2009年10月23日 欧洲:投资组合策略 股市周期第一部分:确认周 Goldman Sachs 期的阶段 股市周期可以分为四个泾渭分明的阶段 投票市场的走势可以分成不同的周期。为了向投资者提供一个参考框架,我们的 分析表明市场从一个高点走向下一个高点的过程可以分成四个泾渭分明的阶段 我们将这四个阶段分别定义为绝望、希望、增长和乐观。在这个系列研究报告的 第一部分中,我们分析了每个阶段的经济背景和股市回报率的决定因素。在第二 部分中,我们分析了资产、风格和行业表现。我们认为欧洲目前处于希望阶段 并在2010年初期进入增长阶段。 我们分析了何时盈利增长才会带来高回报 在增长阶段发生的大多数盈利增长并不能产生合理的回报,盈利增长只有在希望 阶段被准确预见到时和投资者对乐观阶段的未来增长潜力感到过度乐观时才会带 来高回报。增长阶段的盈利增速最高,但回报率在所有阶段中仅排在倒数第 将股市的不同阶段与经济周期联系在一起 周期的不同阶段与经济周期联系在一起。总的来说,绝望阶段往往伴随着经济衰 退。在希望阶段,产出缺口触底而失业率见顶:在增长阶段,产出缺口和失业率 均有显著改善。投资者要求的实际回报率在绝望和增长阶段上升,在希望和乐观 阶段下降 将回报率分成盈利增长和市盈率扩张 a Real earnings growth(%)E Average P/E multiple expa %)Real price returns(%) 彼得欧品海默 4(20)7552-5782 I peteroppenheimer@gscon 24.2% 高盛国际 Christian Mueller-Glissmann CFA 22.5% +44(20)7774-1714 10.9% 2.3% glissmann@gs.com 19% Gerald Moser +44(20)7774-5725Igeraldmoser@gs.com 高盛国际 33 month 14 months 资料来源: Worldscope, Haver Analytics, Datastream,高盛全球经济、商品和策略研究 +44(20)7552-3000Ianderse.nielsen@gs.com Sharon Bell. CFA +44(20)7552-1341| sharon. be@gscm 高盛集团 高盛全球经济、商品和策略研究
2009 年 10 月 23 日 欧洲：投资组合策略 高盛全球经济、商品和策略研究 1 2009 年 10 月 23 日 欧洲：投资组合策略 股市周期第一部分：确认周 期的阶段 股市周期可以分为四个泾渭分明的阶段 股票市场的走势可以分成不同的周期。为了向投资者提供一个参考框架，我们的 分析表明市场从一个高点走向下一个高点的过程可以分成四个泾渭分明的阶段， 我们将这四个阶段分别定义为绝望、希望、增长和乐观。在这个系列研究报告的 第一部分中，我们分析了每个阶段的经济背景和股市回报率的决定因素。在第二 部分中，我们分析了资产、风格和行业表现。我们认为欧洲目前处于希望阶段， 并在 2010 年初期进入增长阶段。 我们分析了何时盈利增长才会带来高回报 在增长阶段发生的大多数盈利增长并不能产生合理的回报，盈利增长只有在希望 阶段被准确预见到时和投资者对乐观阶段的未来增长潜力感到过度乐观时才会带 来高回报。增长阶段的盈利增速最高，但回报率在所有阶段中仅排在倒数第二 位。 ...将股市的不同阶段与经济周期联系在一起 周期的不同阶段与经济周期联系在一起。总的来说，绝望阶段往往伴随着经济衰 退。在希望阶段，产出缺口触底而失业率见顶；在增长阶段，产出缺口和失业率 均有显著改善。投资者要求的实际回报率在绝望和增长阶段上升，在希望和乐观 阶段下降。 将回报率分成盈利增长和市盈率扩张 -30 -20 -10 0 10 20 30 40 50 60 Real earnings growth (%) Average P/E multiple expansion (%) Real price returns (%) 26 months 10 months 33 months 14 months Despair Hope Growth Optimism -24.9% -7.3% 51.2% 0.7% 10.9% 22.5% 27.1% 24.2% -19% 50.2% -9.5% 2.3% 资料来源：Worldscope、Haver Analytics、Datastream、高盛全球经济、商品和策略研究 彼得·欧品海默 +44(20)7552-5782 | peter.oppenheimer@gs.com 高盛国际 Christian Mueller-Glissmann, CFA +44(20)7774-1714 | christian.muellerglissmann@gs.com 高盛国际 Gerald Moser +44(20)7774-5725 | gerald.moser@gs.com 高盛国际 Anders Nielsen +44(20)7552-3000 | anders.e.nielsen@gs.com 高盛国际 Sharon Bell, CFA +44(20)7552-1341 | sharon.bell@gs.com 高盛集团与本研究报告所分析的企业存在业务关系，并且继续寻求发展这些关系。因此，投资者应当考虑到本公司可能存在可能影响本报告客观性 的利益冲突，不应视本报告为作出投资决策的唯一因素。有关分析师的申明，见本报告最后部分。其他重要信息披露见分析师申明之后部分，或参 阅 www.gs.com/research/hedge.html。由非美国附属公司聘用的分析师不是美国 FINRA的注册/合格研究分析师。 高盛集团 高盛全球经济、商品和策略研究
October 23 2009 Europe: Portfolio Strategy man The equity cycle part 1: sans Identifying the phases The equity cycle is divided in 4 distinct phases Peter Oppenheimer The equity market moves in cycles. In order to develop a frame of +44(20)7552-5782ipeter.oppenheimer@gs.com reference for investors, we show how the cycle from one peak of the Goldman Sachs Internation market to the next is divided into four distinct phases, which we describe as: Despair, Hope, Growth and Optimism. Here, in Part I of thisChristian Mueller-Glissmann,CFA seriesweanalyzetheeconomiccontextandthedriversofstockmarketglissmann@gs.com returns for each phase. In Part ll, we will analyze asset, style and sector Goldman Sachs International performance. We believe Europe is currently in the Hope phase and will move into the growth phase in the early part of 2010 Gerald I +44(20)7774-5725geraldmoser@gs.com Goldman Sachs International We analyze when earnings growth is paid for Most earnings growth is not paid for when it occurs during the Growth Anders Nielsen +44(20)7552-3000anders.e.nielsen@gs.com phase, but when it is correctly anticipated during the Hope phase, and Goldman Sachs Interna tional when investors get overly optimistic about the future growth potential during the Optimism phase. The Growth phase sees the highest rate of Sharon Bell,CFA earnings growth, but the second lowest rate of return over the cycle Goldman Sachs Internation and tie these patterns to the economic cycle The phases are related to the economy. Generally the Despair phase is associated with a recession. The output gap troughs and the unemployment rate peaks during the Hope phase, while the growth phase sees sharp improvements in both variables. Investors real required return rises during the despair and growth phases and falls during the Hope and Optimism phases Decomposition of returns into earnings growth and P/E expansion Real earnings growth(%) Average P/E multiple expansion (% Real price retums ( 50 24.2% 27.1% 0.9% 2.3% -9.5% 19% 30 Despai 0 months mm→: optimism 14 months Source: Worldscope, Haver Analytics, Datastream, Goldman Sachs Global ECS Research man Sachs G Inm dv hs ve d seen'sicto o tesis sh at ith ua afect h e opered ivititsr heare ports. as a re y registered/qualified as research analysts w Goldman Sachs Global Economics, Commodities and strategy R
October 23, 2009 Europe: Portfolio Strategy Goldman Sachs Global Economics, Commodities and Strategy Research 1 Europe: Portfolio Strategy The equity cycle part 1: Identifying the phases The equity cycle is divided in 4 distinct phases The equity market moves in cycles. In order to develop a frame of reference for investors, we show how the cycle from one peak of the market to the next is divided into four distinct phases, which we describe as: Despair, Hope, Growth and Optimism. Here, in Part I of this series, we analyze the economic context and the drivers of stock market returns for each phase. In Part II, we will analyze asset, style and sector performance. We believe Europe is currently in the Hope phase and will move into the Growth phase in the early part of 2010. We analyze when earnings growth is paid for Most earnings growth is not paid for when it occurs during the Growth phase, but when it is correctly anticipated during the Hope phase, and