Goldman Sachs' 3 most underpriced market risks for 2024

If there is one thing that markets and global investors are fixated on ahead of 2024, it's the "rate cuts" question - not just when but how much is in the pipeline. At one end of the spectrum, some investors believe the "higher for longer" mantra is real and that there may be no rate cuts at all in 2024 from major central banks. At the other end of the spectrum, some economists think central banks could be forced into rate cuts by as early as mid-next year. 

But Goldman Sachs Asset Management's senior investment team believe there are more pressing risks that have not been priced in by markets. 

In turn, this is also influencing the way they are investing on behalf of their high-net-worth client base. In this wire, I'll pull back the curtain on Goldmans' portfolio construction thesis for 2024 - allowing you to get an insight into how one of the world's largest institutional players is thinking. 

The big macro view

On the first and most discussed question, Goldman Sachs Asset Management's chief investment officer for public investing (listed stocks, fixed income, and multi-asset) Ashish Shah argued a dual case. Interest rates will be higher for longer, but rate cuts may become a factor for countries where economic growth is running at a slower pace than wanted.

"We think that central banks are going to be more reactive rather than proactive when it comes to easing, and they're going to be more hesitant to go in and ease conditions when they have just come off from higher inflationary conditions in order to maintain their credibility," he added.

2023 has also been a year mired by geopolitical conflict - most prominently in Eastern Europe and in the Middle East. Shah said that the biggest lesson for investors is to find value in the three secular trends that will come out of heightened tensions.

1. Supply chain diversification: "Companies are very focused on kind of the increased volatility in geopolitics. That's going to favour countries like India and Japan, as manufacturing and tech hubs look to diversify their exposure away from core manufacturing locations like China," Shah argued.
2. Sustainability: "I think you're going to see continued investment in alternative energy and the alternative energy value chain. That's going to create opportunities in new locations as that manufacturing needs to take place in the sourcing of core materials and needs to take place on a more diversified basis," he said.
3. Security (especially cybersecurity and AI): "The rise of AI is going to lead to new capabilities on the part of bad actors, which will equally require kind of defences from those bad actors," he said.

The impact of AI on private markets

While the influence of generative AI is well-known in public markets, artificial intelligence is also making waves in private markets as well. Goldman Sachs economists estimate that it will add 1.5% to productivity growth for the next 10 years, equivalent to the impact caused by the introduction of electricity and computers into the workforce.

"What we're seeing here in the first wave is that generative AI will most likely be transformative at the portfolio companies. So at our existing portfolio companies, we see the application of AI. It can be across a number of different businesses and across a number of different functions," Goldman Sachs Asset Management's co-head of private equity Michael Bruun said during the webinar.

"That's also why every time an investment team comes to the investment committee now, we ask the obvious question, which is, how will generative AI impact this business? How will it impact this sector? Is this company prepared to adopt and is this company going to be a leader or a laggard in this space?" Bruun added.

Three other underpriced risks (which are not AI)

The presenting team also provided their views on the risks that remain underpriced or undervalued by the investing consensus. 

Bruun, who speaks primarily to CEOs and business leaders in his role, nominated geopolitical flare-ups as the big underpriced risk. 

"As private equity investors that are intentionally focused on value add and working with our operating partners, we hate risks that are outside our control. So I cannot predict and cannot control geopolitical risk. And at this moment in time, it is probably underpriced versus what we're observing and can control," Bruun said. 

Shah, who translates macroeconomics into investable ideas on a daily basis, pointed to the risk of deflation. Shah said that the US Federal Reserve continues to wind back its pandemic-era stimulus even if it is no longer raising rates. At the same time, a cocktail of regulation and increased rates is raising the cost of capital. Put together:

"While we've been so focused on the inflationary environment and the risk of inflation, I think not realising and pivoting quickly enough is something that can actually lead to the opposite risk within the marketplace around deflation," Shah warned.

Remember, deflation is not disinflation. Deflation is harmful to an economy because it can cause a spiral of reduced economic activity, and can weigh on consumer psychology even if central banks cut interest rates and increase liquidity.

Finally, we heard from Alexandra Wilson-Elizondo, head of multi-Asset funds and model portfolio management, who nominated the very idea of a global soft landing. She argues investors are not considering the risks posed by a massive and unexpected spike in unemployment. 

Portfolio construction

Wilson-Elizondo then elaborated on how the Goldman Sachs Asset Management team are allocating client cash from a high-level perspective. Top of mind is the art of stock picking:

"Within public equity markets, we think they're going to continue to be driven by company-specific characteristics," she said. "The micro will dominate the macro and we're going to maintain an emphasis on quality and profitability as we look to be active managers," she added.

In fixed income, Shah suggested that more buyers will come into the government bond market once there are clearer signs the Fed is ready to cut rates. But Wilson-Elizondo also called out the corporate bond market - which has shown plenty of resilience this year despite the macro headwinds that remain in the market.

"We didn't see that feared downgrade cycle. Fundamentals for IG companies remain extraordinarily strong. Now that said, we're still suggesting an up-in-quality approach with yields in the 4% to 6% range, which is about double what we saw over the 2009 to 2019 decade. Simply stated, you just don't have to stretch for returns," Wilson-Elizondo said.

Finally, Wilson-Elizondo built on earlier comments made by Bruun on the benefits of adding private credit and alternatives to your portfolio.

"Private credit has been one of the hot topics this year, and the investment backdrop remains highly attractive to us. And we think investors can achieve 11% to 12% yields for first-dollar risk on secured cash flows," she said before adding "We think investors can capitalise on higher funding costs."

And yes, gold is also a good idea. "In our view, it has very strong tactical properties, especially in an environment like this, but it's also a very strong diversifier given that lack of correlation," she added.