Real GDP Growth
Core Inflation We expect growth in most EM countries to slow in 2023,
Inflation in emerging markets has surged and is well above except in China.
central bank target ranges in many countries.
% YoY % YoY
30 Inflation Target Range 10 9.4
Turkey Headline: 84% Headline Inflation 8.7
Turkey Core: 69% 8.1
25 Core Inflation
8 7.1
6.8 6.8 6.9
20 6 5.6
4.8 4.9 5.0 4.7
4.6
15 4.0
4 3.7
3.3 3.3 3.1
2.7
10 2.3
2 1.4
0.9
5
0
0
2021
Turkey
Hungary
Poland
Romania
Czech Republic
Chile
Colombia
Russia
Peru
Philippines
Mexico
South Africa
Brazil
India
Thailand
Indonesia
Israel
Korea
Malaysia
Taiwan
China
-2
2022 ISG Estimate
2023 ISG Forecast -2.6
-3.0
-4
EM EM Asia CEE* Latam China India Brazil Russia

Data through November 2022. Data through Q3 2022, forecasts through 2023.
Source: Investment Strategy Group, Haver Analytics. Source: Investment Strategy Group, International Monetary Fund.
* Excludes Russia and Ukraine
Note: Forecasts are estimated, are based on assumptions, are subject
to revision, and may change as economic and market conditions change.
There can be no assurance the forecasts will be achieved.

cost of further increases in already elevated public

Exhibit 105: Policy Rate Changes During 2022 debt-to-GDP ratios. In sum, these crosscurrents led
Many emerging market central banks aggressively tightened to EM GDP growth of 3.3% last year, well below
monetary policy in 2022. the 4% trend and less than half the 6.8% pace
Basis Points registered in 2021 (see Exhibit 106).
1,200 1,060 Many of last year’s challenges are likely to
1,000 900
persist in 2023. While food and energy prices are
800 725
not expected to surge again this year, they remain
600 500 500 500
450
350 325 325 315
425 well above pre-pandemic levels and will continue
400
225 225 200 to weigh on household budgets. Lingering inflation
200 100 75 63
0
also makes rate cuts by global central banks less
-200 -100 likely, implying a continuation of tight financial
-400 conditions. On the external front, slower growth
-600 -500 in major developed market countries will be a
headwind to EM exports, while the reopening of
Hungary
Colombia
Chile
Peru
Poland
Mexico
Brazil
Philippines
Czech Republic
South Africa
Israel
Korea
India
Indonesia
Malaysia
Thailand
Taiwan
Russia
Turkey
US

China’s economy this year should benefit EMs

more broadly. All things considered, we expect
3.7% EM GDP growth in 2023, a modest pickup
Data through December 31, 2022.
Source: Investment Strategy Group, Bloomberg. from last year but still below trend.

Asia
Although such an abrupt decline in economic Growth prospects in Asia look stronger than in
activity would typically lead to supportive other EM regions, but they hinge on China’s exit
monetary policy, higher-than-expected inflation from its “zero-COVID” policy. Initially, growth
and the sharp depreciation of most EM currencies is likely to slow in East Asian countries as the
instead forced central banks to hike policy rates surge in China’s COVID cases dampens economic
aggressively (see Exhibits 104 and 105). Fiscal activity. But by the second quarter, we expect a
policy provided some economic relief, but at the pickup in exports to China as the initial infection

62 Goldman Sachs january 2023

Exhibit 107: China’s Fixed Investment by Sector Exhibit 108: China’s Benchmark Interest Rate and
The Chinese government increased infrastructure Required Reserve Ratio
investment to support the economy. The People’s Bank of China cut interest rates and the
required reserve ratio to boost credit growth.
% YoY % %
50 Manufacturing 4.0 20
Infrastructure
40 Real Estate
18
3.5
30
16
20 3.0

10 10.6 14
6.2 2.5
0
12
-10 2.0
10
-20 -19.9
1.5 1-Year Medium-Term Lending Facility (Left)
-30
8
7-Day Reverse Repo (Left)
Required Reserve Ratio (Right)
-40 1.0 6
2019 2020 2021 2022 2015 2016 2017 2018 2019 2020 2021 2022

Data through November 2022. Data through December 2022.

Source: Investment Strategy Group, Haver Analytics. Source: Investment Strategy Group, Haver Analytics.

wave recedes. The region should also benefit from

an influx of Chinese tourists as travel restrictions Exhibit 109: Daily New Symptomatic
are lifted. Hong Kong is set to be a prime COVID-19 Cases
beneficiary, having been the main destination for Countries have experienced a surge in infections after they
Chinese tourists prior to the pandemic. relaxed their COVID-19 controls.
But even here the outlook is not uniform. Slower Per Million People
growth in the US and Europe, along with a global 10,000 Hong Kong
Taiwan
shift from goods to services, will weigh on the 9,000 Singapore

recovery in both Korea and Taiwan. As a result, we 8,000

expect GDP growth in these countries to slow to 7,000

around 2% this year from closer to 3% in 2022. In 6,000

contrast, India is expected to maintain a solid pace 5,000

of growth at around 5.6%. In fact, India is among 4,000

several countries in Asia that may benefit from the 3,000 2,790

global relocation of supply chains over time. 2,000

1,000 906
162
0
China 0 50 100 150 200 250 300 350 400 450 500
China spent much of last year enduring the Days
deleterious effects of its “zero-COVID” policy, Data through December 31, 2022.
including frequent lockdowns and broad mobility Note: Day count starts after the symptomatic cases 7-day moving average exceeds 2 per
million people.
restrictions in response to virus outbreaks. The Source: Investment Strategy Group, Wind.
result was a significant decline in economic
activity, made worse by a slump in the property
sector and various regulatory crackdowns on
private industries. Although the government tried one well below both initial consensus expectations
to cushion the blow with more infrastructure of 5.2% and the government’s own growth target
spending and rate cuts (see Exhibits 107 and 108), of around 5.5%.
GDP growth nonetheless fell from more than China’s decision to begin easing COVID
8% in 2021 to an estimated 2.7% last year. That restrictions late last year in response to widespread
represents the slowest pace of growth since 1976— lockdown protests will have a significant impact on
outside of the initial pandemic shock in 2020—and 2023’s growth outlook. As we have seen repeatedly

Outlook Investment Strategy Group 63

Exhibit 110: China’s Real Disposable Income was last year, particularly given the government’s
Growth per Capita vs. Savings Rate 16-point support plan announced last November.
Household savings remain elevated even as disposable Overall, we expect the Chinese economy to
income growth has slowed. expand by 4.9% in 2023. Despite the pickup in
% YoY % growth, inflation pressures should remain muted
16 Real Disposable Income per Capita (YTD, Left)
Savings Rate (Right)
35
with headline and core inflation of 2.1% and
14 34 1.1%, respectively, both well below the central
12 33 bank’s tolerance level of 3%. For a more complete
10
32 examination of our China views, please see our
8
31 recently published Insight on China, Middle
6
30 Kingdom: Middle Income.
4
29
2
28 Central and Eastern Europe
0
27
Economies in Central and Eastern Europe have
-2
26
been severely impacted by the war in Ukraine, due
-4
to both their proximity to the conflict and their
-6 25
2015 2016 2017 2018 2019 2020 2021 2022 economic ties with Russia, especially through energy
imports. These effects were visible in the region’s
Data through Q3 2022.
Source: Investment Strategy Group, Haver Analytics. negative trade shock last year following sanctions
and embargos on Russian energy, which precipitated
surging inflation, widened current account deficits
in other countries that relaxed COVID controls, and depleted foreign currency reserves. Responding
there is almost certain to be an initial surge in to these pressures, the regions’ central banks
infections. It took four months for the initial wave exacerbated the economic malaise by aggressively
in Hong Kong to subside, while Singapore and tightening monetary policy. In the case of Hungary,
Taiwan saw multiple smaller waves after the first that amounted to more than a 10-percentage-point
surge (see Exhibit 109). China’s wave could be increase in the policy rate, while the Czech central
even more protracted than those in these countries, bank eroded nearly a quarter of its FX reserves
as its population has less natural immunity defending the nation’s currency.
from prior infection and comparatively lower Although growth in the region already slowed
vaccination rates, and its vaccines are considered sharply last year and current account balances are
less effective. At the same time, China’s health- likely to improve in 2023, risks to the economic
care system is not well prepared to handle the outlook remain high, especially if a cold winter
surge in patients. Against this backdrop, we expect intensifies gas shortages. Even with fiscal support
economic activity to remain subdued through the measures, the region is likely to enter a recession
first quarter of this year, as people avoid public early this year. While this should help bring down
spaces and factories struggle to find enough healthy inflation, it is likely to remain far enough above
workers to run at full capacity. central banks’ targets to limit the scope for rate cuts.
The economy should start to recover by Within the region, the outlook for Russia
the second quarter of this year as the virus remains skewed to the downside. While its
wave recedes. We expect consumption to drive economy shrank by 3.0% last year—a smaller-
the rebound on the back of pent-up demand, than-expected decline given the benefit from selling
considerable excess savings (see Exhibit 110) and energy at high prices—we expect it to contract by
an improving labor market. Fixed investment an additional 2.6% in 2023.
should also see a modest lift thanks to the pickup
in consumer demand and continued policy support. Latin America
But these tailwinds will likely be tempered by Although Latin American growth was hurt by
slower growth abroad, which will weigh on the broader global slowdown last year, several
China’s exports and depress capital spending in local drivers also affected activity. For example,
the manufacturing sector. The property sector also the region’s central banks were among the first
remains an important risk to the outlook, but we to tighten monetary policy in response to rising
believe it will be a smaller drag on GDP than it inflation in 2021, leading to a longer period of

64 Goldman Sachs january 2023

tight financial conditions that has weighed on
growth. Commodity price volatility has also had
an impact, albeit a less uniform one. In the case
of Colombia, Mexico and Brazil, higher oil prices
provided a boost to growth, while in the case of
Chile, disappointing Chinese copper demand was
a significant drag. Growth in the region is likely
to remain subdued in 2023, but the end of central
bank tightening and China’s reopening may offer
some reprieve later in the year.
Within the region, Brazil’s economy grew
3.1% last year, led by a strong recovery in the
services sector. Fiscal spending in the run-up to
the presidential election and strong commodity
prices also helped. But with its central bank having
now taken real policy rates deeply into restrictive
territory at nearly 8%, we expect economic growth
to slow to just 0.9% this year. While the further
fiscal support proposed by the new administration
poses upside risk to this forecast, it would also
delay much-needed debt reduction and therefore
result in higher borrowing costs.

Outlook Investment Strategy Group 65

SECTION III

2023 Financial
Markets Outlook:
Looking for Traction

on the road to recovery from the global pandemic,

financial markets hit an icy patch last year. The S&P 500 slid
18%, its largest annual decline since 2008. The wreckage
was not limited to US stocks. At the worst of the downdraft
last October, 85% of the primary equity indices tracked by
Bloomberg showed a loss for the year.47 Collectively, those
declines amounted to nearly $32 trillion in market value at the
time.48 Even bonds—which typically act as a defensive portfolio
asset—were not spared, with the Bloomberg Global Aggregate
Bond Index slipping 16%. This unusual decline in both stocks
and bonds, which has occurred less than 2% of the time
since 1926,49 resulted in the fourth-worst loss for a balanced
portfolio on record.

66 Goldman Sachs january 2023

Outlook Investment Strategy Group 67
 To be sure, many of the key uncertainties from Exhibit 112: Annual Number of Days in a
last year remain, including elevated inflation, Downtrend for S&P 500
ongoing geopolitical tensions, and the murky Last year ranked among the most persistent downtrends
trajectory of the Chinese economy. The risk of a in history.
US recession is also top of mind, especially with Trading Days
central banks continuing to hike policy rates and 300 Year 2022

many recession indicators already flashing red.

250
These are legitimate concerns, and we accordingly
give a US recession this year even odds. 200
213

But we also should not lose sight of the fact

that markets are forward-looking, meaning they 150

typically fall in anticipation of bad news but begin

100
recovering even as the headlines of the day remain
ominous. This has two important implications 50
for 2023. First, risk assets are likely to deliver
attractive returns if a US recession is avoided, 0

given the extent of last year’s losses. Second, even

1946
1950
1954
1958
1962
1966
1970
1974
1978
1982
1986
1990
1994
1998
2002
2006
2010
2014
2018
2022
in the event of a mild US recession that ends this Data through December 31, 2022.
year, stocks could still deliver positive returns, Note: Downtrend is defined as S&P 500 price below its 200-day moving average.
Source: Investment Strategy Group, Bloomberg.
considering the sizable rallies seen in the final
months of past economic downturns. Since not all
paths in a recession lead to stock market losses at
the end of 2023, we believe the odds of positive US Equities: Down but Not Out
US equity returns exceed those of a recession
this year. This also explains why we expect gains Few investors will lament the passing of 2022.
in Eurozone and UK equities even though we US equities lost nearly $13 trillion in market
believe these regions are already in recession (see capitalization last year, roughly equivalent to the
Exhibit 111). combined GDP of Japan, Germany and the UK. Last
Our base case implies financial markets can year’s rout was also the second equity bear market
regain traction in 2023. In equities, we see more in the last three years. But unlike 2020, there was
paths to gains than losses by year-end. Bonds no speedy recovery last year. Instead, US equities
are also expected to rise, as today’s higher yields spent nearly the entirety of the year mired in a
provide an ample cushion to absorb any further double-digit drawdown that ranked among the most
increase in interest rates. But there will no doubt be persistent downtrends in history (see Exhibit 112).
curves along the road ahead. The decline in stocks is understandable
considering the bounty of concerns today. Recession
is chief among these, as investors worry that the

Exhibit 111: ISG Global Equity Forecasts—Year-End 2023

End 2023 Central Case Implied Upside from Current Dividend

2022 YE Target Range End 2022 Levels Yield Implied Total Return
S&P 500 (US) 3,840 4,200–4,300 9–12% 1.8% 11–14%
Euro Stoxx 50 (Eurozone) 3,794 4,000–4,300 5–13% 3.6% 9–17%
FTSE 100 (UK) 7,452 7,800–8,000 5–7% 3.9% 9–11%
TOPIX (Japan) 1,892 2,000–2,100 6–11% 2.6% 8–14%
MSCI EM (Emerging Markets) 956 990–1,040 4–9% 3.0% 7–12%

Data as of December 31, 2022.