when investors get overly optimistic about the future growth potential during the Optimism phase. The Growth phase sees the highest rate of earnings growth, but the second lowest rate of return over the cycle. …and tie these patterns to the economic cycle The phases are related to the economy. Generally, the Despair phase is associated with a recession. The output gap troughs and the unemployment rate peaks during the Hope phase, while the Growth phase sees sharp improvements in both variables. Investors’ real required return rises during the Despair and Growth phases and falls during the Hope and Optimism phases. Decomposition of returns into earnings growth and P/E expansion -30 -20 -10 0 10 20 30 40 50 60 Real earnings growth (%) Average P/E multiple expansion (%) Real price returns (%) 26 months 10 months 33 months 14 months Despair Hope Growth Optimism -24.9% -7.3% 51.2% 0.7% 10.9% 22.5% 27.1% 24.2% -19% 50.2% -9.5% 2.3% Source: Worldscope, Haver Analytics, Datastream, Goldman Sachs Global ECS Research. Peter Oppenheimer +44(20)7552-5782 | peter.oppenheimer@gs.com Goldman Sachs International Christian Mueller-Glissmann, CFA +44(20)7774-1714 | christian.muellerglissmann@gs.com Goldman Sachs International Gerald Moser +44(20)7774-5725 | gerald.moser@gs.com Goldman Sachs International Anders Nielsen +44(20)7552-3000 | anders.e.nielsen@gs.com Goldman Sachs International Sharon Bell, CFA +44(20)7552-1341 | sharon.bell@gs.com Goldman Sachs International The Goldman Sachs Group, Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification, see the end of the text. Other important disclosures follow the Reg AC certification, or go to www.gs.com/research/hedge.html. Analysts employed by non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S. The Goldman Sachs Group, Inc. Goldman Sachs Global Economics, Commodities and Strategy Research
October 23 2009 Europe: Portfolio Strategy The four phases of the equity market cycle The equity market moves in cycles. as the market moves away from the trough in March, it becomes increasingly important for investors to identify alternative points of reference, against which to think about potential investment strategies. Here, we develop a framework of such reference points through out the cycle. We show how each of the five cycles from one peak of the market to the next since 1973 can be divided into four distinct phases, each with its own economic context, drivers of stock market returns and investment strategies Our analysis comes in two parts. In this report, Part I of the series, we identify the phases, discuss their relationship to the economic cycle, and most importantly show that earnings growth is only to a very limited extend paid for when it occurs. In Part l of the series we will show the systematic historical patterns of asset classes, styles and sector performance for each of the phases The division of the cycle into phases is illustrated in Exhibit 1. We identify the phases by determining the extent to which the index price performance is driven by actual profit growth and by expectations, measured as changes in the P/E multiple. The four phases we define are: 1. The Despair phase is defined as the period where the market moves from its peak to its trough. This correction is mainly driven by P/E-multiple contraction as the market anticipates and reacts to a deteriorating macroeconomic environment and its implications in terms of lower future earnings Exhibit 1: The equity market moves in cycles Cycle of the Equity Market for Europe ex UK all growth rates are annualized averages) market moves from peak to trough xpectations are disappoi Poor earnings growth, -7.3% Weak eamings growth, 2.3% Poor earnings growth, 0.7%
October 23, 2009 Europe: Portfolio Strategy Goldman Sachs Global Economics, Commodities and Strategy Research 2 The four phases of the equity market cycle The equity market moves in cycles. As the market moves away from the trough in March, it becomes increasingly important for investors to identify alternative points of reference, against which to think about potential investment strategies.1 Here, we develop a framework of such reference points through out the cycle. We show how each of the five cycles from one peak of the market to the next since 1973 can be divided into four distinct phases, each with its own economic context, drivers of stock market returns and investment strategies. Our analysis comes in two parts. In this report, Part I of the series, we identify the phases, discuss their relationship to the economic cycle, and most importantly show that earnings growth is only to a very limited extend paid for when it occurs. In Part II of the series we will show the systematic historical patterns of asset classes, styles and sector performance for each of the phases. The division of the cycle into phases is illustrated in Exhibit 1. We identify the phases by determining the extent to which the index price performance is driven by actual profit growth and by “expectations”, measured as changes in the P/E multiple. The four phases we define are: 1. The Despair phase is defined as the period where the market moves from its peak to its trough. This correction is mainly driven by P/E-multiple contraction as the market anticipates and reacts to a deteriorating macroeconomic environment and its implications in terms of lower future earnings. Exhibit 1: The equity market moves in cycles 4. Optimism P/E multiple grows faster than earnings - Expectation extrapolated - Second best return, 27.1% - Weak earnings growth, 2.3% 1. Despair Market moves from peak to trough - Expectations are disappointed - Worst return, -24.9% - Poor earnings growth, -7.3% 3. Growth Earnings grow faster than the P/E multiple - Reality catches up to expectations - Second lowest return, 10.9% - HIghest earnings growth, 22.5% Cycle of the Equity Market for Europe ex. UK (all growth rates are annualized averages) Volatility increases Volatility decreases 2. Hope P/E multiple expands - Expectation of a better future - Highest return, 51.2% - Poor earnings growth, 0.7% Source: Goldman Sachs Global ECS Research. 1 We would like to thank Hanyi Lim for her contributions to this report
