Keep on truckin’: Will the US continue to outperform other markets?
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After another stellar year for U.S. equities, how should investors position themselves for 2025? I'm Alison Nathan, and this is Goldman Sachs Exchanges. Today, I have the pleasure of sitting down once again with Sharmeen Mosavaramani. Sharmeen is the Chief Investment Officer of Goldman Sachs Wealth Management and the head of the Investment Strategy Group. Sharmeen and her team recently published their 17th annual Outlook, in which they share their investment themes and recommendations for clients. Sharmeen, welcome back to Exchanges.

Thank you very much, Alison. And until you said 17th, it hadn't registered that there were that many of them, but yeah, quite a few. Time flies. So let's start at the beginning, as I always like to do, and talk first about the cover of your piece and the title in particular, which I know you and your team put tremendous thought in. I say this every year, but every year it's very true. This year's piece is entitled Keep on Truckin'. So talk to us about why you chose this title.

As you know, and hopefully many of your listeners already know, U.S. preeminence has been one of our key investment themes. So we're always trying to convey the message that that investment theme is still valid. Maybe at some point it won't be, but we can't foresee any such change. So again, here, when we say keep on trucking and we have a big image of something very U.S.-oriented,

We're trying to convey the message that U.S. preeminence is intact. And in fact, the U.S. keeps on trucking ahead of everybody else. And the distance between the U.S. and these other countries just continues to get longer and longer. Absolutely. You could not have been more right on that theme that we discussed quite comprehensively last year at this time, but even in prior years. But 2024 was certainly a year of U.S. dominance. But we now had yet another year of phenomenal U.S. stock performance.

And valuations really by most measures are very, very stretched. So even if you believe that companies in the U.S. are going to continue to outperform, is that already fully priced in? That's an excellent question that a lot of our clients are asking.

So on the U.S. side, clients are saying, given how well the U.S. has done, shouldn't we actually continue to be just invested in U.S. equities? And why do we even have any other assets outside of U.S. equities, whether it's public or private, but just the concept of non-U.S. developed equities or emerging market equities? And the non-U.S. clients are saying, given how expensive U.S. equities are, why not tactically shift towards non-U.S.

non-U.S. equities. And our view is that while equities are expensive,

When we actually look at valuations in this environment, we're saying that valuations alone and the level of concentration in the S&P 500 index, for example, alone are actually not good indicators of the next year's returns. So in fact, if you look at these valuation metrics and you look at the range of returns that we've had at different valuation metrics, and you look at, let's say, a scatter chart, and we have some really good exhibits in the actual report,

you see that there's no significance to either of these measures in terms of forecasting the next year's return. So that is actually not a very relevant factor. For us, the fact that U.S. GDP is going to be well above trend, somewhere around 2.3% based on our numbers. We know that Goldman Sachs Research has a slightly higher number than we do, but generally a very good economic backdrop that is more likely to generate really good earnings.

And so with good earnings, we think these valuations are manageable. Now, longer term, it's a different picture. Are we going to get somewhat lower valuations over the next five years? Yes. But we also extensively discuss that it is a myth that equity valuations are mean reverting to a long-term, let's say post-World War II mean.

Interesting. So where does that leave you, that valuation perspective and your earnings expectations leave you for returns for U.S. equities in 2025?

So when we look at the returns for U.S. equities and look at returns outside the U.S., basically we're talking about returns somewhere depending on the country between 7%, 8%, 9%. So for the U.S., our base case is an 8% return. This compares to a 6% from last year, but we don't want clients to think we're actually more bullish because this 8% would have been a lower number if we didn't have the downdraft we had over the last several weeks.

of 2024. So in fact, the number is a tad higher only because we had that big downdraft. So our base case returns are somewhat similar. And then in terms of our upside, we actually have a reasonable probability that U.S. equities will do better than that. That's why we look at the returns and we say stay invested between the base case returns and the upside

we think you're going to have pretty attractive returns. But just to put that in perspective, that's down from high double-digit returns in 2024. Yes, we've had two years in a row of returns over 20%. So when we think about valuations, we totally agree that U.S. equities are expensive. In fact, we have a series of metrics we look at, and based on these metrics, either we're in the ninth or tenth decile of valuation metrics. So no doubt, very expensive.