Source: Investment Strategy Group, Datastream, Bloomberg.
Note: Forecasts are estimated, based on assumptions, are subject to revision and may change as economic and market conditions change. There can be
no assurance the forecasts will be achieved. Indices are gross of fees and returns can be significantly varied. Please see additional disclosures at the end
of this Outlook.

68 Goldman Sachs january 2023

Exhibit 113: Economists’ Probability of a US Exhibit 114: ISG Total Return Forecast Scenarios
Recession in the Next 12 Months for S&P 500—Year-End 2023
There is an unusual consensus among economists that a We assign a combined 70% probability to favorable
recession is likely. equity outcomes.
Probability (%) Total Return (%)
100 Median 30
27
90 25
80
20
70
65 15
60 13

50 10

40 5

30 0
20
-5
-4
10
-10
0
Good Case Central Case Bad Case
1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 (4,800 Price) (4,200–4,300 Price) (3,600 Price)
Forecaster (20% Probability) (50% Probability) (30% Probability)

Data as of October 2022. Data as of December 31, 2022.

Source: Investment Strategy Group, Wall Street Journal Economic Forecasting Survey. Source: Investment Strategy Group, Bloomberg.
Note: Forecasts are estimated, based on assumptions, are subject to
revision and may change as economic and market conditions change.
There can be no assurance the forecasts will be achieved. Indices are
gross of fees and returns can be significantly varied. Please see additional
disclosures at the end of this Outlook.

combination of tighter monetary policy and below-

trend growth necessary to bring down inflation Exhibit 115: S&P 500 Earnings Growth vs. Yearly
will also tip the US economy into contraction. Nominal US GDP Growth
That fear is reinforced by the cautionary signals Earnings tend to track nominal GDP growth closely
emanating from a host of leading indicators, such over time.
as widespread yield curve inversions and the abrupt % YoY % YoY
downturn in the housing market. There is also 80 S&P 500 Earnings
Nominal GDP (Right)
20

an unusual consensus among economists that a 60

15
recession is likely (see Exhibit 113).
Given this backdrop, our expectation for 40
10
positive equity returns in 2023 may seem 20
counterintuitive (see Exhibit 114). After all, how 5
can we assign a combined 70% probability to 0

favorable equity outcomes while also placing even 0

-20
odds to a recession this year? To understand, it is
-5
helpful to look at both the soft landing and hard -40

landing scenarios.
-60 -10
If recession is avoided, we expect mid-single- 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022
digit nominal GDP growth to lift earnings by Data through Q3 2022.
4–6% this year, providing support for higher Source: Investment Strategy Group, FactSet, Haver Analytics.

equity prices. Exhibit 115 shows that earnings

tend to track nominal GDP growth closely over
time, as corporations are paid in nominal dollars. Our expectations for a slower pace of US dollar
As a result, it is very rare for earnings to decline appreciation in 2023 could also help ease some
when the economy is still expanding—a fact that of last year’s pressure on corporate revenues. At
repeatedly confounded bearish calls for a collapse the same time, we do not consider rising interest
in earnings last year. expense a key concern this year, as more than

Outlook Investment Strategy Group 69

Exhibit 116: Percentage of Time Profit Margins Exhibit 118: Indexed Price and EPS During US
Expanded When S&P 500 Sales Grew Bear Markets
Periods with positive sales growth saw margins remain flat Equities have typically troughed 6–9 months before
or expand about two-thirds of the time. earnings reach their low in past bear markets.
% %
100 35 Price
EPS
90 30

80 25
73
70 67 20
65
15
60
10
50
5
40
0
30
-5
20
-10
10
-15
0 -18 -15 -12 -9 -6 -3 0 3 6 9 12 15 18
Full Sample During 1970s Last 20 Years Months Relative to Bear Market Low

Data as of Q3 2022. Data through 2022.

Note: Based on data since 1970. Note: Based on US bear markets since 1903.
Source: Investment Strategy Group, Goldman Sachs Global Investment Research, FactSet, Source: Investment Strategy Group, Goldman Sachs Global Investment Research, Robert Shiller.
Compustat.

the inflationary 1970s (see Exhibit 116). Moreover,

Exhibit 117: GIR Supply Chain Congestion Scale the significant improvement in global supply chains
The congestion scale dropped to 2 from 10 in January 2022. in recent quarters should help ease the pressure on
profit margins this year (see Exhibit 117). Consistent
with this analysis, our base case assumes relatively
flat margins.
If the economy instead enters a recession,
earnings will likely decline from their 2022 level.
2
But whether that results in lower or higher stock
prices at the end of 2023 depends critically on
when the recession ends. As a rule, the market
1 10 has more time to recover the earlier in the year a
Fully Open Fully Bottlenecked recession occurs.
Two factors explain this dynamic. First, stocks
Data as of December 27, 2022.
Note: Scale is based solely on weekly metrics to give more granularity on high-frequency data are forward-looking, meaning they typically
indications. fall in anticipation of a deteriorating economic
Source: Goldman Sachs Global Investment Research.
environment but begin recovering even as earnings
are still being downgraded. During past bear
markets, equities have typically troughed six to
90% of S&P 500 firms’ debt is fixed, its average nine months before earnings reach their low (see
duration is long (at about 12 years) and only 7% Exhibit 118). Equities have also typically bottomed
of it matures this year.50 Interest expense must also about three months before the end of recessions.
be netted against the interest income now being Put simply, markets bottom when the news is
earned on nearly $2 trillion of cash on corporate still bad.
balance sheets. Second, the recovery from past recessionary
We also draw comfort from the strong historical lows has been rapid, with the S&P 500 rallying
correlation between sales growth and profit margins. about 20% over the span of a few months (see
Past periods with positive sales growth—which we Exhibit 119). The combination of these two factors
also expect this year—saw margins remain flat or suggests that even a recession ending late this year
expand about two-thirds of the time, even during would still be consistent with our base case S&P

70 Goldman Sachs january 2023

Exhibit 119: S&P 500 Return from Market Bottom Exhibit 120: Implied Year-End 2023 Price as a
to End of Recession Percentage of Peak Price vs. Recession End Time
Equity recovery from past recessionary lows has been rapid. Even a recession ending late this year would still be
consistent with our base case S&P 500 target.
Price Return (%) % of Peak Price
45 Median 120 Range (25th to 75th Percentile) Median
39
40 115

110 107 107

35 32
31 104
105 103
30 101
25 98
24 100
25 95
18 20 95 92
91
20 20
17 90
15
15
10 85
10 8 80
5 75

0 70
Jun-49 Sep-53 Oct-57 Oct-60 May-70 Oct-74 Mar-80 Aug-82 Oct-90 Mar-09 Mar-20 Apr-23 May-23 Jun-23 Jul-23 Aug-23 Sep-23 Oct-23 Nov-23 Dec-23
Equity Trough Date Recession End Month

Data as of December 31, 2022. Data as of December 31, 2022.

Note: Based on recessions post-WWII, excluding the 2001 recession, which was the only Source: Investment Strategy Group, Bloomberg, NBER.
recession where equities bottomed after the end of recession. The time from market bottom Note: Based on 12 recessions since WWII. For example, if a recession ends in December 2023,
to end of recession ranged from less than one month to eight months and had a median of the historical median episode implies that the S&P 500 would have recovered to 91% of the
about three months. Recession end date is defined as the first date of the NBER business cycle January 2022 peak of 4,797 (that is, a price level of 4,377) at year-end 2023.
trough month. Forecasts are estimated, based on assumptions, are subject to revision
Source: Investment Strategy Group, Bloomberg, NBER.
and may change as economic and market conditions change. There can be
no assurance the forecasts will be achieved. Indices are gross of fees and
returns can be significantly varied. Please see additional disclosures at the
end of this Outlook.

500 target (see Exhibit 120). Because not all paths

in a recession lead to lower equity prices at the end Exhibit 121: S&P 500 Return in 12 Months After a
of this year, we believe the odds of positive equity 20% Pullback Within a Calendar Year
returns exceed those of a recession in 2023. Once the market has fallen into bear-market territory, the
Other factors also support this conclusion. median equity gain in the following year was 23%.
Once the market has fallen into bear-market %
territory—which happened last year around 70 Median
59
3800 on the S&P 500—the median equity gain 60
47
in the following year was 23% (see Exhibit 121). 50

40 38
Similarly, history suggests 83% odds of a gain in 31
30 26
2023 given the rarity of two consecutive down 23 25
23
20
years for the S&P 500. This year is also the third 12
10 7
in the presidential cycle, which has historically had
0
the highest returns of the four-year cycle and 84% -1
-10
odds of a gain (see Exhibit 122). -8 70% of Time Return Was Positive
-20 (9 of 13 Episodes)
It is also worth mentioning that past years -18
-30 -27
that saw a similarly large decline in the S&P 500
-40
P/E ratio have typically been followed by strong 1973 2001 2008 1946 2002 1974 1987 1966 1962 1957 1970 2009 2020
equity returns (see Exhibit 123). While some have Data through 2022.
attributed last year’s P/E de-rating to higher real Source: Investment Strategy Group, Bloomberg.

interest rates alone, we think it also reflects genuine

recessionary concerns. That connection is apparent
in Exhibit 124, which shows that real interest rates aggressive rate hiking cycle. In fact, 2022 featured as
and Bloomberg stories about recession rose in many Bloomberg stories on recession as 2020, a year
tandem last year in response to the Federal Reserve’s when the US economy was actually in recession.

Outlook Investment Strategy Group 71

Exhibit 122: S&P 500 Returns in Each Year of the Exhibit 124: Recession Story Count vs. US Real 10-
Presidential Cycle Year Treasury Yield
The third year in the presidential cycle has historically had Both real interest rates and recession stories rose in tandem
the highest returns and 84% odds of a gain. last year.
% % % Count
25 Average Price Return % Time Higher (Right) 100 2.0 US Real 10-Year Treasury Yield 180,000
Recession Story Count (Right)
84
79 1.5 160,000
20 80
140,000
1.0
63 16
55 120,000
15 60 0.5
100,000
0.0
10 40 80,000
8
7 -0.5
60,000
5 4 20 -1.0
40,000

-1.5 20,000
0 0
Year 1 Year 2 Year 3 Year 4 -2.0 0
Year of Presidential Cycle 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Data through 2022. Data through December 2022.

Note: Based on data since 1946. Source: Investment Strategy Group, Bloomberg.
Source: Investment Strategy Group, Bloomberg.

Exhibit 123: S&P 500 Returns in the Years Exhibit 125: S&P 500 Peak-to-Trough Drawdown
Following 20% Declines in Trailing P/E Ratios Within Two Years Before Start of Recessions
Subsequent equity returns were strong when P/E ratios Last year’s 25% peak-to-trough equity drawdown was the
declined as much as they did last year. largest in advance of a recession in history.
Price Return (%) %
40 Average 0
36
35
-5

30
26 -10
-10.2 -10.1
25
22 -11.7 -11.9
-15 -13.6
20 -14.7 -14.8
-16.4
-17.4 -17.1
16
15 -20 -18.8
-19.8
10 11
10 9 Last Year: -25.4%
-25

5
2 -30
0 Nov-48 Jul-53 Aug-57 Apr-60 Dec-69 Nov-73 Jan-80 Jul-81 Jul-90 Mar-01 Dec-07 Feb-20
Nov-46 Jun-62 Jun-70 Jun-74 Oct-87 Jul-02 Nov-08 Recession Start Month

Data as of December 31, 2022. Data as of December 31, 2022.

Note: The analysis looks for historical instances when the P/E ratio declined by more than 20% Note: Recession start date is defined as the first date of the NBER business cycle peak month.
from a 9-month high and the corresponding price decline was also more than 20%, a case that Source: Investment Strategy Group, Bloomberg, NBER.
occurred last year. This implies that the multiple compression was driven by price decline rather
than earnings growth.
Source: Investment Strategy Group, Bloomberg, S&P Global.

To be clear, we are not arguing that today’s think a significant part of any valuation reset has
valuations fully discount a recession. But already occurred. Current US equity valuations
considering last year’s 25% peak-to-trough equity also seem reasonable compared to past periods
drawdown—which would be the largest in advance with similar interest rates (see Exhibits 126
of a recession in history (see Exhibit 125)—we do and 127).

72 Goldman Sachs january 2023

Exhibit 126: Equity Risk Premium Proxy—Current Exhibit 128: Implied Change in S&P 500 Level
vs. 2003–06 Under Different Scenarios
Current US equity valuations are in line with the levels seen There is a positive skew between upside and downside risks
in 2003–06 when interest rates were similar. from current levels.
Equity Risk Premium Proxy (%) S&P 500 Implied Price Return (%)
6 2003–06 Average 50
Current
40
29 31
5 30
4.6 23 24
4.4 20
20
4 10
0 -4
3
-10
2.2 2.1 -13
-20 -17
2
-30
Average Fundamental High Up vs. Bear 15% Down Yield Curve 20% Down
Recession Recession Down Volume Market Quarter Diffusion First Half
1
Decline Scenarios* in Two Signal***
(30%) Consec. Days**
0
Nominal Real Median Gain in Year After

Data as of December 31, 2022. Data as of December 31, 2022.

Note: Nominal or real equity risk premium is approximated by forward earnings yield minus US Source: Investment Strategy Group, Bloomberg, Datastream, FactSet, I/B/E/S, SentimenTrader.
Treasury 10-year nominal or real yield. * Fundamental recession scenarios are based on a 35–40% peak-to-trough forward P/E
Source: Investment Strategy Group, FactSet, Bloomberg. contraction and on a 15% peak-to-trough forward EPS contraction.
** Defined as back-to-back days with 10-to-1 NYSE up volume/down volume.
*** Based on the 103% median ratio of highest S&P 500 price in year following yield curve
diffusion signal relative to its peak price before the signal.

Exhibit 127: Equity Risk Premium Proxy vs. US 10- Exhibit 129: Professional Forecasters’ Probability
Year Treasury Yield of a Quarterly Decline in Real GDP in 1 Year
Current US equity valuations seem reasonable compared to This is arguably the most widely anticipated recession
past periods with similar interest rates. in history.
Equity Risk Premium Proxy (%) Probability (%)
8 50

45
6 44
40

4 35

30
2
25
Current
0 20

15
-2
10

5
-4
0 1 2 3 4 5 6 7 0
US 10-Year Treasury Yield (%) 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

Data as of December 31, 2022. Data as of Q4 2022.

Note: Equity risk premium is approximated by forward earnings yield minus US 10-year Treasury Note: Data shown is based on the average responses from the Federal Reserve Bank of
yield. All values are nominal. Philadelphia Survey of Professional Forecasters. Shaded periods denote recessions.
Source: Investment Strategy Group, Goldman Sachs Global Investment Research, Bloomberg, Source: Investment Strategy Group, Federal Reserve Bank of Philadelphia, NBER.
FactSet, Compustat.