October 23 2009 pe: Portfolio Strategy 2. The Hope phase is typically a short period (on average 10 months), where the market rebounds from its trough through multiple expansion. this occurs in anticipation of a forthcoming trough in the economic cycle as well as future profit growth and is leading to a local peak in the trailing P/E multiple. We define the end of the Hope phase as this local peak of the trailing P/E multiple 3. The growth phase is a typically longer period(on average 33 months), where arnings growth drives returns We define the end of this period to be when multiple expansion again starts to provide a larger proportion of the returns than earnings growth 4. The Optimism phase is the final part of the cycle, where returns driven by P/E- multiple expansion outpace earnings growth, thereby setting the stage for the next market correction The framework demonstrates that the relationship between earnings growth and price performance changes systematically over the cycle. While earnings growth is what fuels equity market performance over the very long run, most of the earnings growth is not paid for when it occurs but rather when it is correctly anticipated by investors in the Hope phase and when investors get overly optimistic about the potential for future growth during the Optimism phase Exhibit 2 illustrates this for Europe ex UK. For each phase, it indicates the average length of the phase the average annualized price return and how that is distributed between ltiple expansion and earnings growth. While the growth phase sees most of the growth in earnings, the price return mainly occurs in the Hope and Optimism phases Exhibit 2: Decomposition of returns into earnings growth and multiple expansion Annualized contributions to real price returns from real 60 1-Real earnings grow th( %)Average P/E multiple expansion(%) Real price returns (%) 73 -24.9% -30 oPtimism Source: Worldscope, Haver Analytics, Datastream, Goldman Sachs Global ECS Research
October 23, 2009 Europe: Portfolio Strategy Goldman Sachs Global Economics, Commodities and Strategy Research 3 2. The Hope phase is typically a short period (on average 10 months), where the market rebounds from its trough through multiple expansion. This occurs in anticipation of a forthcoming trough in the economic cycle as well as future profit growth and is leading to a local peak in the trailing P/E multiple. We define the end of the Hope phase as this local peak of the trailing P/E multiple. 3. The Growth phase is a typically longer period (on average 33 months), where earnings growth drives returns. We define the end of this period to be when multiple expansion again starts to provide a larger proportion of the returns than earnings growth. 4. The Optimism phase is the final part of the cycle, where returns driven by P/Emultiple expansion outpace earnings growth, thereby setting the stage for the next market correction. The framework demonstrates that the relationship between earnings growth and price performance changes systematically over the cycle. While earnings growth is what fuels equity market performance over the very long run, most of the earnings growth is not paid for when it occurs but rather when it is correctly anticipated by investors in the Hope phase and when investors get overly optimistic about the potential for future growth during the Optimism phase. Exhibit 2 illustrates this for Europe ex. UK. For each phase, it indicates the average length of the phase, the average annualized price return and how that is distributed between multiple expansion and earnings growth. While the Growth phase sees most of the growth in earnings, the price return mainly occurs in the Hope and Optimism phases. Exhibit 2: Decomposition of returns into earnings growth and multiple expansion Annualized contributions to real price returns from real earnings growth and P/E expansion -30 -20 -10 0 10 20 30 40 50 60 Real earnings grow th (%) Average P/E multiple expansion (%) Real price returns (%) 26 months 10 months 33 months 14 months Despair Hope Grow th Optimism -24.9% -7.3% 51.2% 0.7% 10.9% 22.5% 27.1% 24.2% -19% 50.2% -9.5% 2.3% Source: Worldscope, Haver Analytics, Datastream, Goldman Sachs Global ECS Research
October 23 2009 pe: Portfolio Strategy On our way from Hope to Growth The European market is currently in the Hope phase this phase typically lasts 10 months from the trough, seeing expansion of the multiple while LTM earnings are still declining. The range has been from 4 months in the short cycle in the late 1980s to 18 months in the cycle in the early 1980s. We expect earnings to decline 16% in 2009, yet the market is up 25% YTD and we expect the market to rise another 5% from here to our year- We expect the market to switch into the growth phase in the early part of 2010, as earnings growth picks up while our return target of 275 on a 12 month basis indicates only a modest rise in the index of 6% from our 260 year-end 2009 target Our prediction of the timing of the switch from Hope to growth comes with significant uncertainty. On one hand, valuation at the trough of the market was very attractive. This could give room for a longer period of multiple expansion before the switch to the growth phase occurs, consistent with the cycle in the early 1980s. On the other hand given the concerns in the market about final demand recovery in developed economies, we could switch into the"show me the money"environment of the growth phase relatively early Our forecast of the timing of the switch from Hope to growth is based on the economic environment. There is no one economic indicator that precisely determines when the switch occurs, but the PMi and the unemployment rate have historically been useful indicators the switch fror time when the Pmi passed 50. this is consistent with the US experience, where our data goes further back. Here a sustained switch into the ISM being above 50 has coincided with the switch to the growth phase in 3 out of 5 cycles. The European PM is currently at 49. 