But for example, we were in the ninth decile in 2013 and equities were up several hundred percent over a long period of time. So I don't think valuations alone tell you you can't continue to have good returns. And in a good economic environment, our base case is you're going to get good earnings growth. And so hence, stay invested. What about interest rates? I have to ask you this because, of course, today, again, we had a blockbuster payroll number in the U.S. and we've seen interest rates that

the 10-year in the U.S. moving up close to 5%. Many investors now think they're going to be at 5% or above 5% in 2025. Does that pose any risk to your view? Our base case is that interest rates will come down. Now, the market is very jittery because they're worried about tariffs. They're worried about, do we have a trade war? Could that create inflation? But our base case is that

We will have some tariffs. It's not going to be anywhere immediately to the full level that was discussed during the campaign. And so if they're incremental and there's going to be going back and forth, you'll have a lot of market volatility. But the key driver of inflation will be other factors. And we'll continue to have a steady lowering of inflation. Nothing too dramatic, but slowly, slowly going down.

and that will actually lower interest rates. So we expect fixed income rates to actually be a little bit lower. But what's really interesting is the vast majority of corporate debt in the U.S. is fixed. So in terms of affecting companies and having a negative impact, it's actually negligible. The interest burden of U.S. companies right now is so low because we had interest rates at such a low level. So that's not going to be a major factor. The question is, are we going to use a totally different discount rate

for forward earnings. So obviously, if rates were to go to 5% or higher, that would be a factor, but that's not our base case. In addition, people are saying rates could go higher because of the debt trajectory of the U.S. And we've done a lot of work, as have your colleagues in the economics research team, that it is not an immediate concern. It's really a much more long-term concern, and there's enough time to actually change that debt trajectory.

So we're not concerned that in the next year or two, we have to do something about the budget deficit. So you're at, as you said, 7% to 8% for U.S. equity returns and returns of some of the major other indices in developed markets. Where does that leave you in terms of your overall asset allocation strategy recommendations for 25 in the context of what you've just mentioned about rates as well?

We have been overweight U.S. equities for quite some time. So if we go back to 2009 during the global financial crisis, the overweight that we had in our strategic asset allocation recommendation for clients was about 23%. So we were looking at the overall benchmark, let's say the MSCI All-Country World Index, where were U.S. equities and we were significantly overweight.

But as U.S. equities have continued to outperform, the weight in the index has gone up, and now we're only overweight by 7%. So we said, well, that's too little, given our view of U.S. preeminence. So either we could shift out of non-U.S. equities, both developed and emerging markets, and go into U.S. equities, or we actually made a decision to say, we will lower that allocation to non-U.S. equities by a marginal amount. It's not a huge amount.

And we will actually put that in private assets, specifically in buyout and growth equity. Our view is over the next 10 years, for example, buyout and growth equity, most of which tends to be U.S.-oriented, will outperform non-U.S.-developed and emerging market equities. And so we made that shift. And that's, again, a long-term strategic shift.

Interesting. And when we think about those allocations, though, and just bringing up the question that I believe you said your clients outside the U.S. are most asking, though, yes, you might see U.S. companies continuing to outperform, but everything else looks so cheap in other major developed economies and beyond. So to what extent, though, should that be considered a buying opportunity for some markets outside the U.S.? Should there be some increase in allocations at all to some of these places?

Our response to that question for clients is that, yes, when you look at the numbers at a very superficial level, it looks like they're extremely cheap. By any measure, the discount is, let's say, in non-U.S. developed economies at historic lows. We actually have never seen them be so low, the discounts relative to the U.S. However, our view is you need to actually dig a little bit deeper to understand what is the true level of cheapness. What do we mean by that? If you look at U.S. equities, 50%,

30% of the earnings of the S&P 500, for example, comes from the broad technology sector. If you look at the UK equity market, which is one of the cheapest out there, only 1% comes from the technology sector. So if you have a bigger weight to a sector that trades

at a higher valuation because the earnings growth is much faster, then you're not really comparing apples to apples. So if you look at the UK, it looks cheaper partly because it has so little technology. Another sector to look at is the energy sector. The energy sector is a mid-single digit in the S&P 500. It's double digits in the UK market.

And so again, that's a much cheaper sector. So the UK has less of a more expensive sector and a lot more of a cheaper sector. And so you need to make that adjustment. And suddenly these markets do not appear as cheap. And so our view is, yes, they are cheap. They're not as cheap as it appears initially. And then when we make this sector adjustment, one of the questions we're asking ourselves is what is the right discount for

for these various countries. What is the discount they should have relative to the U.S. given it is a faster economically growing country? It has a very diverse economy and it is not exposed meaningfully to a slowdown in China's economy. A lot of these other markets are going to be severely impacted

as China's economy continues to steadily, really steadily slow down. So does it go without saying, given your views on China in the past, which have been very pessimistic and very, very right, honestly, that China is not a buy here, even though we are seeing more stimulus moving into the economy and some investors seem to want to try to take advantage of the very low valuations there? One of our views about China is that China at best

will follow the path of Japan. They will have a Japanese slowdown. It's inevitable from our perspective, not just because of demographics, but because of all kinds of headwinds that they're facing. And so when we look at the Japanese equity market since it peaked, you have had opportunities in the general downdraft for big rallies. And so we look at that and say, well, maybe China could follow that because they could have stimulus programs, they could make statements,

investors could get all excited and you could have a rally, just like we had last year. But it's not sustainable. And to give you a good comparison to Japan, if you look at Japanese equities, where were they at the end of 1989, 1990, when the Japanese equity market bubble burst? It did not exceed that peak level.

until the summer of 2024. So it's actually incredible that there've been opportunities to buy Japanese equities and big rallies, but they've all lasted a limited amount of time and then we've had a downdraft. And so again, if at best China follows the path of Japan, that would be why it's a trading environment, not an investing environment.