Exhibit 128 summarizes the dilemma facing in the event of a recession. But that risk must
investors today. The favorable equity outcomes be weighed against the attractive returns that
we discussed previously for year-end 2023 do not could follow a variety of soft and hard landing
preclude lower prices during the year, especially scenarios. Furthermore, it is difficult to imagine

Outlook Investment Strategy Group 73

Exhibit 130: Net Percentage of Bullish vs. Bearish Exhibit 131: 2022 Public Equity Returns
Investors Over Time Non-US developed equities fared well relative to the US and
This is one of the longest streaks of bearish investor EM in 2022.
sentiment in the US on record.
Yearly Average (%) Total Return (%)
40 10
7

5
30 2
0
20 -1
-5 -4
10 -7 -7
-10 -8

0 -15
-16 -16
-10 -20 -18
-20

-25 -23
-20
-21

EAFE

US

EM

UK

Australia

Spain

Japan

France

Italy

Switzerland

Germany

Netherlands
-30
1988 1992 1996 2000 2004 2008 2012 2016 2020

Data through December 29, 2022. Data through December 31, 2022.
Note: Calculated as 52-week average of percentage of bullish investors minus percentage of Note: All returns are in local currencies except for the Emerging Market return, which is in US
bearish investors. dollars. The US return is based on the S&P 500 index. The returns for non-US equities are based
Source: Investment Strategy Group, American Association of Individual Investors on MSCI indices.
Sentiment Survey. Source: Investment Strategy Group, Datastream.

that the market would be completely surprised by Although we expect more uniformly positive
a recession at this point, which could temper the equity returns across EAFE countries in 2023,
resulting downdraft. As seen in Exhibit 129, this is the path is unlikely to be smooth. This year
arguably the most widely anticipated recession in likely begins with recessions in two of the largest
history and has already been preceded by one of developed equity markets outside the US, the
the longest streaks of bearish investor sentiment on Eurozone and the UK, which together represent
record (see Exhibit 130). around half of EAFE market capitalization. At
Given the uncertainties above, investors should the same time, ongoing geopolitical uncertainty in
first ensure that their strategic asset allocation many countries likely sets a practical limit on how
accurately reflects their risk tolerance. But provided much of last year’s equity decline can be recouped.
that is the case, history suggests investors are Despite these headwinds, we think forward-
better off staying the course and even looking for looking investors will push valuation multiples
opportunities to overweight stocks if they weaken higher this year as they anticipate an eventual
further, given the positive skew between upside and recovery in earnings. For EAFE, that implies a
downside risks from current levels. low-double-digit total return in local currency
terms. We also forecast positive gains for European
markets this year, but we expect only the UK to
Non-US Developed Market Equities: A recapture its previous peak.
Rocky Road to Recovery

The relative performance of non-US developed Eurozone Equities: Continued Resilience

equities was a bright spot last year. As seen in
Exhibit 131, the 7% decline in the MSCI EAFE Eurozone equities bested their global peers last
(Europe, Australasia, and the Far East) index in year (see Exhibit 131), a notable departure from
local currency terms significantly outperformed their tendency to lag in down markets. This
the declines seen in both US and emerging market surprising outcome was rooted in a more than
stocks, which were closer to 20%. Some developed 20% increase in earnings, which reached their
equity markets, such as the UK and Australia, even highest level in more than a decade. Considering
finished 2022 with gains. the Eurozone’s proximity to Ukraine and its

74 Goldman Sachs january 2023

Exhibit 132: Eurozone P/E Change Around Exhibit 133: Decomposition of Eurozone Equity
Prior Recessions Return in 2022 and 2023
Multiple expansion has been usual following the start of We expect multiple expansion will offset the decline in
prior recessions. earnings in 2023.
P/E Change Relative to 3 Months Before Recession Start (%) %
35 40 2022 2023
30 28
30
25 24
20 20
12 13
15
10
10 3 4

5 0
-2
0
-10 -9
-5
-10 -20

-15
-30
-20 -31
-3 0 3 6 9 12 -40
Months Around Start of EU Recession EPS Growth Change in P/E Dividend Yield Total Return

Data through 2022. Data through December 31, 2022.

Note: Based on data since 1990. Note: The returns and decomposition are based on the midpoint of ISG’s central case forecast
Source: Investment Strategy Group, Datastream. range. Total return includes the compounding effect between earnings and valuation multiple.
Source: Investment Strategy Group, Datastream, I/B/E/S.

reliance on Russian energy, the resilience of its losses in their loan books. Finally, the sector is
companies last year was remarkable. attractively valued, particularly relative to what
This resilience is likely to give way to lower investors have historically paid for the level of
earnings in 2023, as Europe begins the year in profitability it currently has. Against this backdrop,
a recession amid a global growth slowdown. we continue to recommend an overweight to
Even so, we expect investors to push P/E ratios Eurozone banks given their improving profitability,
higher as the region emerges from a short-lived scope for higher valuations and attractive 6%
and relatively shallow economic downturn this dividend yield.
year, just as they have during prior recessions (see
Exhibit 132). That view is supported by the area’s
relatively attractive valuations. At just 11.3x, the UK Equities: Still Playing Catchup
Eurozone’s P/E ratio stands in the bottom 30%
of the post-GFC distribution and below its pre- The gain in UK equities last year in local currency
pandemic value. The net result of falling earnings terms stood in sharp contrast to the significant
amid rising valuations should be a low-double- losses seen in almost all other major equity
digit total return for Eurozone equities this year; markets. Last year was also the first time since
many elements of our forecast are the mirror image 2016 that UK equities had outpaced the MSCI
of their values last year (see Exhibit 133). World Index. This outperformance can be traced
As discussed in Section I, we remain overweight to a few factors, including the FTSE 100’s high
the Eurozone banks. Not only did the sector concentration of value stocks and commodity-
outperform broader Eurozone equities
once again last year, but it also generated
a positive return despite a global bear
market. Several factors underpin this
resilience. First, the ongoing increase
Considering the Eurozone’s proximity
in global interest rates directly benefits to Ukraine and its reliance on
the banks’ net interest income. Second,
the banks have spent the last decade
Russian energy, the resilience of its
improving their balance sheets, resulting companies last year was remarkable.
in higher capital ratios and fewer

Outlook Investment Strategy Group 75

Exhibit 134: FTSE 100 and MSCI World Total Exhibit 135: UK P/E Change Around
Returns Since 2020 Prior Recessions
UK equities have not yet closed the performance gap with Multiple expansion has been usual following the start of
other developed equities. prior recessions.
Total Return (Start of 2020 = 100) P/E Change Relative to 3 Months Before Recession Start (%)
150 FTSE 100 20
MSCI World
140 15 14
130 10

120 20%
5

110 10%
0
100
-5
90
-10
80
-15
70
-20
60 -3 0 3 6 9 12
2020 2021 2022 Months Around Start of EU Recession

Data through December 31, 2022. Data through 2022.

Note: Total returns in local currency terms. Note: Based on data since 1990.
Source: Investment Strategy Group, Datastream. Source: Investment Strategy Group, Datastream.

exposed stocks, its record-low relative valuations The combination of declining profits and a
at the start of 2022 and the depreciation of the modestly higher P/E ratio—along with the FTSE
currency. Yet despite last year’s strength, UK 100’s 3.9% dividend yield—supports a low-double-
equities have still not closed the performance gap digit total return in our base case (see Exhibit 111).
that emerged relative to other global equities after The currently depressed levels of investor sentiment
the start of the pandemic (see Exhibit 134). also imply similar total returns to our baseline
That gap is likely to extend into 2023, as UK forecast in 2023, as this has been a contrarian
earnings decline in response to a domestic recession indicator of future equity returns in the past.
and slowing global growth, as well as a waning
tailwind from commodity prices and past sterling
depreciation. But as was the case in the Eurozone, Japanese Equities: Encore Unlikely
we expect investors’ willingness to pay higher
valuations as the UK economy exits its recession
Japan also outperformed global equities last year.
to fully offset the decline in profits this year (see
Three main factors drove this achievement. First,
Exhibit 135). Japan’s overseas earnings benefited from the
limited rise in the country’s interest rates and the
sharp depreciation in its currency, both
the result of the BOJ’s unwillingness to
follow other central banks in tightening
Japan’s overseas earnings benefited policy. Second, the Japanese economy
was able to sustain above-trend growth.
from the limited rise in the country’s Lastly, the underweight position of foreign
interest rates and the sharp investors at the start of last year left little
for them to sell (see Exhibit 136). Because
depreciation in its currency, both these investors are typically the marginal
the result of the BOJ’s unwillingness buyers or sellers of Japanese equities,
their underweight positioning indirectly
to follow other central banks in supported the stocks.
tightening policy. We forecast a low-double-digit total
return for Japan in 2023 (see Exhibit

76 Goldman Sachs january 2023

Exhibit 136: Cumulative Net Purchases of Exhibit 137: Contributions to MSCI EM
Japanese Equities by Foreign Investors Since 2010 Annual Returns
Equity inflows from foreign investors remain well below China, Korea and Taiwan were a large drag on returns
their Abenomics peak. last year.
JPY Trillions Total Return (%)
30 50 Contribution from North Asia Contribution from Other Countries
MSCI EM Return
37.8
40
25
30

20 18.9 18.7
20
11.6
10
15 1.8
0
10 -2.3 -1.8 -2.2
-10

5 -20 -14.6 -14.2

-19.7
-30
0 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2013–22
2010 2012 2014 2016 2018 2020 2022 CAGR

Data through December 23, 2022. Data through December 31, 2022.
Source: Investment Strategy Group, Haver Analytics. Source: Investment Strategy Group, Datastream, MSCI.

111). As with our views on other EAFE markets, also benefit from abating declines in chip prices,
we expect higher valuations to be the key driver less regulatory pressure on China’s internet sector
of equity prices this year, offsetting flat earnings and less of a drag on profit margins from spiraling
growth. But we expect a smaller rise in Japan’s commodities prices. As a result, we expect MSCI
P/E ratio than in other markets, as the BOJ seems EM forward earnings to rise by 10% in 2023, to
poised to tighten monetary policy just as other $90 per share. At the same time, valuation multiples
central banks reach the end of their hiking cycles. should decline modestly to 11.4x, as slightly lower
In fact, a more rapid or forceful tightening of interest rates are offset by a moderate increase in the
monetary policy represents a key downside risk to equity risk premium. Combined with EM equities’
our forecast. Given this balance of risks, an encore 3% dividend yield, these elements imply a high-
of last year’s outperformance is unlikely. single-digit total return in 2023 (see Exhibit 111).
Despite these projected equity gains, we still
see four dark clouds on the horizon. First, the
Emerging Market Equities: outlook for China remains foggy given its rising
Fading Headwinds from the North economic, social and geopolitical risks, discussed
in greater detail in our December 2022 Insight
Emerging market equities had another challenging report, Middle Kingdom: Middle Income. Second,
year in 2022. Their 20% decline capped slower global growth will weigh heavily on
the sixth year of losses—and eighth year of export-dependent North Asia. Third, outflows
underperformance relative to the S&P 500—in from global investors could gain speed due to EM
the last decade. While 16 of the 24 countries equities’ continued underperformance. Finally,
in the MSCI EM Index had negative returns in tightening in monetary policy last year—which
2022, North Asia was the largest headwind to the saw the median policy rate among the 17 countries
index’s performance (see Exhibit 137). Indeed, in the MSCI EM Index with inflation-targeting
China, Korea and Taiwan—which together account central banks increase from 3% to 7%51 after
for 58% of MSCI EM market capitalization— 101 collective rate hikes—was dramatic, and its
collectively lost 25% last year, more than twice the ultimate impact remains highly uncertain.
11% decline for the rest of the index. Although the gale-force headwinds of last year
We expect calmer winds from North Asia in are likely to subside, we still expect some gusts
2023. Not only will conditions look more favorable ahead. For this reason, we continue to recommend
with China’s reopening, but the region should a tactically neutral allocation to EM equities.

Outlook Investment Strategy Group 77

Exhibit 138: 2022 Currency Performance (vs. US Dollar)
Most major currencies depreciated against the US dollar last year.
2022 Spot Return (%)
G-10 EM Asia EM EMEA EM Latin America

10 5 5 5
&"& 1 1 0
0
-1
-4 -3
-6 -6 -7 -7 -5 -6 -6
-10 -8 -9 -9 -8
-10 -11 -10 -10
-12 -13 -13
-15
-20
USD
Appreciation
-30
-29

-40
Switzerland

Eurozone

Australia

Canada

New Zealand

Norway

UK

Japan

Sweden

Singapore

Thailand

Malaysia

Korea

Indonesia

Philippines

India

South Africa
China

Taiwan

Russia

Czech Republic

Poland

Hungary

Turkey

Brazil

Mexico

Peru

Chile

Colombia
Data as of December 31, 2022.
Source: Investment Strategy Group, Bloomberg.
Note: Past performance is not indicative of future results.