3, so we are around that level Unemployment: In the cycles in the 1970s and early 1980s the unemployment rate peaked in the Us before the market switched into the growth phase. this relationshi hanged in the last two jobless recoveries, where the switch from Hope to growth ccurred at or slightly before the peak in the unemployment rate. In Europe the same picture emerges for the last two cycles where we have data On our economists forecasts the unemployment rate for Euroland will peak in the third quarter of 2010 at 10.5%, but reach 10.4% in the second quarter of 2010 In sum the PMi would suggest that the switch is likely to occur relatively soon whereas the unemployment forecast would suggest the timing to be around the middle of the next year this range is consistent with our forecasts for earnings and DJ Stoxx index returns. We believe the switch is most likely to occur in the first half of the range, which would give a slightly longer Hope phase than the historical average oldman Sachs Global Economics, Commodities and strategy Research
October 23, 2009 Europe: Portfolio Strategy Goldman Sachs Global Economics, Commodities and Strategy Research 4 On our way from Hope to Growth The European market is currently in the Hope phase. This phase typically lasts 10 months from the trough, seeing expansion of the multiple while LTM earnings are still declining. The range has been from 4 months in the short cycle in the late 1980s to 18 months in the cycle in the early 1980s. We expect earnings to decline 16% in 2009, yet the market is up 25% YTD and we expect the market to rise another 5% from here to our yearend target of 260. We expect the market to switch into the Growth phase in the early part of 2010, as earnings growth picks up while our return target of 275 on a 12 month basis indicates only a modest rise in the index of 6% from our 260 year-end 2009 target. Our prediction of the timing of the switch from Hope to Growth comes with significant uncertainty. On one hand, valuation at the trough of the market was very attractive. This could give room for a longer period of multiple expansion before the switch to the Growth phase occurs, consistent with the cycle in the early 1980s. On the other hand, given the concerns in the market about final demand recovery in developed economies, we could switch into the “show me the money” environment of the Growth phase relatively early. Our forecast of the timing of the switch from Hope to Growth is based on the economic environment. There is no one economic indicator that precisely determines when the switch occurs, but the PMI and the unemployment rate have historically been useful indicators. • PMI: In the last cycle the switch from Hope to Growth in Europe occurred around the time when the PMI passed 50. This is consistent with the US experience, where our data goes further back. Here a sustained switch into the ISM being above 50 has coincided with the switch to the growth phase in 3 out of 5 cycles. The European PMI is currently at 49.3, so we are around that level. • Unemployment: In the cycles in the 1970s and early 1980s the unemployment rate peaked in the US before the market switched into the Growth phase. This relationship changed in the last two jobless recoveries, where the switch from Hope to Growth occurred at or slightly before the peak in the unemployment rate. In Europe the same picture emerges for the last two cycles where we have data. On our economists’ forecasts the unemployment rate for Euroland will peak in the third quarter of 2010 at 10.5%, but reach 10.4% in the second quarter of 2010. In sum, the PMI would suggest that the switch is likely to occur relatively soon, whereas the unemployment forecast would suggest the timing to be around the middle of the next year. This range is consistent with our forecasts for earnings and DJ Stoxx index returns. We believe the switch is most likely to occur in the first half of the range, which would give a slightly longer Hope phase than the historical average
October 23 2009 pe: Portfolio Strategy The phases can be interpreted in relationship to the economy The phases are clearly linked to the economy. this allows for a clearer interpretation of the phases and helps in identifying when we are moving from one phase to the next. The output gap falls in the Despair and Hope phase as output falls behind potential. The trough occurs between the middle and the end of the Hope Phase. In the growth Phase the We measure investors' forward-looking return requirements in terms of the Real Required Return(RRR)defined as the equity Risk Premium plus the 10 year nominal bond yield minus five year historical average inflation. this measure generally increases in the Despair and growth phases and decreases in the Hope and optimism phases. We interpret these movements in investors' forward-looking return requirements across the phases as follows During the Despair phase, investors get increasingly concerned about future prospects, and therefore require an