Goldman Sachs said low levels of volatility reflect fundamental forces which will continue next year according to the bank's Top Ten Market Themes for 2015.
In a report, "Keeping the faith", Goldman Sachs described the top 10 macro themes that it expects to dominate asset markets in 2015.
The report said: “Despite the periodic spikes in volatility, most notably in October, the VIX average for 2014 is the lowest of the recovery so far. We think this basic environment will persist into 2015.”
The Goldman Sachs team said there will still be volatility spikes which offer opportunities to add risk, but overall, the volatility of economic data has fallen to new lows, unemployment continues to decline, macro-prudential measures are restraining leverage and the risk of a US recession risk looks low.
“Our simple models imply that equity volatility could be modestly higher on average in 2015 than in 2014, but not in a material way,” added Goldman. “The same set of forces informs our still quite benign view of US credit.”
Low volatility will result in low absolute returns for major asset classes. The bank compared expected real returns from a range of core assets and found the earnings yield on equities (and on a volatility- adjusted basis, on parts of credit) makes them relatively more attractive than sovereign bonds.
“Already this year, we have seen sharp rallies (as in the last six weeks) but we have also seen a number of pullbacks that quickly eroded several months of modest gains,” the study added. “ The value of being able to increase exposures into these pullbacks – which means not being over-exposed beforehand – has been even higher than normal, and we expect that to remain the case. That is easier said than done.”
The study found that emerging markets equities now trade with earnings yields that are above their long-run averages. "For the first time in a while, we find ourselves thinking that they offer at least the possibility of significantly higher returns than in developed markets over the medium term, even if they still offer significantly more risk,” the bank added.
Low volatility and returns will also continue to add pressure on investors to increase leverage through financial gearing or through use of options.
Goldman Sachs said: “If returns on core assets prove lower than average, foreign exchange returns are likely to be a more important component of overall asset returns across countries and hedging choices more critical as a result.”
The divergence between the US and other developing market economies, in particular the Euro area, will remain wide next year.
In the Euro area Goldman expects a modest pick-up in 2015 to 0.9% GDP growth but with risks skewed to the downside.
“We expect the Stoxx 600 to rise to 365 by end 2015; a real total return of 11% (including dividends) in local currency, but only 2% in $ terms,” Goldman said. “While low, the total real return is in the 47th percentile of historical distribution and 64th percentile relative to bonds.”
The bank expects the Federal Reserve to increase interest rates in September for the funds rate to rise faster than the market now expects.
“We think that the neutral rate is still around 4% and so rates will ultimately climb further than the market is pricing. As a result, our view of the rates path further out in the forecast is now clearly above what the market is pricing and by a significant margin by 2017,” added Goldman Sachs.
Featured image via Eisenhans/Dollar Photo Club