2023 Global Currency Outlook between the US and its developed market peers
still wide against an uncertain global backdrop,
The US dollar enjoyed a banner year in 2022, our forecast calls for the US dollar to rise in 2023.
posting its second consecutive year of broad gains But compared with last year, we expect a smaller
and surpassing every other developed market low-single-digit pace of appreciation and more
currency, as well as all but a handful of those in dispersion in the US dollar’s relative performance.
emerging markets (see Exhibit 138). Several factors Regardless of our tactical views, we continue
underpinned this outperformance, including the to recommend that clients fully hedge their
most aggressive Federal Reserve hiking cycle in offshore fixed income. We also recommend that
decades, along with a global energy shock and US and non-US clients hedge 50% and 70%,
flagging risk sentiment that prompted investors to respectively, of their non-local developed market
turn to the dollar as a safe haven. equity holdings to reduce portfolio volatility and
The yen endured the worst of the US dollar’s provide diversification.
strength and stood out as the worst-performing
currency among developed market peers after US Dollar
the Swedish krona. Surging import prices and an It is hard to find fault with the US dollar’s
exceptionally accommodative Bank of Japan sent performance over the past decade. Not only has
the yen 12% lower versus the dollar. The British the greenback posted eight winning years over this
pound also suffered a double-digit downdraft period, but it has also advanced 46% since the
against the backdrop of a mini-budget crisis and lows of the financial crisis, including an 8% gain
resignation of two prime ministers. Its 11% decline in 2022 alone. The dollar’s outperformance against
was the pound’s worst annual showing since 2016, every other developed market currency last year
when the UK voted to leave the European Union. was yet another reminder of its hegemony.
EM currency performance was slightly Although the dollar index recently traded
less uniform. While most Asian and European at its highest level in 20 years, we think several
currencies fell against the greenback, several Latin factors continue to support dollar outperformance.
American currencies—including the Mexican For one, US growth is likely to outpace that in
peso, Brazilian real and Peruvian sol—posted most other major developed markets this year,
moderate gains. supporting the positive policy rate differential with
We expect the interplay of global growth and developed market peers (see Exhibit 139). In turn,
central bank policy to remain a critical driver of the these policy and growth differentials should entice
US dollar’s path. With real interest rate differentials foreign investors to favor US-dollar assets at the

78 Goldman Sachs january 2023

Exhibit 139: Past and Expected Policy Rate Hikes Exhibit 140: US Dollar Returns After the End of a
by Major Central Banks Federal Reserve Hiking Cycle
US policy rates will likely settle at a higher level than in The end of Federal Reserve hiking cycles has typically given
other major developed markets. the US dollar a boost over the following six months.
% USD Index Return (%)
6 Policy Rate Change Since First Hike 10 3 Months After Last Hike 6 Months After Last Hike
Market Expected Policy Rate Change Through Q2 2023
8.2
8
5

6
4
3.9 4.1
4
3
2
1.1
2
0

1 -1.1
-2
-2.4
0 -4
US UK Eurozone Japan Inflationary Period Disinflationary Period All Periods

Data through December 31, 2022. Data through 2022.

Source: Investment Strategy Group, Bloomberg. Source: Investment Strategy Group, Bloomberg.
Note: Inflationary period includes last Federal Reserve hikes that occurred when core inflation was
above 4%: 1974, March 1980, December 1980, 1984, 1989. Disinflationary period includes last
Federal Reserve hikes that occurred when core inflation was below 4%: 1995, 2000, 2006, 2018.
Past performance is not indicative of future results.

expense of lower-yielding alternatives, providing a

tailwind to the greenback. Moreover, the end of a Exhibit 141: US Dollar Real Effective
Federal Reserve hiking cycle—such as is expected Exchange Rate
this year—has typically seen the dollar rise over The dollar’s valuation now stands well above its long-term
the following six months (see Exhibit 140). Finally, average, making the greenback more vulnerable.
noncommercial investors begin the year with light Index Level
US dollar positioning, providing scope for them to 170

increase exposure. 160

That said, there are downside risks as well. 150

The dollar’s valuation now stands well above its 140
long-term average, making the greenback more Current
130 131.0
vulnerable (see Exhibit 141). Such disappointments
could come from abroad—such as materially 120
113.0
stronger foreign growth or tighter monetary policy 110 Average
outside the US—or domestically, if the Federal 100
Reserve is forced to abruptly cut rates. While 90
it is not our base case, a convergence in global
80
monetary policy would potentially erode the yield 1980 1986 1992 1998 2004 2010 2016 2022
advantage of US assets and thereby weigh on Data through November 2022.
the dollar. Source: Investment Strategy Group, Haver Analytics, IMF.

Although we still think this balance of risks

favors a stronger dollar, that appreciation is likely
to be more modest and more diffuse against other euro was down 16% at its worst point before
global currencies than was the case last year. recovering to a still sizable 6% loss for 2022.
Although softer economic growth and Russia’s
Euro invasion of Ukraine were key drivers, last year’s
For the second consecutive year, the euro was a weakness continued a string of losses—in seven
casualty of the US dollar’s strength. In fact, the of the last nine years—that began when the ECB

Outlook Investment Strategy Group 79

Exhibit 142: Eurozone Narrow Basic Balance Exhibit 143: Yen Performance 6 Months After the
A deficit has emerged in both the current account and the Beginning of a US Recession
net foreign direct investment for the first time since 2012. Global growth headwinds that boost risk aversion could lead
investors into the yen as a liquid hedge.
12-Month Rolling Sum (% of GDP) Spot Return (%) %
4 4.5 Average Median Hit Ratio (Right) 100

3 4.0 3.8 3.9 90

3.6
2 3.5 80
3.2
70
1 3.0
60
0 2.5
50
-1 2.0
40
-2 1.5
30
-3 1.0 20
Net FDI Capital Outflow =
-4 Headwind to Euro 0.5 10
Current Account
Narrow Basic Balance
-5 0.0 0
2008 2010 2012 2014 2016 2018 2020 2022 JPY/USD JPY Nominal Trade-Weighted Exchange Rate

Data through October 2022. Data through 2022.

Note: The narrow basic balance reflects the sum of the current account and net foreign Source: Investment Strategy Group, Bloomberg, Haver Analytics.
direct investment. Note: Based on data since 1973.
Source: Investment Strategy Group, Haver Analytics. Past performance is not indicative of future results.

announced plans to cut its deposit rate to below thereby supporting the euro—if the ECB needs to
zero for the first time in history. tighten monetary policy more than expected given
With the euro now nearly 25% below its 2014 historically high inflation.
peak, it may appear undervalued relative to its We give a slight edge to the negative factors
history. But this discount may be warranted given discussed and expect low-single-digit losses for the
the many fault lines running through the Eurozone, euro relative to the dollar.
not the least of which is the region’s lack of energy
security. Structurally higher gas prices resulting Yen
from a lack of low-cost alternatives to Russian Yen investors are forgiven for feeling whiplashed
energy make the continent’s energy-intensive last year. After depreciating close to 25% against
industrial sector less competitive, potentially the US dollar by October—reaching its weakest
justifying a lower exchange rate relative to history. relative level in more than three decades—the yen
The Eurozone’s capital flow profile represents surprised traders with a powerful 15% rally into
another source of vulnerability for the euro. year-end. Despite these wild gyrations, the yen’s
Demand for euro-denominated assets has plunged, 12% loss in 2022 still ranked as its worst since
falling even below levels seen in the sovereign debt 2013 and left it among the worst-performing
crisis. Moreover, both the current account and net developed market currencies for the second
foreign direct investment are in deficit for the first consecutive year.
time in a decade (see Exhibit 142). With the yen having now lost nearly a quarter
Even so, there are several factors that could of its value since the onset of the pandemic, there
potentially limit the extent of any further euro is certainly scope for last year’s depreciation to
weakness. First, there is a low hurdle for euro- reverse. Core Japanese inflation is running at its
friendly surprises given that most investors already highest level in a decade and above the Bank of
expect a mild recession in the region. Second, the Japan’s 2% target. The BOJ is unlikely to duplicate
euro could benefit from both stronger economic the degree of monetary policy tightening seen
activity and a stronger narrow basic balance if a by other major central banks, not least because
warmer winter ends up limiting the need for energy inflation is expected to fall to near 2% this year.
rationing and dampening energy prices. Finally, the But with new BOJ leadership appointments later
yield advantage of euro-denominated assets could this year, the odds are rising that it will soon
improve relative to other developed markets— articulate an endpoint to its near-zero interest rate

80 Goldman Sachs january 2023

Exhibit 144: Japanese Trade Balance Exhibit 145: UK Narrow Basic Balance
Japan’s trade balance shows its largest deficit ever. The UK’s current account has deteriorated and net FDI
stands near its weakest level since the GFC.
12-Month Rolling Sum (% of GDP) 4-Quarter Rolling Sum (% of GDP)
3 Net Services Trade 15 Net FDI
Net Goods Trade Current Account
Net Trade Narrow Basic Balance
2
10

1
5

0
0
-1

-5
-2

-10
-3 Capital Outflow = Capital Outflow =
Headwind to Yen Headwind to Pound
-4 -15
2008 2010 2012 2014 2016 2018 2020 2022 2006 2008 2010 2012 2014 2016 2018 2020 2022

Data through October 2022. Data through Q3 2022.

Source: Investment Strategy Group, Haver Analytics. Note: The narrow basic balance reflects the sum of the current account and net foreign direct
investment.
Source: Investment Strategy Group, Haver Analytics.

policy. Such a development would help narrow Pound

Japan’s cross-border interest rate differential and Along with most other currencies in 2022, the
reduce a recent source of yen weakness. pound fell in relation to the US dollar—its second
Also consider that the yen has historically consecutive year of underperformance. Last year’s
performed well during economic slowdowns. While 11% loss masked a more dramatic 25% peak-
a US recession is not our base case, the possibility to-trough drawdown in the currency through
has risen markedly over the past year. Any September following a budget crisis and the
additional global growth headwinds that boost resignation of two prime ministers. This continued
risk aversion could lead investors into the yen as a the currency’s volatile return profile, which dates
liquid hedge, as we saw after the onset of previous back to 2016 and the United Kingdom’s decision to
recessions (see Exhibit 143). leave the European Union.
Of course, the yen also still faces several We expect further weakness in the pound in
obstacles. Japan’s current account surplus has 2023. The UK economy is forecast to contract
halved over the last year given higher import this year, which may limit how much further the
prices. In turn, the trade balance shows its Bank of England can tighten and opens the door
largest deficit ever (see Exhibit 144). This implies for rate cuts in late 2023 or 2024. A less favorable
marginally less structural demand for the yen and absolute policy rate differential with the US could
may limit its ability to recover to pre-pandemic also diminish the appeal of the pound to yield-
levels. Japanese corporations are also likely to seeking investors. Moreover, the UK’s position as a
generate sustained pressure on the currency, as they net energy importer has pushed its current account
continue to sell yen to invest in foreign ventures deficit to 4.2% of GDP (see Exhibit 145). This
with better long-term growth prospects and higher too will be a drag on the pound unless the energy
yields. Although these outflows slowed during the shock recedes rapidly.
initial stages of the pandemic, they have quickened Still, the risks to the pound are not completely
more recently and now stand at about 3.5% of to the downside. Any combination of better global
GDP, a historically large share. growth or optimism for a faster-than-expected UK
Taking these factors together, we see scope economic recovery could generate foreign demand
for a mid-single-digit rise in the yen, with the for UK assets, which would benefit the pound.
possibility of both long and short tactical trading There is certainly scope for better foreign direct
opportunities throughout 2023. investment, which currently stands near its weakest
level since the GFC (see Exhibit 145). In addition,

Outlook Investment Strategy Group 81

Exhibit 146: Ex Post Real Rates in Exhibit 147: 3-Month Implied Currency Volatility in
Emerging Markets Emerging Markets
Positive real rates in Mexico and Brazil offer investors Investors will want volatility to subside before overweighting
attractive incremental yield. EM currencies.
Real Policy Rate (%) %
10 40 Average EM Implied Volatility
7.9
Low
35 High
5 80th Percentile
2.2 20th Percentile
1.2 30
0.0
0
-0.4 -0.2 25
-1.3 -0.7
-2.1 -2.0 -1.8 -1.5
-5 -3.0
-4.5 -4.3 20

-10 15
-9.5 -9.2
-10.8
10
-15
Poland
Hungary
Czech Republic
Russia
Thailand
Philippines
Chile
Israel
Korea
Colombia
Malaysia
Taiwan
South Africa
Indonesia
India
China
Mexico
Brazil
5

0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Data as of November 2022. Data through December 31, 2022.

Source: Investment Strategy Group, Macrobond, Bloomberg. Source: Investment Strategy Group, Macrobond, Bloomberg.

the political turbulence that has undermined the currencies. In Asia, China’s “zero-COVID” policy,
pound may recede in 2023 for a few reasons, its multiple lockdowns, and the renminbi’s 15%
including last year’s fiscal policy U-turn and the peak-to-trough decline led the rest of that bloc
lack of any major election or referendum votes into weakness. The one bright spot was Latin
this year. America, as the currencies of Mexico and Brazil
On balance, we expect the pound to depreciate ended the year with positive real rates that
by modest single digits versus the US dollar boosted the credibility of their central banks and
this year. offered investors attractive incremental yields (see
Exhibit 146).
Emerging Market Currencies The outlook for 2023 is mixed. On the one
EM currencies disappointed again last year. Their hand, EM currencies should benefit if the Federal
6.1% decline against the US dollar marked the Reserve signals an end to its hiking cycle, as
ninth annual loss for the asset class in the past interest rate differentials favor these currencies.
decade.52 Over this same period, the asset class has On the other hand, investors will want volatility to
cumulatively lost half its nominal value against the subside before overweighting EM currencies (see
US dollar. Exhibit 147). But that stability may prove elusive
While many factors have contributed to given looming risks, such as a US recession.
this underwhelming decade, Russia’s invasion In this environment, we expect investors to
of Ukraine was one of the key drivers of these become more selective and favor higher yielding
currencies’ weakness last year. Surging commodity currencies with improving macro fundamentals.
prices in the wake of the invasion fueled inflation The Chinese renminbi does not cleanly match
across EM, pushing real interest rates into negative either of these criteria, and we see two key reasons
territory despite an early start to the hiking cycle it could weaken this year. First, Chinese bonds
by most EM central banks. Higher energy prices offer less attractive yields, which stand two
were particularly hard on European emerging percentage points below US Treasuries. Second,
market currencies, which depreciated 10−25% into the end of “zero-COVID” is likely to put pressure
last fall. on China’s current account as its service deficit
The hostilities were also accompanied by a widens. At a time when other countries’ current
fast-paced hiking cycle in the US and a broad- accounts are set to improve, this will also weigh on
based selloff in risk assets, leading to tighter the renminbi.
global financial conditions that weighed on EM

82 Goldman Sachs january 2023

Exhibit 148: 2022 Fixed Income Returns by Exhibit 149: Expected Net Supply to the Private
Asset Class Sector Across G3 Economies
Global fixed income delivered negative returns, significantly As central banks reduce their balance sheets, private
underperforming inflation. markets will need to absorb record net issuance.
Total Return (%) US$ billions
10 7.1 3,500 Net Sovereign Issuance
Central Bank Flows $3.1 trillion
5
Net Supply
3,000
0
-1.1
-5
-4.8 2,500
-10
$2.0 trillion
-11.2 -11.7 -11.8 2,000
-15 -13.1
-15.1 -15.8 -16.2
-20 -17.1 -17.8
-19.4 1,500
-25
US CPI Inflation (% YoY)*

Bank Loans

US Muni 1–10 Year

US Corporate High Yield

EM Local Debt

US TIPS

Muni High Yield

US 7–10 Year

US Corporate Investment
Grade

Global Aggregate Index

UK 7–10 Year (Local)

EM US Dollar Debt

Eurozone 7–10 Year (Local)

1,000

500

0
2022 2023

Data as of December 31, 2022. Data as of December 31, 2022.