increasingly high future expected return for holding equities. this reaction happens against a backdrop of an increase in volatility an increase in the output gap and in four out of five cycles the start of a recession during this phase in the US. This leads to lower P/E multiples and a falling market. In the Hope phase, an end to the crisis starts to be visible and this visibility caps the potential downside risk Investors respond to the lower tail risk by accepting lower future expected returns. This drives up multiples and the market. While volatility is still high, it tends to fall towards the end of the Hope phase. In this phase investors essentially prepay for the expected recovery in earnings during the growth phase In the beginning of the growth phase, investors have been through a period with high volatility. This is likely to make investors perceive equities as more risky and therefore less attractive. Investors have also already been paid for expected future earnings growth during the Hope phase, but the growth has yet to materialize. The output gap typically peaks some time during the Hope phase, but remains very high at the beginning of the growth phase. the onset of the growth phase is therefore a reasonable point in time for investors to question long- run growth expectations. These initial negatives tend to make investors less willing to pay for the earnings growth they see in the early stages of the growth phase. this gives lower rates of return, which reinforces the negative picture of equities and makes investors less willing to pay for the improvements in fundamentals that they see on an ongoing basis. The result is that value in terms of expected future returns are rebuilt during the Growth phase as earnings growth outpaces returns, and volatility declines Another likely driver of the higher real return requirements in the equity market that are built up during this phase is the increase in the real yield which is seen in bond Eventually, in the Optimism phase, the built-up value becomes large enough to attract investors and to reverse the dynamic of poor returns keeping away investors despite strengthening fundamentals In the Optimism phase, returns outpace earnings and expected future returns consequently decline. Towards the end of the phase volatility picks up as the sustainability of the high returns are being tested by the market. In the next sections we develop these conclusions in more detail. First we show how investors pay for most of the earnings growth before it occurs in the hope phase and after it occurs in the Optimism phase. We then cover each cycle in detail, showing the cut-offs we have chosen for the phases, and the performance of earnings growth and multiple expansion for the two markets(Europe ex UK and the UK)that we consider. We also oldman Sachs Global Economics, Commodities and strategy Research
October 23, 2009 Europe: Portfolio Strategy Goldman Sachs Global Economics, Commodities and Strategy Research 5 The phases can be interpreted in relationship to the economy The phases are clearly linked to the economy. This allows for a clearer interpretation of the phases and helps in identifying when we are moving from one phase to the next. The output gap falls in the Despair and Hope phase as output falls behind potential. The trough occurs between the middle and the end of the Hope Phase. In the Growth Phase the output gap increases as actual output growth outpaces potential growth. We measure investors’ forward-looking return requirements in terms of the Real Required Return (RRR) defined as the Equity Risk Premium plus the 10 year nominal bond yield minus five year historical average inflation. This measure generally increases in the Despair and Growth phases and decreases in the Hope and Optimism phases. We interpret these movements in investors’ forward-looking return requirements across the phases as follows: • During the Despair phase, investors get increasingly concerned about future prospects, and therefore require an increasingly high future expected return for holding equities. This reaction happens against a backdrop of an increase in volatility, an increase in the output gap and in four out of five cycles the start of a recession during this phase in the US. This leads to lower P/E multiples and a falling market. • In the Hope phase, an end to the crisis starts to be visible and this visibility caps the potential downside risk. Investors respond to the lower tail risk by accepting lower future expected returns. This drives up multiples and the market. While volatility is still high, it tends to fall towards the end of the Hope phase. In this phase investors essentially prepay for the expected recovery in earnings during the Growth phase. • In the beginning of the Growth phase, investors have been through a period with high volatility. This is likely to make investors perceive equities as more risky and therefore less attractive. Investors have also already been paid for expected future earnings growth during the Hope phase, but the growth has yet to materialize. The output gap typically peaks some time during the Hope phase, but remains very high at the beginning of the Growth phase. The onset of the Growth phase is therefore a reasonable point in time for investors to question long-run growth expectations. These initial negatives tend to make investors less willing to pay for the earnings growth they see in the early stages of the Growth phase. This gives lower rates of return, which reinforces the negative picture of equities and makes investors less willing to pay for the improvements in fundamentals that they see on an ongoing basis. The result is that value in terms of expected future returns are rebuilt during