How the economy can help predict the US election

Why government bonds may have more upside # # --------------------------------------------------------------- The key takeaways today: - How the economy might predict the US presidential election - Blackstone's Kathleen McCarthy on the prospects of commercial real estate - US small businesses hold an economic surprise - How much upside can investors expect from government bonds? - Why the US is the world's largest LNG exporter - Briefings Brainteaser: Which sector is headed for the highest corporate default rate in 2024? Was this newsletter forwarded to you? ([Sign up now.]( --------------------------------------------------------------- Incumbent US presidents tend to win elections — except during recessions As the race for the 2024 US presidential election heats up, history suggests [economic metrics can help predict the most likely outcome]( according to Goldman Sachs Research. First-term incumbency typically provides an advantage — unless there's a recession during or just before the election. When there's no recession, the incumbent has always won in the post-World War II era, Goldman Sachs Research's Chief US Political Economist Alec Phillips and economist Tim Krupa write. Goldman Sachs Research finds a 15% probability of a recession over the next 12 months (equal to the average historical probability). Since 1951, when the constitutional amendment to limit presidents to two terms was ratified, the incumbent has lost every time the election followed a recession. The party already in the White House also lost after a recession in two instances when the incumbent candidate was not on the ballot. The strongest statistical relationship with election outcomes is often with variables measured in the second quarter of an election year. Inflation appears to be less predictive of election results than indicators related to growth or the state of the labor market. (Elections during periods of high inflation show a stronger relationship to inflation data, but even in these elections, the signals provided by growth and employment are stronger.) --------------------------------------------------------------- The forces shaping the real estate industry Above (L to R): Kathleen McCarthy of Blackstone and Alison Mass of Goldman Sachs As global co-head of real estate at Blackstone, Kathleen McCarthy has helped grow the firm's real estate assets to more than $330 billion — accounting for more than 30% of the firm's $1 trillion of assets under management. Much of that growth has come from making high-conviction bets in the real estate market. The growth in e-commerce, for example, led to an early bet on logistics and warehouses. “We said, okay, technology's changing,” McCarthy tells Goldman Sachs' Alison Mass on the latest episode of [Goldman Sachs Exchanges: Great Investors](. “Where the shopping is getting done, we want to invest our clients' capital into the assets that are benefiting from that. And conversely, try to stay away from things like regional malls. We haven't bought one in over a decade.” Blackstone was also early in reducing its holdings in the office market when it saw that office properties were spending a greater percentage of their net operating income on transforming their spaces to attract tenants. “At the time, I might have joked that every office building lobby started to look like a hotel lobby,” says McCarthy, who notes that traditional office buildings, which represented 61% of Blackstone's equity book in 2007, make up only 2% today. “That was concerning for a number of reasons, and particularly because we were looking out and thinking that if we ever found ourselves in a higher-rate environment, an office building which was starting to look like a zero-coupon bond would not perform particularly well if cap rates were going up and you didn't have cash flows to offset that.” For now, McCarthy says she's focused on sectors that can withstand the higher-rate environment. “If you just look at our portfolio, about half of the portfolio is concentrated in warehouses and student housing and data centers. These are sectors that are having high cash flow growth. And cash flow growth is really the strongest mitigant against a higher rate environment.” --------------------------------------------------------------- US small businesses are on a surprisingly strong footing Many small businesses in the US are coping with [higher interest costs surprisingly well]( according to Goldman Sachs Research. That's notable because these companies tend to be more vulnerable to funding stress. - Small enterprises typically pay higher interest rates. They paid an effective interest rate of roughly 10.5% in 2019, compared with 6.5% for the corporate sector, Goldman Sachs Research economists Manuel Abecasis and Spencer Hill write in the team's report. - While the full effect of Federal Reserve rate hikes has yet to be felt, strong profits and ample cash on hand are also making small businesses more resilient to rising borrowing costs. - Abecasis and Hill estimate that higher rates will increase the interest burden for small businesses as a share of revenues by just over one percentage point by 2024, from roughly 5.8% of revenues in 2021 to around 7% next year. They forecast this share will increase further to just under 8% as term loans gradually mature. That's above pre-pandemic levels but similar to the mid-1990s. - Our economists expect the economy-wide GDP growth drag from small business borrowing costs to peak this year at just 0.1 percentage point. --------------------------------------------------------------- Government bonds: More upside than downside? Bond returns are expected to be positive as interest rates decline over the coming year, according to the Asset & Wealth Management Investment Strategy Group at Goldman Sachs. Government bond yields across developed markets have typically fallen in the year following the peak in policy rates, and ISG's base case is that the Federal Reserve, European Central Bank, and Bank of England [have likely reached the end of their hiking cycles](. In addition, there is more upside than downside (or positive asymmetry) in forward bond returns in response to the next 50 basis point move, which makes the outlook for fixed income attractive. The total returns for US and UK government bonds are around 8% over the next 12 months if yields fall by 50 basis points, but returns will be roughly flat for an equivalent rise in yields. If clients hold cash or short-duration bonds (typically debt securities with short maturities) in their portfolio, ISG recommends that its clients increase the duration of their portfolio toward their target duration, which is four years for a US taxable moderate portfolio. --------------------------------------------------------------- How the US became the world's largest LNG exporter The global supply of [liquefied natural gas is expected to grow significantly]( the next three years. A major contributor to that growth will be exports from the US. In 2023, the US became the largest exporter of LNG, supplying a fifth of the world's gas. That share is expected to rise to a quarter by 2025, according to Samantha Dart, head of Global Natural Gas for Goldman Sachs Research's commodities team. - The US's LNG exports have surged because of domestic shale gas production. But the presence of a robust natural gas grid has also helped. “In the US, if you want to export LNG, the only thing you need to do is build a liquefaction train, a big compression chamber to liquefy the natural gas,” says Dart. “Then you hook it to the grid and you're ready to go.” Other LNG exporting nations often have to build the upstream infrastructure first, leading to high capex investments before exporting can get off the ground. - Among the major producers of LNG, Qatar's exports have stayed remarkably steady over the past eight years. “One factor was that they had a moratorium on further development of their gas fields for many years, so as not to completely exhaust it,” Dart says. That 12-year moratorium ended in 2017, and Qatar is building new liquefaction trains, a process that can take up to six years or more. “They've financed their expansion now, and the first liquefaction train will come out in early 2026,” says Dart. “Ultimately they're likely to increase their exports by 50% or so.” --------------------------------------------------------------- Briefings Brainteaser: Brace for defaults In a world of higher interest rates, Goldman Sachs Research expects US company defaults to accelerate in the first half of 2024. Which of these sectors is forecast to have the highest default rate in the year ahead on a par-value weighted basis (the face value of the defaulted bonds divided by the total amount of debt for the sector)? A) Telecom (wirelines) B) Pharmaceuticals C) Paper D) Retail [Check the answer here](. --------------------------------------------------------------- Goldman Sachs in the news [CNBC]( December 5 [Goldman Sachs' Richard Ramsden on the 2024 outlook for banks (4:32)]( [CNBC]( December 5 [Stock market has ‘modest upside' in 2024, says Goldman's David Kostin (5:02)]( --------------------------------------------------------------- --------------------------------------------------------------- Some of the images used in this newsletter are sourced via Getty Images. The information provided in this newsletter is for informational purposes only and does not constitute a recommendation from any Goldman Sachs entity to the recipient. Goldman Sachs is not providing any financial, economic, legal, investment, accounting, or tax advice through this newsletter or to its recipient. 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