Source: Investment Strategy Group, Bloomberg. Note: Based on estimates from Goldman Sachs Global Investment Research, converted to US
* Inflation data as of November 2022. dollars using year-end 2022 exchange rate.
Source: Investment Strategy Group, Goldman Sachs Global Investment Research, US Treasury,
European Commission, UK Office for Budget Responsibility.

Global Fixed Income Outlook eventual Federal Reserve rate cuts. Against this
backdrop, we expect lower 10-year yields across
Most bond investors will be glad to turn the page most advanced and emerging economies this year.
on 2022. A combination of aggressive interest rate Of course, our constructive view on bonds
hikes by global central banks and historically low does not imply the absence of risks. Across the US,
bond yields at the start of the year resulted in deep Eurozone and United Kingdom, private markets will
losses for fixed income portfolios last year. The need to absorb a record $3 trillion in estimated net
Bloomberg Global Aggregate Bond Index fell 16%, bond supply this year (see Exhibit 149), composed
a decline three times larger than the previous worst of around $2 trillion in net new sovereign debt and
reading since the benchmark’s inception in 1990. $1 trillion fewer bond purchases by central banks
While credit fared better than duration—with (i.e., quantitative tightening). With central banks
spreads supported by robust nominal growth—all withdrawing the largest source of demand in recent
fixed income categories suffered losses last year years, there is risk that private investors will require
(see Exhibit 148). higher risk premiums to accommodate the elevated
Fortunately for bondholders, an encore is funding needs of advanced economies. Continued
unlikely for several reasons. The higher
starting level of today’s yields provides
bond investors with a buffer to absorb
any further increases in interest rates. The upward pressure on rates from
Moreover, the upward pressure on rates
from central bank hikes should ease central bank hikes should ease given
given our expectation that the Federal our expectation that the Federal
Reserve will conclude its tightening cycle
in the first half of 2023, and that the
Reserve will conclude its tightening
ECB and BOE will do the same shortly cycle in the first half of 2023, and that
thereafter. Lastly, our forecast of below-
trend growth implies easing inflationary
the ECB and BOE will do the same
pressures and higher risk of recession, shortly thereafter.
both of which increase the odds of

Outlook Investment Strategy Group 83

Exhibit 150: 2023 US Treasury and Municipal Bond exceeded even our pessimistic forecasts. In the case
Return Projections of the 10-year Treasury, investors were left with
We expect intermediate Treasuries will outperform cash. a historic 16% loss after its yield registered the
Total Return (%) largest increase in a calendar year on record.
10
7.8 The prospects for 10-year Treasuries are
5.0
6.1 brighter now, with the midpoint of our year-end
5 3.6
3.15–3.65% yield target range implying positive
1.3
0
high-single-digit returns in 2023. We expect the
Federal Reserve to conclude its hiking cycle before
-5 the middle of the year, as its focus shifts from
-4.8
curtailing inflation to avoiding a hard landing of
-10
-9.7
the economy. The combination of still-restrictive
policy rates and the market’s expectation of
-15
2022 Returns
eventual rate cuts in response to slowing growth is
2023 Projected Returns -16.3
likely to keep the yield curve inverted.
-20
US Cash 5-Year Treasury 10-Year Treasury Muni 1–10 Investors are focused on when policy rates and
bond yields will peak. While history is not a perfect
Data as of December 31, 2022.
Source: Investment Strategy Group, Bloomberg. guide, it does show that in nearly every hiking
Note: Past performance is not indicative of future results. Forecasts are cycle over the last 40 years, the 10-year Treasury
estimated, based on assumptions, are subject to revision and may change
yield reached its high before or around the time
as economic and market conditions change. There can be no assurance
the forecasts will be achieved. Indices are gross of fees and returns can when policy rates peaked. Only twice—in May
be significantly varied. Please see additional disclosures at the end of 1974 and December 1980—did the 10-year yield
this Outlook. peak after the policy rate did. Both exceptions
occurred in a decade of “stop-go” monetary policy
shifts that ultimately allowed inflation expectations
uncertainty around the path of inflation could also to become unanchored.
weigh on bond demand. Yet in contrast with that period, market-based
Still, we think the balance of risks supports inflation expectations now remain well anchored
positive total returns for intermediate fixed income following the fastest hiking cycle in decades.
in our base case (see Exhibit 150). While cash History suggests that 10-year yields could peak
offers attractive returns, unexpected rate cuts by before or around the second quarter of this year as
the Federal Reserve in response to a growth shock the Federal Reserve concludes its hiking cycle. In
could quickly erode its yield. In contrast, high- fact, yields may have already peaked last year.
quality fixed income is the only asset that has Prior peaks in the policy rate have been
effectively hedged against past deflationary shocks. followed by large declines in 10-year yields over
In the sections that follow, we will review the the subsequent year, ranging from 80 basis points
specifics of each major fixed income market. to 330 basis points. The 3.4% midpoint of our
forecast range implies a more gradual decline in
US Treasuries yields than is suggested by history, but we anticipate
Our 2022 Outlook featured the most negative this slower decline for three reasons. First, positive
expected returns for US Treasuries that we have economic growth in our base case should support
ever published. Yet the actual losses last year yields. Second, we expect inflation to moderate
but remain above the Federal Reserve’s
target this year. Finally, the bond market
will have to absorb around $2 trillion of
net Treasury supply this year—up from
In nearly every hiking cycle over the $1.6 trillion in 2022—as US funding
last 40 years, the 10-year Treasury needs remain elevated at a time when
the Federal Reserve is winding down its
yield reached its high before or around balance sheet.53
the time when policy rates peaked. Investors might ask whether mid-
single-digit returns for intermediate

84 Goldman Sachs january 2023

Exhibit 151: ISG Prospective 2023 US Fixed Exhibit 152: US Market-Implied Inflation
Income Scenarios Expectations
The distribution of risks for intermediate Treasuries has Inflation expectations fell sharply from their highs and
become attractive. remain well anchored.
Total Return (%) %
20 Bull Case 7 Current
Base Case 18 2022 High
Bear Case 6 6.0 Year-end 2021
15
5

10 4 3.7
8 3.6
7
3 2.9 2.9
5 5 5
5 4
3
2.5 2.5
2 2.6
2.6
0 1
-1
0
-5 Next 12 Months 1-Year Average 5-Year Average
Cash 2-Year Treasury 10-Year Treasury Starting in 2 Years Starting in 5 Years

As of December 31, 2022. Data as of December 31, 2022.

Source: Investment Strategy Group. Note: Inflation swaps track CPI inflation, which has historically run above PCE inflation, the
Note: Forecasts are estimated, based on assumptions, are subject to Federal Reserve’s preferred metric.
Source: Investment Strategy Group, Bloomberg.
revision and may change as economic and market conditions change.
There can be no assurance the forecasts will be achieved. Indices are
gross of fees and returns can be significantly varied. Please see additional
disclosures at the end of this Outlook.

Treasuries are sufficiently compelling given similar limited. Moreover, TIPS should benefit from some
returns from cash and lingering inflation uncertainty. retracement in real rates after last year’s surge,
We believe so, since unexpected rate cuts by the as we expect stable inflation breakeven rates and
Federal Reserve in response to a growth shock could declining nominal 10-year Treasury yields.
quickly erode the yield on cash. At the same time, Still, TIPS investors face several familiar
such a scenario could see 10-year Treasuries deliver headwinds. For one, TIPS lack the hedging
double-digit total returns, roughly four times larger qualities of traditional bonds since breakeven
than those of cash (see Exhibit 151). As we often inflation rates tend to fall during cyclical
highlight, Treasuries are the only asset class that has downturns. TIPS are also less liquid than nominal
effectively hedged against deflationary shocks in Treasuries and hence an inferior source of liquidity
the past. during market turbulence.54 Additionally, TIPS are
not tax efficient for taxable clients. For all these
Treasury Inflation-Protected Securities (TIPS) reasons, we continue to advise US clients with
After the fastest Federal Reserve hiking cycle in four taxable accounts to use municipal bonds for their
decades, market-based inflation expectations fell strategic allocation.
sharply from their highs last year and remain well
anchored near the bank’s 2% inflation target (see US Municipal Bonds
Exhibit 152). Rising nominal interest rates coupled There was little to celebrate for municipal bond
with lower inflation expectations drove 10-year real investors last year. The Bloomberg Municipal
rates higher by a staggering 268 basis points. The Bond Index fell 8.5%, its worst decline since 1982.
resulting 12% loss in TIPS last year underperformed Similarly, the 4.8% loss in the shorter duration
similar-duration nominal bonds despite the sharpest 1- to 10-year municipal bond index was its worst
increase in inflation since the 1980s. performance since the inception of the index in
We think the outlook for TIPS is brighter in 1993. Municipal high yield bonds were not spared
2023. With 10-year breakeven inflation rates either, losing 13.1% for the year (see Exhibit 153).
already near the Federal Reserve’s 2% inflation Several factors contributed to this poor
target, the scope for further declines is more performance. Chief among these was the nearly

Outlook Investment Strategy Group 85

Exhibit 153: Total Returns of US Municipal and Exhibit 155: Aggregate Rainy Day Fund Balances
Corporate Credit Indices During 2022 Among US State Governments
Rates, rather than credit spreads, were the key drivers of Rainy day fund balances among state governments stood at
credit index returns during 2022. all-time highs in Q3 last year.
Total Return (%) US$ Billions %
3 160 Aggregate Rainy Day Fund Balance by Fiscal Year 14
1.3 Median RDF Balance as a % of Expenditure (Right)
0 140 135 12
11.6
-0.6
-1.2 -1.1
-3 120
10
-3.7
-6 -4.8 100
8
-9 80
6
-12 -11.2 60
-13.1 4
-15 40
-15.8
-18 20 2
IG 1–10 HY IG Exc Ret CDX IG HY Exc Ret CDX HY Bank Loans
Municipal Bonds Investment Grade High Yield 0 0
Corporate Corporate 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 2021

Data as of December 31, 2022. Data through Q3 2022.

Note: IG: Investment Grade; HY: High Yield; Exc Ret: Excess Return; CDX IG: Credit Default Swap Note: Rainy day funds are budget stabilization funds that may be used to supplement general
Index Investment Grade; CDX HY: Credit Default Swap Index High Yield. fund spending during an economic downturn or other events triggering a shortfall.
Source: Investment Strategy Group, Bloomberg, Barclays, Credit Suisse. Source: Investment Strategy Group, National Association of State Budget Officers.

bonds registered $118 billion of outflows from

Exhibit 154: Annual Flows into US Municipal Bond mutual funds and ETFs in 2022, around twice the
Mutual Funds and ETFs amount seen during the 2013 “taper tantrum.”
Last year saw the worst outflows on record since 1984. Last year’s poor performance stands in contrast
US$ Billions to municipal fundamentals, which remain healthy.
150
General fund revenue for states grew 14.5% year-
over-year to $1.17 trillion in fiscal 2022, following
100
a 16.6% increase in fiscal 2021. Although spending
50
rose by 18.3% year-over-year in response to a
variety of factors, including higher inflation and
0 lingering pandemic costs, no state made a budget
cut due to a revenue shortfall last year. As shown
-50 in Exhibit 155, the states’ general fund rainy day
-59
balances grew to an all-time high of $134.5 billion in
-100
2022, with the median balance as a share of annual
-118 spending also reaching an all-time high of 11.6%.55
-150
1984 1988 1992 1996 2000 2004 2008 2012 2016 2020 Looking ahead, we expect mid-single-digit nominal
consumption growth in 2023 to underpin healthy
Data through December 28, 2022.
Note: Data prior to 2006 is only composed of mutual funds. sales tax collections. Moreover, our expectation
Source: Investment Strategy Group, Haver Analytics, Investment Company Institute (ICI).
for only a modest rise in the unemployment rate
to 4.1% implies that personal income tax revenues
should remain resilient. The same could be said for
250 basis point increase in the yield on the property taxes, an area in which it will take a few
broader municipal bond index last year. This drag years for recent housing weakness to have an impact.
was made worse by the historically low level of Consistent with the above, broad credit trends
municipal bond yields and spreads at the start remain positive. Consider that credit agency
of 2022, which provided little buffer to absorb upgrades outpaced downgrades by 4.2 times for
higher rates. The largest exodus from the asset tax-backed issuers and by 2.7 times for revenue-
class since 1984 was also a material headwind to backed issuers (see Exhibit 156). Based on dollars
performance. As seen in Exhibit 154, municipal of bond par value, upgrades outpaced downgrades

86 Goldman Sachs january 2023

Exhibit 156: Upgrade-to-Downgrade Ratios for US Exhibit 158: Ratio of AAA US Municipal Bond
Municipal Bond Issuers Yields to Treasury Yields
The number of upgrades outpaced downgrades by a factor Municipal bond yield ratios have improved, but remain
of 2.7–4.2x among municipal bond issuers. below long-run averages.
Upgrade-to-Downgrade Ratio of Issuer Counts (x) Ratio (%)
13 Tax-Backed Issuers Ratings Trend 100 Start of 2022 99
12 Revenue-Backed Issuers Ratings Trend Current 94
Average Ratio Since 2000 90 91
11 90 Average Ratio Since 1987
85
10 83
9 80 79
80
8
7 69
70 69
6
63
5
4.2 60
4
3
2.7
2 50 47
1
0 40
1989 1993 1997 2001 2005 2009 2013 2017 2021 5-Year Bonds 10-Year Bonds 30-Year Bonds

Data through Q3 2022. Data as of December 31, 2022.

Source: Investment Strategy Group, Moody’s Investors Service. Source: Investment Strategy Group, Municipal Market Data, Bloomberg.

Exhibit 157: US Municipal Bond Upgrades Exhibit 159: Incremental Yield of AAA Municipal
vs. Downgrades Bonds Over Treasuries
Upgrades outpaced downgrades by a factor of nearly 10 on Incremental yields of municipal bonds have improved since
a par value basis in 2022. the start of 2022, but remain below long-term averages.
US$ Billions Spread (%)
350 Par Value Upgraded 327 2.5 10-Year
Par Value Downgraded 316 10-Year (Average Since 2010)
5-Year
300
2.0 5-Year (Average Since 2010)

250
1.5

200
1.0
150
0.7
0.5 0.4
100 0.3
0.2
54
0.0
50 34

0 -0.5
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Data through Q3 2022. Data through December 31, 2022.