the Growth phase as earnings growth outpaces returns, and volatility declines. Another likely driver of the higher real return requirements in the equity market that are built up during this phase is the increase in the real yield which is seen in bond markets. • Eventually, in the Optimism phase, the built-up value becomes large enough to attract investors and to reverse the dynamic of poor returns keeping away investors despite strengthening fundamentals. In the Optimism phase, returns outpace earnings and expected future returns consequently decline. Towards the end of the phase volatility picks up as the sustainability of the high returns are being tested by the market. In the next sections we develop these conclusions in more detail. First we show how investors pay for most of the earnings growth before it occurs in the Hope phase and after it occurs in the Optimism phase. We then cover each cycle in detail, showing the cut-offs we have chosen for the phases, and the performance of earnings growth and multiple expansion for the two markets (Europe ex UK and the UK) that we consider. We also
October 23 2009 Europe: Portfolio Strategy provide data on the Us for illustrative purposes only. this allows us to test the robustness ur conclusions by showing that they are not driven by a Europe-specific factor or the lower frequency of earnings reports in Europe. Finally, we provide a more in depth analysis of the economic backdrop for the phases and, in an appendix, show how key economic variables have moved for each cycle Most earnings growth is not paid for when it occurs In this section we aggregate the earnings growth and price return performance for each phase across the five cycles. there are three key conclusions: The highest annualized returns occur during the Hope phase, followed by the Optimism phase, the growth phase and finally the Despair phase. This has been true in every cycle in the US and holds in all regions on average Actual profit growth and returns are surprisingly unsynchronized. Almost the entire earnings growth for each region occurs during the growth phase, yet only 28%, 3%and% of the index real price return from the trough to the peak of the market accumulates during that phase, for Europe ex. UK, the UK and the Us respectively It is not surprising that the market rises in expectation of future earnings growth and that a part of the earnings growth in the growth phase is therefore paid for during Hope phase. But the degree to which this happens is surprising, leaving negative returns on average for the growth phase in the US market, where the quarterly reporting of earnings allows us to make the most precise cut-off between the historical Real interest rates recover in the growth phase in the Us In every cycle since 1973 the largest increase in the real interest rate occurred during the growth phase. In total across the five cycles, the real interest rate increased 10.2 percentage points during the Growth phase. In Europe the pattern has been much less clear. We believe this is partly due to the lower frequency of earnings data making the changes between phases less clear, and partly due to European equities pricing the Us The data are given in Exhibits 3-5. The aggregate section of each Exhibit shows the cumulative real price return, real earnings growth and P/E expansion these are calculated by looking at the compound growth in each of the metrics over the 5 times each phase has occurred between the market peak in 1973 and the market peak in 2007. As an example, Exhibit 3 shows that an investor, who invested in Europe ex UK from the beginning to the end of each Despair phase and earned a zero return in all other phases would have earned a compounded real return of -95%, and have owned the index during periods of time where the compound real earnings growth(on an LTM basis)was-56% The proportion of return line shows how much of the compound return from the trough the peak of the five cycles was earned in the Hope growth and Optimism phases respectively. Finally, the change in real interest rate line shows the sum over the five cycles, of the change in real interest rate from the beginning to the end of each phase. Some of these figures are then annualized in the lower section of the tables oldman Sachs Global Economics, Commodities and strategy Research
October 23, 2009 Europe: Portfolio Strategy Goldman Sachs Global Economics, Commodities and Strategy Research 6 provide data on the US for illustrative purposes only. This allows us to test the robustness of our conclusions by showing that they are not driven by a Europe-specific factor or the lower frequency of earnings reports in Europe. Finally, we provide a more in depth analysis of the economic backdrop for the phases and, in an appendix, show how key economic variables have moved for each cycle. Most earnings growth is not paid for when it occurs In this section we aggregate the earnings growth and price return performance for each phase across the five cycles. There are three key conclusions: • The highest annualized returns occur during the Hope phase, followed by the Optimism phase, the Growth phase and finally the Despair phase. This has been true in every cycle in the US and holds in all regions on average. • Actual profit growth and returns are surprisingly unsynchronized. Almost the entire earnings growth for each region occurs during the growth phase, yet only 28%, 3% and -1% of the index real price return from the trough to the peak of the market accumulates during that phase, for Europe ex. UK, the UK and the US respectively. It is not surprising that the market rises in expectation of future earnings growth and that a part of the earnings growth in the Growth phase is therefore