The tech revolution that has powered the US market for the past decade still has further to go, according to Goldman Sachs.
For the past decade or so, US equities have been unstoppable. Despite some major hiccups, the US market has dumbfounded sceptics and experienced a more than 10-year-long bull market. Not even Covid-19 and the resulting global recession could derail US equities for too long, with US markets quickly recovering and major market indices recording new all-time highs.
But surely, many argue, this cannot continue forever. After a decade of solid returns, the party must come to an end. And for some, the recent sell-off in famous tech stocks (the stars of the US market in recent years) confirms that the past decade’s bull market is coming to a close.
Peter Oppenheimer, chief global equity strategist at Goldman Sachs, however, disagrees. Rather than viewing the party in US equities as coming to an end, he sees a new party in the US market starting up. In a new paper for Goldman Sachs, he argues that following the market declines triggered by Covid-19, the US is at the start of a whole new bull market.
Over the past four trading sessions (since 3 September), US tech stocks have posted notable falls. Some commentators view the sell-off as investors taking profits following strong share price performance in 2020, while others suggest the sell-off stems from broader concerns over the health of the US and global economy, among other reasons.
Despite this, Oppenheimer believes that the tech and digital revolution still has further to go. This, alongside the factor characteristics of tech firms, should allow both the sector and US market as a whole to continue to do well.
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Oppenheimer notes: “In the current environment of very low interest rates, high uncertainty and rapid digital disruption, the technology sector offers attractive characteristics, including strong balance sheets and high proﬁt margins, as well as the resilience of its earnings.
“In addition, low interest rates increase the value of the sector’s long-term growth prospects, which, in cases like e-commerce and cloud usage, have been accelerated by the impact of the pandemic on consumer and business activity. We think this transformation of the economy and stock markets has further to go. These companies could continue to drive valuations and returns in this bull market.”
The important thing to understand, Oppenheimer says, is the precise nature of the sell-off in March. With markets falling peak-to-trough by significantly more than 20%, in theory the market had entered “bear-market” territory. But the key detail here, according to Oppenheimer, is that the sell-off was an “event-driven bear market”. In such a bear market, stock prices fall due to an outside (or “exogenous”) event. In the case of the March sell-off, it was “triggered by deliberate government actions to restrict economic activity to contain the pandemic”.
This kind of bear market must be distinguished from broadly two other types: 1) cyclical bear markets, which are triggered by the motions of the economic cycle such as a rise in interest rates, and 2) structural bear markets, which result from asset price bubbles, often associated with property price bubbles or banking crises, the 2008 crash being the pre-eminent example.
According to Oppenheimer, both cyclical and structural bear markets have, historically, seen larger market declines and taken longer to recover. He notes: “Historically, structural bear markets have experienced falls of 57% (taking US datasets since 1880), have lasted 3.5 years (from peak-to-trough) and have taken around a decade to recover (in nominal terms). Cyclical bear markets have typically experienced falls of around 30% over 2.5 years and have taken an average of four years to recover.”
In contrast, event-driven bear markets, on average have led to falls of around 30% and take much less time to recover. Oppenheimer notes: “In this context, the bear market of 2020 seemed to make sense – it was sharp and short-lived like other event-driven bear markets in the past.”
So, in theory, the Covid-19 sell-off marked the point at which the past decade’s bull market came to an end. Everything since, it is argued, should be viewed as the US beginning a new equity market cycle.
In the ‘hope’ phase of a new cycle
If we have entered a new equity market cycle (or bull market), we are currently in the “hope” phase, says Oppenheimer. Every equity market cycle can be split into four distinct phases: hope, growth, optimism and despair.
Oppenheimer says: “The hope phase, the ﬁrst part of a new cycle, which usually begins in a recession as investors start to anticipate a recovery, is typically the strongest part of the cycle. That is what we have been seeing this year.”
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The strong returns in recent months may start to moderate in the future, particularly if, as Oppenheimer thinks, we are transitioning from the “hope” to the “growth” stage of the cycle. He notes: “As we transition from the initial ‘hope’ phase to a more sustainable ‘growth’ phase, it would not be unusual for the market to experience a near-term setback if the animal spirits unleashed in the hope phase prove to have been too optimistic.”
However, even if we are moving towards the growth stage of the cycle, we should expect to see positive returns from US equities for the time being. And there are several factors underpinning this, says Oppenheimer.
First, equities will continue to be helped by extremely accommodative policy. In the aftermath of the global financial crisis, developed economy governments engaged, to varying degrees, in quantitative easing policies, which supported equity prices. This time around, countries have done the same but at a much faster and larger rate.
Oppenheimer notes: “This time, we have seen an even more aggressive monetary response, which was implemented in fewer months than it took in years following the ﬁnancial crisis (at least in Europe). The support programmes are also bigger and more generous, with a wider range of assets bought in the US (including corporate bonds).”
On top of that, governments have been less obsessed with fiscal discipline. Following the 2008 crisis, governments quickly grew concerned about the amount of public debt they had racked up. In contrast, this time around, there has been little talk of the need for austerity (so far), with many pointing out that continued historically low yields mean governments still have plenty of capacity to borrow and spend more. Perhaps the change in thinking on debt is best symbolised by the European Union’s agreement to introduce “coronabonds”.
Both of these policies are key to underpinning the new bull market, argues Oppenheimer. He says: “In effect, they substantially reduce tail risks for investors. The monetary support, as in the post-ﬁnancial crisis period, provides a central bank ‘put’ – a belief that central banks will be there to provide as much liquidity as is required – while also extending forward guidance on zero interest rates. At the same time, the upscaled ﬁscal support introduces a government ‘put’: the belief that governments will step in with up-scaled programmes to prevent another imminent economic downturn.”
In total, Oppenheimer offers 10 reasons why investors can be hopeful that the US market will continue to see strong returns:
- We are in the ﬁrst phase of a new investment cycle following a deep recession. The ‘hope’ phase – the ﬁrst part of a new cycle, which usually begins in a recession as investors start to anticipate a recovery, is typically the strongest part of the cycle. That is what we have been seeing this year.
- The economic recovery looks more durable as vaccines become more likely.
- Our economists have recently made upward revisions to their economic forecasts and it is likely that analysts’ expectations will follow.
- Our Bear Market Indicator (GSBLBR), which was at very elevated levels in 2019, is pointing to relatively low risks of a bear market despite very high valuations.
- Policy support remains very supportive for risk assets. There is both a central bank “put” – a belief that central banks will be there to provide as much liquidity as is required – and a ﬁscal “put” as governments have scaled up their willingness to support growth.
- The Equity Risk Premium has room to fall.
- The resumption of zero nominal interest rate policy in the recent past, together with the extended forward guidance, has created an environment of greater negative real interest rates. This should be highly supportive to risk assets in an economic recovery.
- Equities offer a reasonable hedge to higher inﬂation expectations.
- Equities look cheap relative to corporate debt, particularly for strong balance sheet companies (60% of US companies and 80% of European companies have dividend yields above the average corporate bond yield).
- The digital revolution continues to gather pace. We think this transformation of the economy and stock markets has further to go. These companies could continue to drive valuations and returns in this bull market.
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