Source: Investment Strategy Group, Moody’s Investor Service. Source: Investment Strategy Group, Municipal Market Data, Bloomberg.
Note: Past performance is not indicative of future results.

by a factor of nearly 10 last year, with $327 billion the incremental after-tax yield investors earn for
of upgrades but just $34 billion of downgrades (see owning municipal bonds instead of matched-
Exhibit 157). duration Treasuries also stands well below average
While municipal issuer fundamentals are for both 5-year and 10-year maturities (see Exhibit
sound, valuations in the sector are less appealing. 159). The same is true for spreads on the Muni
As seen in Exhibit 158, the ratio of municipal 1-10 index (see Exhibit 160).
yields to Treasury yields remains below its long- Against this backdrop, we expect US municipal
term average despite last year’s selloff. Similarly, bonds to generate a low-single-digit gain this year

Outlook Investment Strategy Group 87

Exhibit 160: Nominal and After-Tax Spread of 1- to Exhibit 162: Defaults in the US High Yield
10-Year US Municipal Bond Yields to Treasuries Municipal Bond Universe by Sector
Nominal and after-tax spreads are low relative to history. Defaults declined across most sectors in 2022 versus 2021,
concentrated in CCRCs and IDR bonds.
CEO
Spread (%) Par Value US$ Millions
4 Nominal Spread 1,200 2020
After-Tax Spread 1,062 2021
Long-Term Median After-Tax Spread 2022
3 1,000

778
2 800 747

1 0.9 600 526

0.6
391
0 400
308
259
217
-1 200 126
-1.1
92 83
72 60 82 66 70
23 20 13 10 6 25
0 0
-2 0
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 CCRC IDR Sp. Tax Utilities Housing Transp Hospitals Other

Data through December 31, 2022. Data as of November 2022.

Source: Investment Strategy Group, Bloomberg. Note: CCRCs: Continuing Care Retirement Communities; IDRs: Industrial Development Revenue
Bonds; Sp. Tax: Special Tax Issuers.
Source: Investment Strategy Group, Barclays.

Exhibit 161: US High Yield Municipal Bond Spread Exhibit 163: Distress Rate in the US High Yield
The incremental yield above that of Treasuries is still below Municipal Bond Universe
the long-term average. The share of bonds with spreads above 750 bps in the high
yield municipal bond universe is low.
CEP
Spread (%) Distress Ratio (%)
10 Spread 70 Share of the High Yield Municipal Bond Universe With Spreads > 750 bps
Median Average Since 2008
9
60
8

7 50

6
40
5
30
4

3 20
2.6
2 2.0
End ‘21: 10
1 7.9
1.6
1.4
0 0
1995 2000 2005 2010 2015 2020 2008 2011 2014 2017 2020

Data through December 31, 2022. Data through November 2022.

Source: Investment Strategy Group, Bloomberg. Source: Investment Strategy Group, Bloomberg, Barclays.
Note: Past performance is not indicative of future results.

that is roughly in line with their current 2.9% US High Yield Municipal Bonds
yield, as a decline in Treasury yields is partially High yield municipal bonds were not immune
offset by some widening in municipal spreads. to last year’s fixed income weakness. Their
relatively long duration—roughly eight years—was
particularly costly given sharply higher interest
rates last year, driving the sector’s 13.1% loss.
There was considerable dispersion beneath this

88 Goldman Sachs january 2023

Exhibit 164: Years with Negative US Investment Exhibit 165: Years with Negative US High Yield
Grade Total Returns (1973–Present) Total Returns (1983–Present)
2022 represented the worst annual total returns for US high yield posted its second-worst return on
investment grade fixed income since 1973. record in 2022.
CEQ CER
Total Return (%) Total Return (%)
0 0
-0.3 -0.7 -1.0
-1.0 -1.4
-2 -1.5 -2.1
-2.0 -2.1
-2.5 -5 -4.5
-4 -5.9
-3.9
-4.9
-6 -10
-5.9 -9.6
-11.2
-8
-15
-10

-12 -20

-14
-25
-16 -26.2
-15.8
-18 -30
1980 2015 2021 2013 1999 1979 2018 1994 2008 1974 2022 1994 2002 2018 2015 2000 1990 2022 2008

Data as of December 31, 2022. Data as of December 31, 2022.

Source: Investment Strategy Group, Bloomberg, Barclays. Source: Investment Strategy Group, Bloomberg, Barclays.
Note: Past performance is not indicative of future results. Note: Past performance is not indicative of future results.

headline return, however, with sectors such as

utilities, transportation and airlines outperforming Exhibit 166: Changes in Spreads During 2022
housing, tobacco and hospitals. Investment grade and high yield spreads were orderly, but
Like broader municipal bonds, the high yield leveraged loan spreads ended the year close to 2022 highs.
CES
subsector features resilient fundamentals that Spread (basis points)
are reflected in tighter than normal spreads. 800
652
As seen in Exhibit 161, the 195 basis points of 700 674
(+213)
incremental yield these bonds offer relative to 600 583

10-year Treasuries is 60 basis points lower than 500

469
(+186)
439
the long-run average spread. This difference is
400
explained by solid credit fundamentals; last year’s
300 283
defaults were 41% lower than in 2021 (see Exhibit
130
162). Moreover, only 1.4% of these bonds trade 200 165
(+38)
at distressed spreads, well below the 7.9% average 100
92

since 2008 (see Exhibit 163). 0

With spreads already tight relative to history Dec. 31,
2021
2022
High
Dec. 31,
2022
Dec. 31,
2021
2022
High
Dec. 31,
2022
Dec. 31, 2022
2021 High
Dec. 31,
2022
and with economic growth slowing, we expect Investment Grade High Yield Bonds Leveraged Loans
wider spreads to erode part of the benefit of lower Data as of December 31, 2022.
Treasury yields and the sector’s current 5.9% yield. Source: Investment Strategy Group, Bloomberg, Barclays, Credit Suisse.

The result would be positive mid-single-digit returns

in 2023, which in our view argues for clients staying
invested at their customized strategic weight. loss was a relative bright spot (see Exhibit 153 in
the US Municipal Bond section).
US Corporate High Yield Credit The bulk of these losses came from sharply
Last year was a tumultuous one for corporate higher interest rates rather than credit. In fact,
credit. The 15.8% decline in investment grade the trailing high yield default rate, including
bonds was the worst since 1973, while the 11.2% distressed exchanges, stood at just 1.6% at the end
loss in corporate high yield was its second-worst of November last year, about half of its long-run
since 1983 (see Exhibits 164 and 165). Although average. In turn, high yield bond spreads—which
bank loans declined as well, their modest 1.14% represent investors’ compensation for taking

Outlook Investment Strategy Group 89

Exhibit 167: Median Interest Coverage and Exhibit 169: Share of US High Yield New
Leverage for US High Yield Borrowers Issuance—Use of Proceeds
Low leverage and high interest coverage helped keep high Issuance of low-rated companies remained low relative
yield spreads well-behaved in 2022. to history.
CET
Net Debt to EBITDA (x) EBIT to Interest Expense (x) Share of High Yield New Issuance (%)
Leverage 5 60 2005–07 Average 2010–20 Average 2022
Interest Coverage (Right)
52
50 48
4 44
4.0 4
99th 40
36
percentile

30 27 28
3
23
3
20
2.8
11th 2 10
percentile 10 6

0
2 1 Used for LBO and M&A Used for Refinancing Issued by Low-Rated
1999 2002 2005 2008 2011 2014 2017 2020 Companies

Data through Q3 2022. Data as of November 2022

Source: Investment Strategy Group, Goldman Sachs Global Investment Research. Source: Investment Strategy Group, JP Morgan.

Healthy corporate fundamentals help explain

Exhibit 168: Median Leverage and Interest why high yield bond spreads have remained so
Coverage for US Leveraged Loan Issuers well-behaved. As seen in Exhibit 167, median
Fundamentals for the median leveraged loan issuer leverage among high yield issuers has been lower
remained healthy during 2022. only 11% of the time since 1999. At the same
CEU
Net Debt to EBITDA (x) EBIT to Interest Expense (x) time, the earnings of the median issuer are four
6.0 Leverage
Interest Coverage (Right) 5.2
times larger than their interest expense, close to the
5.0 highest coverage ratios on record. These figures are
5.5 equally sturdy for leveraged loan borrowers (see
4.0
Exhibit 168).
5.0 The underlying credit quality of the high yield
universe has also improved, with BB-rated bonds
4.5
3.0
representing nearly half the index today compared
4.4 to about a third of it historically. Similarly, the
4.0 2.0 share of bonds rated CCC and lower—which
are at higher risk of default—stands below its
historical average. Issuance by these lower-rated
3.5 1.0
2001 2004 2007 2010 2013 2016 2019 2022 companies is also still low relative to history (see
Exhibit 169). The same could be said for the share
Data through Q3 2022.
Source: Investment Strategy Group, S&P LCD. of LBO and M&A-related issuance, which is
below its pre-GFC average. Consistent with this
backdrop, credit rating agency upgrades of high
default risk—rose 186 basis points during 2022 yield bonds outpaced downgrades by 1.8 times last
but remain well below average (see Exhibit 166). year based on dollar par value, and recovery rates
The result was that only 3.7% of high yield’s total on defaulted securities were well above average.
11.2% loss was attributable to wider spreads and Whether fundamentals remain resilient in
actual default losses. Similarly, the corporate high the face of slower economic growth this year is
yield credit default swap index—which reflects just a critical question facing investors. To be sure,
the default risk of the underlying bonds—suffered several factors point to higher default risk, including
a loss of less than 1% last year (see Exhibit 153 in tightening lending standards for commercial and
the US Municipal Bond section). industrial loans, a rising share of securities trading

90 Goldman Sachs january 2023

Exhibit 170: Net Share of Lending Officers Exhibit 172: Moody’s Liquidity Stress
Tightening Conditions for C&I Borrowers Indicator (LSI)
Lending standards for commercial and industrial loans Liquidity stress is low, but has risen in recent months.
tightened significantly during 2022.
SLOOS C&I Lending Indicator (Net %) Index (%) Moody’s LSI Median (Q4 2002 to Present)
Large C&I Loans Small C&I Loans 30
100

80

60 20

40 39.1
31.8
20
10
0

4.9
-20
2.7

-40 0
1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020 2002 2005 2008 2011 2014 2017 2020

Data through Q3 2022. Data through November 2022.

Note: Shaded periods denote recessions. Note: Shaded periods denote recessions.
Source: Investment Strategy Group, Federal Reserve SLOOS. Source: Investment Strategy Group, Moody’s Investors Services.

Exhibit 171: Share of Distress in the US High Yield Exhibit 173: Share of the US High Yield and
Bond and Leveraged Loan Universe Leveraged Loan Markets Maturing by Year
The share of distress among both high yield bonds and The share of high yield bonds and leveraged loans maturing
leveraged loans has risen. in the next two years is low.
% Share of Universe Maturing (%)
Share of High Yield Market Below or Equal to $70 35 US High Yield
Share of Leveraged Loan Market Below or Equal to $80 US Leveraged Loans
90 30
30
80
25
70

60 20
17 18
16
50 16 15
15 14 14
40 11 12
10 9
30 7
6 6
5
20 5 3
2
10 8.7 0 0 0
7.2 0
0 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 or
1997 2000 2003 2006 2009 2012 2015 2018 2021 Later

Data through November 2022. Data through November 2022.

Note: Shaded periods denote recessions. We define high yield bonds trading below $70, and Source: Investment Strategy Group, JP Morgan.
leveraged loans below $80 as distressed.
Source: Investment Strategy Group, JP Morgan.

at distressed spread levels and recent deterioration by 1.4 times last year, and the share of the universe
in our preferred leading indicator of defaults (see rated BB has fallen below its long-run average.
Exhibits 170, 171 and 172). These borrowers—in aggregate—have also not
There is also some credit deterioration already adequately hedged their interest rate exposure,
evident in the leveraged loan market. Downgraded which becomes a larger drag on their earnings the
bank loan issuers outnumbered upgraded issuers longer rates stay at current levels.

Outlook Investment Strategy Group 91

Exhibit 174: Trailing 12-Month and Projected Exhibit 175: Incremental Risk Premiums of High
12-Month Default Rates for US High Yield Bonds Yield Spreads in Excess of Default Cost
We project default rates to rise during 2023. Incremental risk premiums could rise toward the long-run
average in 2023.
Trailing 12-Month Default Rate (%) Credit Risk Premium (%)
21 Par-Weighted Default Rate 16 High Yield Credit Risk Premium
Projected Par-Weighted Default Rate Average
Issuer-Weighted Default Rate 14
18
Projected Issuer-Weighted Default Rate
12
15

10
12
8
9
6
6
4.2 4 3.4
3.0 3.2
3 2
1.5
0.8
0 0
1996 2001 2006 2011 2016 2021 1987 1991 1995 1999 2003 2007 2011 2015 2019

Data through November 2022. Data through December 2022.

Source: Investment Strategy Group, JP Morgan. Source: Investment Strategy Group, Haver Analytics, Federal Reserve.