paid for during the Hope phase. But the degree to which this happens is surprising, leaving negative returns on average for the Growth phase in the US market, where the quarterly reporting of earnings allows us to make the most precise cut-off between the historical phases. • Real interest rates recover in the Growth phase in the US. In every cycle since 1973 the largest increase in the real interest rate occurred during the Growth phase. In total across the five cycles, the real interest rate increased 10.2 percentage points during the Growth phase. In Europe the pattern has been much less clear. We believe this is partly due to the lower frequency of earnings data making the changes between phases less clear, and partly due to European equities pricing the US economic cycle to some extent. The data are given in Exhibits 3-5. The aggregate section of each Exhibit shows the cumulative real price return, real earnings growth and P/E expansion. These are calculated by looking at the compound growth in each of the metrics over the 5 times each phase has occurred between the market peak in 1973 and the market peak in 2007. As an example, Exhibit 3 shows that an investor, who invested in Europe ex UK from the beginning to the end of each Despair phase and earned a zero return in all other phases, would have earned a compounded real return of -95%, and have owned the index during periods of time where the compound real earnings growth (on an LTM basis) was -56%. The proportion of return line shows how much of the compound return from the trough to the peak of the five cycles was earned in the Hope, Growth and Optimism phases respectively. Finally, the change in real interest rate line shows the sum over the five cycles, of the change in real interest rate from the beginning to the end of each phase. Some of these figures are then annualized in the lower section of the tables
October 23 2009 pe: Portfolio Strategy Exhibit 3: Decomposition of Europe ex UK equity market performance over the cycle Despair Hope Growth Optimist Average length(months 14.3 emulative Real Price Return -95.3 453.0 316.0 55.8 2.8 14.6 P/E expansion 89.5 438.2 74.0 263.0 Proportion of Retum(% 42.2 28.4 Change in real interest rate 222 Real Price Return(%) 24.9 51.2 0.9 27.1 Real Earnings Growth 22.5 .3 Change in real interest rate(pp) 1.1 0.9 Source: Worldscope, Haver Analytics, Datastream, Goldman Sachs Global ECS Research Exhibit 4: Decomposition of UK equity market performance over the cycle Despair Hope Growth Optimism ge length(months) 17.1 emulative Real Price Return (% 96.2 40.4 7.1 P/E expansion -95.513273 82.2 381.8 Proportion of return (%) 37.9 Change in real interest rates(pp 352 3.0 28.0 Real Eamings Growth Change in real interest rates (pp) 2. 0.3 0.0 Source: Worldscope, Haver Analytics, Datastream, Goldman Sachs Global ECS Research. Exhibit 5: Decomposition of Us equity market performance over the cycl Despair Hope Growth Optimism ngth(months) Real Price Return 2.9 392.3 16.1 836.6 Real Eamings Growth 41.5 92.8 84.5 Proportion of return(%) 32.3 13 69.0 Change in real interest rates(pp) 2 10.2 Real Price Return(%) 32.9 50.9 1.2 eal Earnings Growth .2 hange in real interest rates(pp) -0.3 oldman Sachs Global Economics, Commodities and strategy Research
October 23, 2009 Europe: Portfolio Strategy Goldman Sachs Global Economics, Commodities and Strategy Research 7 Exhibit 3: Decomposition of Europe ex UK equity market performance over the cycle Despair Hope Growth Optimism Average length (months) 25.7 9.9 32.5 14.3 Cumulative Real Price Return (%) -95.3 453.0 304.8 316.0 Real Earnings Growth -55.8 2.8 1456.1 14.6 P/E expansion -89.5 438.2 -74.0 263.0 Proportion of Return (%) 42.2 28.4 29.4 Change in real interest rate (pp) -2.2 -4.5 -0.1 5.1 Annualized Real Price Return (%) -24.9 51.2 10.9 27.1 Real Earnings Growth -7.3 0.7 22.5 2.3 Change in real interest rate (pp) -0.2 -1.1 0.0 0.9 Source: Worldscope, Haver Analytics, Datastream, Goldman Sachs Global ECS Research. Exhibit 4: Decomposition of UK equity market performance over the cycle Despair Hope Growth Optimism Average length (months) 21.4 17.1 27.5 16.7 Cumulative Real Price Return (%) -96.2 716.7 40.4 461.3 Real Earnings Growth -17.1 -42.8 687.5 16.5 P/E expansion -95.5 1327.3 -82.2 381.8 Proportion of return (%) 58.8 3.3 37.9 Change in real interest rates (pp) 12.0 -15.7 3.4 0.1 Annualized Real Price Return (%) -30.8 34.3 3.0 28.0 Real Earnings Growth -2.1 -7.5 19.8 2.2 Change in real interest rates (pp) 1.3 -2.2 0.3 0.0 Source: Worldscope, Haver Analytics, Datastream, Goldman Sachs Global ECS Research. Exhibit 5: Decomposition of US equity market performance over the cycle Despair Hope Growth Optimism Average length (months) 15.9 9.3 34.1 24.1 Cumulative Real Price Return (%) -92.9 392.3 -16.1 836.6 Real Earnings Growth -1.4 -21.4 441.5 -17.5 P/E expansion -92.8 525.9 -84.5 1035.5 Proportion of return (%) 32.3 -1.3 69.0 Change in real interest rates (pp) -1.2 -5.0 10.2 -3.1 Annualized Real Price Return (%) -32.9 50.9 -1.2 24.9 Real Earnings Growth -0.2 -6.0 12.6 -1.9 Change in real interest rates (pp) -0.2 -1.3 0.7 -0.3 Source: Compustat, Haver Analytics, Datastream, Goldman Sachs Global ECS Research