The other asset I wanted to ask you about is gold. It had a very strong year in 2024, and it is historically thought of as an inflation hedge. And as we've been discussing, there are some concerns that inflation could resurge in 2025 off the back of Trump policies and in general, the resilience of the U.S. economy that we have been seeing. So should gold be a bigger allocation in portfolios this year?

We've done a lot of work on commodities in general and then gold and oil specifically. They're definitely not strategic asset classes. There are times where you want to be tactical. And over the life of the investment strategy group, we have been tactical both on oil, on natural gas, on gold. And so, yes, there are opportunities to be tactical. But right now, what is driving gold is not inflation, because in fact, gold has shown not to be a good inflation hedge.

In fact, U.S. equities are the best inflation hedge. Gold and commodities are not a good hedge against inflation. And so they're not a great store of value, nor short-term a good inflation hedge. So then what is actually driving gold right now? It is significantly driven by central bank purchases, and then specifically by Chinese purchases, both central banks and consumers.

And so how long will that last? Maybe China, as a protection against any kinds of sanctions or freezing of assets, if geopolitical tensions were to escalate, they want to diversify away from certain assets and own actually directly some gold for a while. That could continue and that could drive some upside. But that's, again, more of a trading issue and trying to figure out what China could be doing long term, which I think is very hard to predict.

And so we're somewhat agnostic about the pricing. And we say we don't think we can predict it. And so we don't think clients should tactically get engaged. I think that's an interesting point because empirically you're saying gold has not shown to be a good inflation hedge, even though many investors think it is. So interesting point there.

Should I even dare to ask you about Bitcoin, which is another asset that investors seem to be excited about in this type of environment in particular? And ultimately, we have seen more institutional investors getting involved. We've seen a proliferation of instruments that allow them to do so. So where do you stand on Bitcoin today or crypto in general? So when it comes to Bitcoin or crypto in general, we have not changed our view. There's a great quote that we refer to,

from an information gathering firm, and they curate information and present it. And they had a great quote, and we referred to it in our outlook, that price action creates its own investment thesis. So just because prices have gone up, now everybody's coming up with reasons one should own Bitcoin. And we're like, that is not a legitimate argument. What is the underlying investment rationale to own or not own Bitcoin? And we've had this view all along. We've said,

It is not an investment asset class. If you think about it, it doesn't generate cash flows. It doesn't generate earnings. It's not a portfolio diversifier. It doesn't dampen volatility. You could go through all the different reasons. So it's still not an investment asset class, but it is a trading speculative asset. And so if people want to speculate, then they should.

But it's not something we recommend because there's no way of knowing if the current price is a good price. There's no way of actually assigning value to something. And there's certainly no shortage of cryptocurrencies. A lot of the rally that came in Bitcoin came after the election. And there's a view that a lot of people have that this administration will make a huge difference to it. But the actual value argument hasn't really changed.

So given everything we've discussed, is this the kind of environment in which you want to be hedging your portfolio?

The most important recommendation we make to clients so that they can withstand the unknown volatility is to make sure they have a strategic asset allocation that allows them to withstand the downside. Because hedging is expensive. If you buy a lot of put options to protect yourself against equity market downside, or if you go out of equities, whether it's U.S. or non-U.S., you could be giving up a lot of upside.

And if you're a U.S. taxpayer, you'd certainly be paying a lot of taxes if you sell your current equities with a lot of gains. And so the best way to prepare for this volatility is to make sure you have the right strategic asset allocation that would have enough fixed income in it. High quality fixed income long-term is the best hedge and gives clients the ability to withstand that interim volatility because actually hedging with derivatives is very expensive. You could be hedging against the downside

and need to buy options for a couple of years before anything happens. And so that is not our recommendation. Charmaine, always a pleasure to talk to you. Thanks so much for joining us today. Thank you very much. If you want to learn more about the IST outlook, you can find a link to the report in the description. This episode of Goldman Sachs Exchanges was recorded on Friday, January 10th, 2025. I'm your host, Alison Nathan. Thank you for listening.

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