Still, rising defaults should not be equated to growth by confronting inflation through tighter
soaring ones. The default rate ended last year in the monetary policy or dampen the energy shock by
bottom 15% of its historical distribution, making instituting fiscal stimulus that risked pushing prices
some increase in 2023 very likely. In addition, even higher. UK policymakers decided to try both
the risk of refinancing-related defaults is low in at once, upsetting an already fragile European bond
the next two years, with less than 10% of the complex. Fortunately, subsequent BOE intervention
securities in the high yield market maturing (see and a tighter fiscal budget in the UK ultimately
Exhibit 173). Higher interest rates are also likely prevented broader contagion and stabilized
to continue constraining high yield bond issuance European bond markets. Even so, yields rose sharply
after it decreased by more than 60% last year. in 2022 and European bonds fell nearly 20%,
Against this backdrop, our model implies a 3% underperforming US Treasuries.
par-weighted default rate for high yield bonds this Europe faces the same uncomfortable trade-
year, roughly in line with their long-term average off in 2023. With inflation pressures still elevated,
(see Exhibit 174). The rate is a slightly higher 3.5% energy supply impaired and the region likely in
for leveraged loans, given the idiosyncratic factors recession, policymakers must tread carefully. Our
discussed earlier. With default rates normalizing base case calls for the ECB and BOE to extend
higher, we expect high yield spreads will widen their hiking cycles to a range of 3.25–3.75% and
to around 550 basis points. Such a spread would 4.25–4.75%, respectively. Restrictive monetary
be sufficient to offer investors an incremental risk policy—combined with the hit to disposable
premium above expected default losses consistent income from higher energy prices—is likely to
with the historical average (see Exhibit 175). Given weigh on growth significantly. Put simply, the
the current level of spreads—including higher longer rates stay in restrictive territory, the greater
spreads for leveraged loans, which have a weaker the odds the market will price in a deeper-cutting
credit profile—our forecasts imply mid-single-digit cycle by the end of this year. We therefore expect
total returns for both high yield bonds and bank German and UK 10-year yields will respectively
loans this year. stand about 150 basis points and 125 basis points
below their policy rate by year-end.
European Bonds While the outlook for their prices is
As energy shocks roiled the continent and inflation improving, our enthusiasm for European bonds
climbed to 40-year highs, European policymakers is tempered by the elevated volatility that we
faced an uncomfortable trade-off: sacrifice economic expect. Inflation is likely to decrease even more

92 Goldman Sachs january 2023

Exhibit 176: Expected Government Bond Net meaning tolerance for negative surprises will be
Supply to the Private Sector more limited and the risk premium priced into
Increased net supply from fiscal deficits and balance sheet the bonds by investors more persistent. Second,
runoff put upward pressure on the term premium. the nature of the UK mortgage market results
Local Currency, Billions in rapid transmission of monetary policy. With
300 Net Sovereign Issuance
Central Bank Flows
around half the stock of mortgages repricing this
260
250
2022 Net Supply year to much higher rates, many households will
see their monthly mortgage payments double,
200
170 denting disposable income.56 Third, net supply of
150
140 gilts the private sector must absorb is estimated to
quadruple to £260 billion. Based on the foregoing,
100 90
70
we expect term premium in the UK gilt market
will remain elevated through 2023, supporting our
50
3.0–3.5% target range for 10-year gilt yields.
0

Emerging Market Local Debt

-50
UK Germany France Italy Spain Investors fled from emerging market local debt
(EMLD) in 2022. The asset class saw $44.1
Data as of December 31, 2022.
Note: Based on estimates from Goldman Sachs Global Investment Research. billion in outflows last year, which pushed foreign
Source: Investment Strategy Group, Goldman Sachs Global Investment Research, European
Commission, UK Office for Budget Responsibility.
holdings of domestic government securities to
below the 15-year average.57 The 11.7% loss in
EMLD last year represented its second consecutive
gradually in Europe and the UK than in the US, annual decline.
increasing the uncertainty this year about whether We think divergences across regions will be
inflation expectations will become unanchored. critical to the EMLD outlook in 2023. While
Additionally, weaker economic activity may test monetary policy tightening cycles are close to
central bankers’ resolve and lead to more opaque ending in most EM countries, the dispersion of
forward guidance. Furthermore, both the ECB terminal rates is wide. Brazil and Hungary, for
and BOE are attempting to reduce their balance instance, will potentially end their cycles with
sheets at a time when government issuance remains policy rates near 14%, compared with near 2%
elevated, forcing the private sector to absorb in Korea and Thailand. Similarly, interest rate
record net supply in 2023 (see Exhibit 176). differentials between domestic yields and US yields
Our expectation that the ECB will extend its are much narrower in Asia than in Latin America,
hiking cycle—a remarkable feat following nearly Central and Eastern Europe, the Middle East and
a decade of negative policy rates—comes with Africa (see Exhibit 177). These divergences should
another unique challenge. The heterogeneous nature precipitate tactical opportunities during the year.
of the currency bloc means ECB policy impacts More broadly, we think EMLD could benefit
countries differently. Consider that real rates in this year as inflation moderates, especially if
Italy stand more than two percentage points above central banks begin easing cycles and fiscal policies
those in Germany despite substantially lower remain prudent, keeping yield curves anchored.
potential growth. Higher funding costs
in the economies least able to bear them
are likely to ignite concerns around
debt sustainability, putting pressure on We think divergences across regions
peripheral spreads. Against this backdrop, will be critical to the EMLD outlook
and despite expecting German 10-year
yields to fall toward our 1.75–2.25%
in 2023. While monetary policy
forecast range, we recommend a neutral tightening cycles are close to ending
stance to peripheral bonds.
The BOE also faces several hurdles.
in most EM countries, the dispersion
First, the policy debacle last September of terminal rates is wide.
remains fresh in investors’ minds,

Outlook Investment Strategy Group 93

Exhibit 177: Interest Rate Differentials Exhibit 179: EM Credit Spreads
Between EM and US EM spreads remain well-behaved and stand near long-
Asia stands out as having a particularly low interest rate run averages.
differential.
Interest Rate Differential (basis points) Spread (basis points)
1,400 Current 2,000 Emerging Markets Spread
Historical Mean Investment Grade Spread
1,200 High 1,800 High Yield Spread
Low Historical Mean Emerging Markets
1,600
1,000 Historical Mean Investment Grade
1,400 Historical Mean High Yield
800 732
583 1,200
600
275 1,000
400
800 822
200
600
10
0 453
400

-200 200
139
-400 0
Asia Europe Latin America Mideast & Africa 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020

Data as of December 31, 2022. Data through December 31, 2022.

Note: Based on data since 2004. Source: Investment Strategy Group, Macrobond, Bloomberg, JP Morgan.
Source: Investment Strategy Group, Macrobond, Bloomberg, JP Morgan. Note: Past performance is not indicative of future results.

Emerging Market Dollar Debt

Exhibit 178: EM External Debt Total Returns Emerging market dollar debt (EMD) was held
Last year’s return for EM external debt was the worst since hostage by higher US Treasury yields in 2022. As
its inception. seen in Exhibit 178, EMD’s 18% loss last year
Total Return (%) represented the worst annual return since its
50 inception in 1993. The bulk of this loss resulted
40 38 from the sharp increase in US Treasury yields, as
30 EMD spreads ended the year around their 10-year
30 27
22 average, despite significant widening in countries
20
20
14
17
15 such as Pakistan and Sri Lanka (see Exhibit 179).
13 12 10 10 12
11
10
10
6 7 7
10 10
5
As the market shifts its focus from high
1 inflation to slower growth in 2023, we believe
0
-2 that spreads are likely to face more pressure than
-5 -4
-10 -8 they did last year. History corroborates this view,
-12
-20 -18
as EMD spreads have typically widened by 250
basis points during mild recessions and 650 basis
-30
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 points during deeper global downturns. Even so,
the drag from wider spreads this year should be
Data through December 31, 2022.
Source: Investment Strategy Group, Macrobond, Bloomberg, JP Morgan. more than offset by EMD’s yield and the benefit
Note: Past performance is not indicative of future results. from its longer, nearly seven-year duration given
the lower US Treasury yields we expect. Taking
all these factors into account, we forecast positive
Our cautious optimism on EMLD is reflected in low-single-digit EMD returns in 2023.
our mid-single-digit EMLD total return forecast
for 2023, which also reflects EMLD’s 6.8% yield
net of the 1.5% drag we expect from currency 2023 Global Commodity Outlook
depreciation and 0.4% positive contribution
arising from duration. Commodities were a bright spot for markets last
year (see Exhibit 180). The S&P GSCI returned
23%, topping all other major asset classes for a

94 Goldman Sachs january 2023

Exhibit 180: Commodity Returns in 2022
Commodities topped all other major asset classes for a second consecutive year in 2022.

S&P GSCI Energy Agriculture Industrial Metals Precious Metals Livestock

Spot Price Average, 2022 vs. 2021 31% 46% 20% 5% -1% 12%
Spot Price Return 9% 14% 6% -10% 0% 11%
Investor ("Excess") Return* 23% 39% 10% -10% -2% 3%

Data as of December 31, 2022.

Source: Investment Strategy Group, Bloomberg.
* Investor (or “excess”) return corresponds to the actual return from being invested in the front-month contract and differs from spot price return, depending on the shape of the forward curve. An
upward-sloping curve (contango) is negative for returns, while a downward-sloping curve (backwardation) is positive.
Past performance is not indicative of future results. Investing in commodities involves substantial risk and is not suitable for all investors.

second consecutive year. But this impressive gain

belied a more nuanced reality, as returns reached Exhibit 181: Global Oil Production by Country
54% by early June, only to be halved in the Russia accounts for a large portion of global oil production.
second half of the year. Investors also faced a wide Global Production (%)
dispersion among individual commodities and their
source of returns. In contrast to the index’s overall 17
US
strength, both industrial metals and precious Saudi Arabia
23

metals suffered losses last year. And while the Russia

Canada
energy subindex outperformed with a 39% gain, Iraq
China
the bulk of this came from positive carry, or the UAE 11
additional return holders of a commodity get when Iran 2
Brazil 3
the futures curve is strongly downward sloping, Kuwait
3
called “backwardation.” The appreciation in spot Norway
Others Russia
4
energy prices was a much smaller 14%. 11
4
The disjointed nature of these returns reflects 4 5
4
the tug-of-war between bullish supply-side
pressures and bearish demand-side concerns that is Data as of 2021.
likely to continue in the year ahead. Although years Source: Investment Strategy Group, BP Statistical Review of Energy.

of underinvestment are an underlying support for

many commodity prices, a deeper global economic
slowdown could quickly undermine demand, Oil: High Risks, Low Inventories
especially given the still-uncertain trajectory of Oil prices last year were driven by geopolitical
China’s economy amid its shifting COVID policies. developments to a degree not seen since the
Against these risks, we note that global turbulent 1970s. As seen in Exhibit 181, close
inventories have remained low across most to 10% of global oil production found itself at
commodities despite months of weak Chinese risk of disruption virtually overnight in the wake
demand—a sign of equally weak supply trends. A of Russia’s invasion of Ukraine and the ensuing
thinner inventory buffer also leaves prices sensitive rollout of Western sanctions. Given already low
to potential supply disruptions in politically global oil inventories and thin spare capacity, oil
unstable areas, such as South America for base prices understandably spiked higher, reaching $124
metals, or—discussed further below—Russia and at their peak closing level last March.
the Middle East for oil. Given these crosscurrents, Prices have since fallen back below pre-war
we believe that risks around our base case are levels. This surprising retracement reflects not only
roughly balanced for industrial metals and oil the failure of supply risks to materialize, but also
prices this year. As for gold, we remain doubtful a combination of bearish developments, including
about its ability to provide investors with a reliable an unprecedented 200-million-barrel release from
hedge against inflation or political risk given its the US Strategic Petroleum Reserve, a COVID-
notable failure to do so in the past year. driven slump in Chinese oil demand and fears of
an impending recession.

Outlook Investment Strategy Group 95

Exhibit 182: 2022 Russian Waterborne Crude Exhibit 183: Chinese Oil Demand
Oil Exports 2022 saw a rare and large decline in Chinese oil demand
The bulk of Russian exports to Europe were redirected to due to COVID.
India and China.
Million b/d Million b/d Million b/d
4.5 Europe China India Turkey Unknown Other 1.4 YoY Change Average Annual Level (Right) 18

4.0 1.2 16
3.7 3.7
3.6
3.5 3.4 1.0 14
3.3 3.3 3.3 3.3 3.3
3.2
3.1 3.0 0.8
3.0 12
0.6
2.5 10
0.4
2.0 8
0.2
1.5 6
0.0
1.0 4
-0.2
0.5 -0.4 2

0.0 -0.6 0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 1990 1994 1998 2002 2006 2010 2014 2018 2022e

Data through December 2022. Data through 2022.

Source: Investment Strategy Group, Kpler. Source: Investment Strategy Group, BP Statistical Review of Energy.

Although oil prices have receded, the bullish COVID wave could exacerbate demand concerns.
risks that underpinned their initial spike higher For now, we expect global demand to remain on an
have not disappeared. The full effect of European upward trajectory in our base case, exceeding pre-
sanctions on Russia will not be visible in energy COVID levels by year-end.
markets until the first quarter of this year. These Meeting this demand will require continuing
curbs directly impact 0.5 million b/d of seaborne growth from US producers, as OPEC has already
crude oil and 1.1 million b/d of refined products. ramped its output back to pre-COVID levels
While Russia has so far been successful at and has limited spare capacity. But to incentivize
redirecting crude exports to India and China, this additional drilling, oil prices must remain high
strategy is starting to show some limits (see Exhibit enough to overcome the cost inflation and self-
182). Moreover, it will be difficult for Russia to imposed capital discipline now holding back
replicate this strategy in refined products, as both US production. In contrast, lower prices and
China and India were net exporters in this category disappointing demand would likely restrain
last year. production growth. Tellingly, the November and
As a result, close to 2 million b/d of Russian December oil price slump was rapidly followed by
supplies to Europe remain at risk. Consensus a decline in US drilling and completion activity,
currently expects a net loss of less than half that while OPEC immediately announced a production
amount, increasing the risk of an upside surprise. cut to rescue prices.
Upward pressure on energy prices could also Given these moving pieces, we expect WTI
arise from supply disruptions in other countries, prices to trade in a $70–100 range by year-end,
given geopolitical tensions in the Middle East and which would imply upside from current levels.
domestic instability in Libya and other exporting But we are mindful of the many risks that could
countries. undermine this forecast—including a US recession,
To be sure, the demand for oil faces an equally another wave of global COVID infections or a
high degree of risk amid a potential US recession and quick resolution to the conflict in Ukraine—any
the still-uncertain trajectory of China’s economy. We one of which could push prices down to cost
estimate that Chinese demand fell by 0.5 million b/d support near $60. That said, we would not expect
on average last year, marking the first annual decline these lower prices to be sustained for an extended
since 1990 (see Exhibit 183). While a successful period, given producers’ likely reaction. There are
reopening of China’s economy could help offset also upside risks. Any additional supply disruptions
weaker oil demand elsewhere, a more protracted would be magnified by still-low inventories (see

96 Goldman Sachs january 2023

Exhibit 184: Observable Global Petroleum Exhibit 185: Gold Price and US 10-Year Real
Inventories Interest Rates
Inventories failed to rebuild in 2022, with still-low levels a The spike in real rates last year was a strong headwind to
cause for both volatility and upside risks to prices in 2023. gold prices.
Billion Barrels US$/Ounce %
8.5 Global Onshore and Seaborne Crude Oil and Products 2,500 Gold Price -1.5
2017–19 Average 10-Year Real Interest Rate (Right, Inverted)
-1.0

2,000 -0.5
8.0
0.0

1,500 0.5

7.5 1.0

1,000 1.5

2.0
7.0
500 2.5

3.0

6.5 0 3.5
Jan-17 Jan-18 Jan-19 Jan-20 Jan-21 Jan-22 2006 2008 2010 2012 2014 2016 2018 2020 2022

Data through December 31, 2022. Data through December 31, 2022.
Source: Investment Strategy Group, Kpler, S&P Global Platts, IEA, EIA, PJK, PAJ, International Source: Investment Strategy Group, Bloomberg.
Enterprise Singapore.