October 23 2009 pe: Portfolio Strategy The 1970s cycle in charts: a tough cycle for equity markets The cycle in the 1970s was the worst of the five cycles we consider in Continental Europe, the UK and the Us from an equity market perspective. Multiple contraction over the cycle ranging from 42% in the UK to 52% in the US overpowered earnings growth ind led to negative price returns over the cycle for all three markets The poor market performance reflected the large supply-side shock from higher oil prices and the inflationary process initiated by this shock getting out of control Generally cycles where the initial setback is driven by structural problems tend to have longer growth phases than other cycles, as it takes longer for investors to regain the confidence that makes them willing to pay more for earnings and therefore move the market into the optimism phase. this is particularly pronounced in the US where the growth phase in the 1970s was the longest on record The end of the cycle includes the first part of the double dip recession in the early 1980s for the Us but not in Continental Europe and the UK. We have done this as the Us index recovered enough between the two dips to make up the lost ground from the first dip whereas this did not happen in Europe Exhibit 6: Division of the 1970s cycle into phases for Europe ex UK Europe ex UK Cumulative Change -Despair- Grow th. 100 80 Mar-73 Mar-74 Mar-78 US Recessions -Returns End date07/101974150419751507/197720101978 Length(in months) 15.2 39 12.9 Eamings Growth 48.9 P/E expansion Proportion of return ( Annualized 38.5 Earnings Growth Change in real interest rate (pp) 1.0 Analytics,Datastream,Goldman Sachs Global ECS. Goldman Sachs Global Economics, Commodities and strategy Research
October 23, 2009 Europe: Portfolio Strategy Goldman Sachs Global Economics, Commodities and Strategy Research 8 The 1970s cycle in charts: A tough cycle for equity markets The cycle in the 1970s was the worst of the five cycles we consider in Continental Europe, the UK and the US from an equity market perspective. Multiple contraction over the cycle ranging from 42% in the UK to 52% in the US overpowered earnings growth and led to negative price returns over the cycle for all three markets. The poor market performance reflected the large supply-side shock from higher oil prices and the inflationary process initiated by this shock getting out of control. Generally cycles where the initial setback is driven by structural problems tend to have longer growth phases than other cycles, as it takes longer for investors to regain the confidence that makes them willing to pay more for earnings and therefore move the market into the optimism phase. This is particularly pronounced in the US where the growth phase in the 1970s was the longest on record. The end of the cycle includes the first part of the double dip recession in the early 1980s for the US but not in Continental Europe and the UK. We have done this as the US index recovered enough between the two dips to make up the lost ground from the first dip, whereas this did not happen in Europe. Exhibit 6: Division of the 1970s cycle into phases for Europe ex UK Europe ex UK 20 40 60 80 100 120 140 160 180 200 Mar-73 Mar-74 Mar-75 Mar-76 Mar-77 Mar-78 US Recessions Returns Earnings PE Cumulative Change Despair Hope Growth Optimism Start date 22/03/1973 07/10/1974 15/04/1975 15/07/1977 End date 07/10/1974 15/04/1975 15/07/1977 20/10/1978 Length (in months) 18.5 6.2 27.0 15.2 Real Return -52.8 39.8 12.9 13.0 Real Earnings Growth 19.6 1.2 48.9 -8.8 P/E expansion -60.5 38.1 -24.1 23.9 Proportion of return (%) 60.5 19.7 19.8 Annualized Real Return -38.5 90.4 5.6 10.1 Earnings Growth 12.3 2.4 19.3 -7.0 Change in real interest rate (pp) 0.7 -2.0 -2.3 1.0 Source: Worldscope, Haver Analytics, Datastream, Goldman Sachs Global ECS Research
October 23 2009 pe: Portfolio Strategy Exhibit 7: Division of the 1970s cycle into phases for the UK and US United Kingdom emulative Change espair----------> 120 80 Jan -73 an-76 Jan -77 Jan-78 Jan-79 Earnings Despair Growth Start date10/01/19731212/197430/01/197609031978 End date12/12/197430/01/1976o9/03/19780405/1979 Real Ret 122.8 25.7 P/E expansion 310.3 -31.1 Proportion of return (% .5 66.6 25.4 armings Growth Change in real interest rate(pp) 5.6 22.1 0.9 United States Cumulative change Grow theas ><Optimism Jan-74 Jan-75 Jan-76 Jan77 Jan-78 Jan-79 Jan-80 US Recessions etu 03/1019741507/197527/03198020/11/1980 Length(n m he Real Eamings Growth 15.6 9 48.8 Proportion of return ( %6 90.4 59.7 -36.6 60.3 7.1 56.9 7 -0.2 Source: Worldscope, Compustat, Haver Analytics, Datastream, Goldman Sachs Global ECS Research. oldman Sachs Global Economics, Commodities and strategy Research
October 23, 2009 Europe: Portfolio Strategy Goldman Sachs Global Economics, Commodities and Strategy Research 9 Exhibit 7: Division of the 1970s cycle into phases for the UK and US United Kingdom 0 20 40 60 80 100 120 140 160 180 Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 US Recessions Returns Earnings PE Cumulative Change Despair Hope Growth Optimism Start date 10/01/1973 12/12/1974 30/01/1976 09/03/1978 End date 12/12/1974 30/01/1976 09/03/1978 04/05/1979 Length (in months) 23.0 13.6 25.3 13.8 Real Return -76.0 122.8 -13.4 29.9 Real Earnings Growth 66.1 -45.7 25.7 -9.0 P/E expansion -85.6 310.3 -31.1 42.7 Proportion of return (%) 88.2 -9.6 21.5 Annualized Real Return -52.5 102.6 -6.6 25.4 Earnings Growth 30.2 -41.6 11.4 -7.8 Change in real interest rate (pp) 2.0 -5.6 -2.1 0.9 United States 20 40 60 80 100 120 140 160 Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 Jan-80 -100 -90 -80 -70 -60 -50 -40 -30 -20 -10 0 US Recessions Returns Earnings PE Cumulative Change Despair Hope Growth Optimism Start date 11/01/1973 03/10/1974 15/07/1975 27/03/1980 End date 03/10/1974 15/07/1975 27/03/1980 20/11/1980 Length (in months) 20.7 9.4 56.4 7.8 Real Return -54.5 44.5 -29.4 34.2 Real Earnings Growth 21.4 -15.6 37.9 -8.1 P/E expansion -62.5 71.3 -48.8 46.0 Proportion of return (%) 90.4 -59.7 69.3 Annualized Real Return -36.6 60.3 -7.1 56.9 Earnings Growth 11.9 -19.5 7.1 -12.1 Change in real interest rate (pp) 0.7 -0.2 2.5 -0.9 Source: Worldscope, Compustat, Haver Analytics, Datastream, Goldman Sachs Global ECS Research
