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A regime change appears to be taking place. Last year, global central banks commenced one of the most aggressive coordinated tightening of monetary policy on record, causing financial conditions to tighten sharply.

Investors had few places to hide as historically negative correlations broke down between equities and bond prices. This not only led to the largest decline in both bonds and equities in years, it also led to central banks and macro being the most dominant factors impacting performance, with company-level fundamentals pushed to the background.

The debate around regime shift may in fact be more about regime resumption – a resumption back to the pre-Quantitative Easing (QE) era. While the virtues and vices of QE can be debated, the extreme results were evident: the USD 18 trillion of debt trading at negative nominal yields, resulting in elevated valuations across all asset classes; a massive compression of risk premium; capital being forced into more illiquid assets to satisfy liabilities; and the capitulatory TINA – ‘there is no alternative.’

Figure 1: Bloomberg Global Aggregate negative yielding debt market value (USD)

Source: Data from Bloomberg, �۶���Ƶ Asset Management analysis. As of January 13, 2023.

While nothing is ever 100% certain, we feel strongly that the bar for redeploying QE is extraordinarily high. The ‘Fed put’ has become more “out-of-the-money,” and central banks will likely resort to more traditional tools unless the market suffers a severe break.

While macro is always on stage, we believe 2023 will see it move from “the” factor to “a” factor. As central banks begin to taper and pause, the effects from tightening will shift to company fundamentals and earnings. We anticipate more sector and security dispersion which has historically been an optimal environment for long/short investing.

Given the outperformance of US markets and elevated multiples, we see ample alpha hunting ground in Europe and Asia – areas we have committed resources and capital for years. As mentioned in past letters, we continue to believe strongly in the long-term relative value opportunities in China. The picture has become clearer following the National People's Congress (NPC) meeting in October 2022. Policy guidance, combined with a quicker reopening, should reverberate into more company and sector-level relative value opportunities.

Figure 2: Valuation ranges (MSCI Regions) over a 20-year timeline - 12m fwd P/E

Source: Data from Factset, Goldman Sachs Global Investment Research analysis. As of January 2023.

Inflation is, and should, continue coming down. The unknown is where we land and the resultant terminal rate. One thing we can point to with certainty is that nominal yields available in fixed income are the highest and most compelling we have seen in over 15 years.

For the first time since the Global Financial Crisis, 2Y Treasury yields are higher than the forward yield of the S&P 500 and cash is finally earning a carry. In addition, high-yield is providing a healthy 8.5% yield after hitting a low of 3.5% in 2021. Having experienced historically low yields and coupons for many years, corporate bond prices are now at non-recessionary lows, giving investors protection on the downside and convexity on the upside. In addition, credit risk premium looks fair, especially when compared to historically low equity risk premium.

Figure 3: For the first time since the Global Financial Crisis, 2Y Treasury yields are higher than the forward yield of the S&P 500

Source: Data from Bloomberg, �۶���Ƶ Asset Management analysis. As of December 30, 2022.

Figure 4: The equity risk premium has fallen below the post-Global Financial Crisis average

Source: Data from Bloomberg, �۶���Ƶ Asset Management analysis. As of January 6, 2023.

Figure 5: Yield comparison between S&P 500 earnings, 6-month T-bill and US Corporate 1-5y yields

Source: Data from Bloomberg, �۶���Ƶ Asset Management analysis. As of January 6, 2023.

Predicting whether a regime is secular or cyclical is notoriously difficult. Time will tell if the epitaph has been written for the QE era, and if this is indeed the end of the 40-year bull market in rates and ever-expanding central bank balance sheets. Our hunch is that the QE era will be viewed as a cyclical anomaly vs. as a secular shift. Either way, we think those utilizing the QE playbook, which is dependent on secular factors, will be well rewarded in breaking out the pre-QE playbook where fundamentals and valuations ultimately matter.

With our teams looking across the capital structure, and working together with bottom-up expertise in various thematically relevant areas, we are excited about the backdrop for our strategies this year.