Exhibit 184), which could push prices above our

forecast range, as happened last year. Exhibit 186: Average Gold Returns by Interest
Although we do not have an active tactical Rate Regime
allocation to oil, we do continue to recommend Positive real rates have historically led to lower-than-
a small overweight to the US midstream sector, average gold returns.
which benefits from strong cash flows and less Gold Average Monthly Return (%)
direct exposure to oil price volatility. 3 Real US Policy Rate
Real 5-Year Treasury
Real 10-Year Treasury

Gold: Not as Advertised

Since its meteoric rise in the 1970s, gold has been 2
2.0

hailed as an effective hedge against inflation. But

that reputation was tarnished in 2022, as gold
prices spent most of the year trading in negative 1.2
0.9
territory despite the highest inflation in four 1 Unconditional: 0.9%

decades. This disappointing performance was 0.6 0.6

0.4
yet another reminder that gold is subject to a
multitude of often opposing factors. Case in point:
0
the impact of last year’s inflation surprise was Negative Positive
largely offset by the combination of higher interest Data as of December 31, 2022.
rates and the surge in the US dollar, with which Source: Investment Strategy Group, Bloomberg.

gold tends to be negatively correlated. Note: Past performance is not indicative of future results.
These types of crosscurrents leave us tactically
neutral on gold again this year. As seen in Exhibit
185, our expectation for softer nominal and generates no cash flow or yield income and must
real interest rates removes one of last year’s key be physically stored, often at a cost.
headwinds to gold. Yet real rates are still likely We also do not see a compelling argument for
to remain in positive territory, which historically investors to replace their US dollar holdings with
has resulted in lower-than-average gold returns gold this year, given our still constructive view on
(see Exhibit 186). After all, positive interest rates the currency. Consider that since 1971, there has
create an opportunity cost of holding gold, which been only a 24% chance of a meaningful gold

Outlook Investment Strategy Group 97

rally of more than 10% in periods when the dollar Exhibit 187: Investor Positioning in Gold
was stable or rising. In fact, most meaningful While still historically elevated, investor length in gold is
gold rallies have happened when the US dollar well off its peak.
was depreciating. Put simply, when the dollar is US$ Billions
appreciating—a situation we expect this year— 300
269
the low probability of strong gold returns has
250
not historically justified the risk and volatility of
holding the yellow metal. 200 200
Still, there are a few factors that could buoy
gold, not the least of which is a US recession that 150
might rekindle demand for gold as a safe-haven
asset. Gold also stands to benefit if currently 100

underweight investors increase their positions

(see Exhibit 187), which now stand 28% below 50

their recent peak in early 2022 and back at levels

0
last seen in early 2020. Demand from EM central 2012 2014 2016 2018 2020 2022
banks looking to diversify their FX reserves into Data through December 31, 2022.
gold is another source of upside risk. The latest Note: Includes ETF holdings, futures and options.
Source: Investment Strategy Group, Bloomberg.
data from the World Gold Council already points
to record-high purchases in the most recent
quarter, with countries such as Turkey, China and
India leading the pack. Further geopolitical strife
could even accelerate this trend.
Given these contradictory factors, we remain
neutral on gold until a clearer opportunity
presents itself.

98 Goldman Sachs january 2023

Outlook Investment Strategy Group 99
Abbreviations Glossary

AAA: American Automobile Association JCPOA: Joint Comprehensive Plan of Action

JGB: Japanese government bond
b/d: barrels per day JPY: Japanese yen
BOE: Bank of England Latam: Latin America
BOJ: Bank of Japan
bps: basis points M&A: mergers and acquisitions
MLP: master limited partnership
CAPE: cyclically adjusted price-to-earnings MLF: medium-term lending facility
CAGR: Compound Annual Growth Rate MMBtu: Million British thermal units
CDX: credit default swap index MSCI: Morgan Stanley Capital International
CEE: Central and Eastern Europe MSCI ACWI: MSCI All Country World Index
COLA: cost-of-living adjustment
CPI: Consumer Price Index NBER: National Bureau of Economic Research
NIRP: negative interest rate policy
DPI: disposable personal income NYSE: New York Stock Exchange
DXY: Dollar Index
OPEC: Organization of the Petroleum Exporting Countries
EAFE: Europe, Australasia, and the Far East
EBITDA: earnings before interest, taxes, depreciation and PCE: Personal Consumption Expenditures [price index]
amortization P/E ratio: price-to-earnings ratio
ECB: European Central Bank PMI: Purchasing Managers’ Index
EM: emerging market
EMCI: Emerging Market Currency Index SDMT: Systematic Downside Mitigation Tilt
EMD: emerging market dollar debt SUIT: Systematic Upside Improvement Tilt
EMEA: Europe, Middle East and Africa
EMLD: emerging market local debt TBR: Trend-Based Rotation
EPS: earnings per share TIPS: Treasury Inflation-Protected Securities
ERP: equity risk premium TOPIX: Tokyo Price Index
ETF: exchange-traded fund TTM: trailing 12 months

FANGMANT: Facebook/Meta, Apple, Netflix, Google/Alphabet, UN: United Nations

Microsoft, Amazon, Nvidia and Tesla US: United States
FDI: foreign direct investment
FOMC: Federal Open Market Committee WTI: West Texas Intermediate [oil price]
FTSE 100: Financial Times Stock Exchange 100
FX: foreign exchange YCC: yield curve control
YE: year-end
GDI: gross domestic income YoY: year over year
GDP: gross domestic product YTD: year to date
GIR: [Goldman Sachs] Global Investment Research
GFC: global financial crisis
GSCI: Goldman Sachs Commodity Index
HY: high yield

I/B/E/S: Institutional Brokers’ Estimate System

IMF: International Monetary Fund
ISG: Investment Strategy Group
Notes

1. Ashton Carter, conference call 17. These forecasts have 27. “CIA Director William Burns the Death Toll Even Higher:
with the Investment Strategy been generated by ISG for on War in Ukraine, Intelligence ‘They Never Had a Plan B’,”
Group, December 17, 2021. informational purposes as of the Challenges Posed by China, PBS Fortune, December 20, 2022.
date of this publication. Total NewsHour, December 16, 2022
2. General Mark A. Milley, 42. Jan Hatzius et al., “10
return targets are based on ISG’s and Ian Bremmer, conference call
transcript from the Economic Questions for 2023 (Mericle/
framework, which incorporates with the Investment Strategy
Club of New York 683rd Phillips),” Goldman Sachs
historical valuation, fundamental Group, December 19, 2022.
meeting, moderated by David Global Investment Research,
and technical analysis. They are
Westin, November 9, 2022. 28. “With Fewer Guardrails, the December 26, 2022.
based on proprietary models and
3. UN Refugee Agency, “Ukraine Risk of Conflict on the Korean
there can be no assurance that 43. Michael Hartnett, “The
Emergency,” December 27, Peninsula Will Continue
the forecasts will be achieved. Thundering Word Year Ahead
2022. to Grow,” Eurasia Group,
The following indices were used 2023,” Bank of America Global
November 17, 2022.
for each asset class: Barclays Research, November 22, 2022.
4. Kiel Institute, “Ukraine Support
Municipal 1-10Y Blend (Muni 29. David Albright, “Iran Building
Tracker,” December 7, 2022. 44. Ibid.
1-10); BAML US T-Bills 0-3M Nuclear Weapons,” Institute
5. Anna Bjerde (World Bank vice Index (Cash); JPM Government for Science and International 45. Vince Golle and Kyungjin Yoo,
president), interview with Die Bond Index; Emerging Markets Security, December 5, 2022. “Economists Place 70% Chance
Press, December 3, 2022. Global Diversified (Emerging for US Recession in 2023,”
30. General Sir Nick Carter, in
Market Local Debt); Barclays Bloomberg, December 20, 2022.
6. “Joint Statement of the Russian a conference call with the
High Yield Municipal Bond Index
Federation and the People’s Investment Strategy Group, 46. Aditya Aladangady et al.,
(Muni High Yield); HFRI Fund of
Republic of China on the December 7, 2022. “Excess Savings During the
Funds Composite (Hedge Funds);
International Relations Entering COVID-19 Pandemic,” FEDS
Barclays US Corporate High 31. Sir Alex Younger, in a
a New Era and the Global Notes, October 21, 2022.
Yield (US High Yield); MSCI EM conference call with the
Sustainable Development,”
US$ Index (Emerging Market Investment Strategy Group, 47. Based on global indices shown
February 4, 2022.
Equity); FTSE 100 (UK Equities); December 9, 2022. under the WEIS function in
7. Federal Reserve Chair Jerome MSCI EAFE Local Index (EAFE Bloomberg.
Powell, transcript from press 32. “Conference Call Notes: Iran
Equity); Euro Stoxx 50 (Eurozone
conference, Federal Reserve, outlook for 2023,” Eurasia 48. Based on the decline in the
Equity); TOPIX Index (Japan
December 14, 2022. Group, December 12, 2022. Bloomberg World Exchange
Equity); S&P 500 (US Equity).
A moderate risk portfolio is Market Capitalization index
8. Lawrence H. Summers, “What 33. “CIA Director William Burns
allocated among equities, fixed from December 31, 2021, to
the Fed Should Do Next on on War in Ukraine, Intelligence
income and additional asset October 12, 2022.
Inflation,” Washington Post, Challenges Posed by China,”
classes and designed to track PBS NewsHour, December 16, 49. That is, over rolling 12-month
December 19, 2022.
8% volatility. 2022. windows since 1926.
9. Seth Klarman, “The Value of
18. We have applied the fees 34. The governments of France, 50. JP Morgan 2023 Global Equity
Not Being Sure,” Value Investor
associated with a fund that Germany and the United Outlook, December 1, 2022.
Insight, February 23, 2009.
implements the tactical tilts. Kingdom joint statement on
10. Federal Reserve Chair Jerome Returns are subject to change 51. Based on data for Brazil, Chile,
the JCPOA, Transcript: “E3
Powell, transcript from press based upon client circumstances Colombia, Czech Republic,
Statement After UN Security
conference, Federal Reserve, and how tilts are executed. Egypt, Hungary, India, Indonesia,
Council Meeting on Iran,”
December 14, 2022. Korea, Malaysia, Mexico, Peru,
December 19, 2022.
19. General Sir Nick Carter, Philippines, Poland, South
11. The R-CPI-U-RS retroactive conference call with the 35. Robin Wright, “The Looming Africa, Thailand and Turkey.
series, which tries to correct for Investment Strategy Group, Threat of a Nuclear Crisis with
changes in methodology, has December 7, 2022. 52. Measured through JP Morgan’s
Iran, New Yorker, December
peaks of 11.8% for headline and EMCI spot currency index
27, 2021.
20. Ian Bremmer, conference call from December 31, 2021, to
9.9% for core.
with the Investment Strategy 36. “Annual Threat Assessment December 30, 2022.
12. Erica Thompson, Escape from Group, December 19, 2022. of the U.S. Intelligence
Model Land: How Mathematical 53. Based on Goldman Sachs
Community,” Office of
21. Sir Alex Younger, conference call Global Investment Research
Models Can Lead Us Astray and the Director of National
with the Investment Strategy estimates.
What We Can Do About It, Basic Intelligence, March 8, 2022.
Group, December 9, 2022.
Books, 2022. 54. Martin M. Andreasen, Jens
37. “The Terrorist Threats and
22. “Is Russia Running Out of H. E. Christensen and Simon
13. “Consumer Checkpoint: End Trends to Watch Out for in
Ammunition?,” The Economist, Riddell, “The TIPS Liquidity
of year health check,” Bank of 2023 and Beyond,” Combating
December 20, 2022. Premium,” Federal Reserve
America Institute, December Terrorism Center at West Point,
8, 2022. 23. Aleksei Aleksandrov, “Russian Bank of San Francisco Working
November/December 2022.
Mercenary Leader’s War of Paper 2017-11, July 2020.
14. Joseph Briggs, “US Economics 38. Omicron Offshoot XBB.1.5 Could
Words With Moscow’s Military 55. National Association of State
Analyst: Monetary Policy Drive New COVID Surge in the
Brass Deepens Amid Fighting In Budget Officers, Fall Fiscal
Affects Growth with a US,” CNN, January 3, 2023.
Bakhmut,” RFE/RL, December Survey of States. Rainy day
Short Lag,” Goldman Sachs
31, 2022. 39. Qianer Lui, Cheng Leng, Sun Yu funds, also known as budget
Global Investment Research,
December 18, 2022. and Ryan McMorrow, “China stabilization funds, serve as
24. “Chinese Aircraft Carrier Nears
Estimates 250mn People Have states’ “savings accounts” and
US Territory of Guam,” Radio
15. Sujeet Indap, “Apollo Defends Caught COVID in 20 Days,” may be used to supplement
Free Asia, December 30, 2022.
Push to Retail Investors Amid Financial Times, December 25, general fund spending during
Blackstone Storm,” Financial 25. US Indo-Pacific Command 2022. an economic downturn or other
Times, December 13, 2022. Public Affairs, “USINDOPACOM events triggering a shortfall, if
40. Helen Davidson, “China’s
Statement on Unsafe Intercept the specific restrictions on the
16. Sir John Templeton is credited Cities Fall Quiet Amid Warning
of U.S. Aircraft Over South China use of the fund(s) are met.
with saying, by at least 1993, of Three COVID Waves Over
Sea,” United States government,
“The four most expensive Winter,” Guardian, December 56. Bank of England, “Financial
December 29, 2022.
words in the English language 19, 2022. Policy Summary and Record—
are ‘This time it’s different.’” It 26. Agence France-Presse, December 2022,” December
is quoted in The Four Pillars of 41. Erin Prater, “The Public Health
“China’s Warplane Incursions 13, 2022.
Investing: Lessons for Building Organization That Forecast 1
Into Taiwan Air Defence Zone
a Winning Portfolio (2002), by Million COVID Deaths in China 57. JP Morgan EM local flow data
Doubled in 2022,” The Guardian,
William Bernstein. Says a ‘Tripledemic’ Could Push as of mid-December 2022.
January 2, 2023.
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Other contributors from the
Investment Strategy Group include:

Thomas Devos
Managing Director

Shantall Tegho
Managing Director

Anais Boussie
Vice President

Jeremy Nalewaik
Vice President

Howard Spector
Vice President

Matthieu Walterspiler
Vice President

Olivia Xia
Vice President

Grant Nelson
Analyst

Jonas Schmitten
Analyst

Tia Sparks
Analyst
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