gs - goal - adventures in wonderland

October 21, 2014

GOAL- Global Strategy Paper No. 16

Portfolio Strategy Research

Adventures in Wonderland Through the looking glass: Scenarios for a post-crisis world

Seven years after the start of the financial crisis, economic and financial conditions remain far from

normal. In the ‘Wonderland’ of near-zero interest rates, many of the traditional relationships that have

governed the way in which markets and cycles evolve have broken; the value of historical analysis

has weakened.

There are three main paths from here, in our view: a ‘secular stagnation’ scenario, a ‘sustained

moderation’ and a ‘normalisation’ based on a new global growth engine (driven by restructuring, the

US energy revolution and/or a major consumption shift in China). The first is broadly better for bonds

than equities, while the second is better for equities than bonds. ‘Normalisation’ would be very good

for equities and negative for bonds.

A stagnation scenario would keep bond yields lower for longer. Financials would likely underperform

alongside domestically focused companies, particularly in Europe. In a moderation scenario, we

would expect the scarcity of growth and income to drive returns. Growth stocks would likely re-rate

further, while companies with reasonable yields and dividend growth prospects should perform well.

‘Normalisation’ would be best for equities and benefit cyclicals and financials in particular.

Markets seem to be pricing in a growing probability of stagnation, particularly in Europe. Conditions

do not have to improve much to imply reasonable returns in equities. If, as we expect, growth

expectations stabilise, the perception of a ‘risky’ asset might shift to fixed income given that risk

premia are so low and yields have overshot fundamentals, in our view.

We see sustained moderation as the most likely scenario for the global market, with moderate

stagnation in Europe. Equities should continue to outperform bonds, but with much lower absolute

returns than enjoyed since 2010. This global ‘moderation’ may continue for some years. It is likely to

end as a result of either: (1) the bursting of a bond bubble as interest rates finally start to rise; or (2)

significant further valuation expansion of equities (reducing long-term returns).

Despite the recent spike, the trend of volatility is likely to remain low given macro stability and

regulation – volatility tends to be affected by recent experience, but is also related to valuations. With

low macro volatility, it is unlikely that market volatility will rise significantly and in a sustained way

until valuations become stretched.

Goldman Sachs 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 and other important disclosures, see the Disclosure Appendix, 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.

Peter Oppenheimer

+44(20)7552-5782 [email protected] Goldman Sachs International

The Goldman Sachs Group, Inc. Global Investment Research

October 21, 2014 GOAL - Global Strategy Paper

Goldman Sachs Global Investment Research 2

Table of content

Adventures in Wonderland … Investing through the looking glass 3

Where to from here? 7

What outcomes are the markets discounting? 10

What works under different outcomes? 18

The implications of low volumes and volatility 30

Postscript: Anatomy of the crisis 32

Disclosure Appendix 37



Adventures in Wonderland … Investing through the looking glass

“Would you tell me, please, which way I ought to go from here?”

“That depends a good deal on where you want to get to,“ said the Cat.

“I don’t much care where –“ said Alice.

“Then it doesn’t matter which way you go,“ said the Cat.

“– so long as I get SOMEWHERE,“ Alice added as an explanation.

“Oh, you’re sure to do that,“ said the Cat, “if you only walk long enough.“

(Alice’s Adventures in Wonderland, Chapter 6, Lewis Carroll)

Alice in Wonderland was confused. In that strange world, nothing seemed to make sense.

Investors today face a similar sense of the unfamiliar. In the unusual world of zero interest

rates and low growth, many of the rules and relationships that typically drive the way in

which markets move no longer seem to apply – equity markets have often fallen alongside

lower bond yields, while some of the strongest markets have been in the areas with the

weakest activity.

Alice in Wonderland, faced with a fork in the road, couldn’t decide which route to take;

investors are facing a similar dilemma. Markets and economies have recovered a great

deal from the crisis that has overshadowed the market over the past half-decade, but it is

far from clear what the route is from here. Do we return to ‘normal’ but with the risks of

rates rising sharply, or do we not have normal growth but benefit from permanently lower

rates? Questions about what ‘normal’ really looks like, how we get there and what happens

along the way are ever more pressing as some central banks get close to monetary exit. It

is the nature of the next phase of the economic and market development that we focus on

in this paper.

The weakest of recoveries

While economic conditions have improved since the dark days of the crisis, they have done

so very slowly. From that perspective, conditions remain anything but ‘normal’. Discussions frequently revolve around the question of how this new cycle will evolve.

But the reality is that it is likely to remain very different from anything we have seen

before. The temptation to look to historical comparisons to help inform how markets

will evolve and what appropriate valuations are for assets is unlikely to be fruitful

since there are no appropriate analogies.

What makes the current world very different from the past is the combined impact of the

crisis and the regulatory changes that have followed, coupled with rapid and highly

disruptive technological developments. Seven years after the start of the crisis, growth

continues to lag previous recoveries quite sharply and deflationary forces remain ever

present. As Exhibit 1 shows, even in the US (which has been out of recession for five years),

growth is tracking below equivalent points in past economic recoveries.



Exhibit 1: US GDP growth continues to track below equivalent points in past recoveries

Source: Haver Analytics, Goldman Sachs Global Investment Research.

For other economies, the lack of growth has been even more striking. Of course, part of the

reason that growth has been so tepid is that the economic downturn has been exacerbated

by the financial crisis. The US housing crash and credit crunch have had a bigger effect on

activity than ‘normal’ recessions, and their impact has been amplified further around the

world by the banking and sovereign crisis in Europe. But even in comparison to previous

major banking/financial crises (the ‘big 5’ historically), growth rates have been unusually

lacklustre in this cycle, particularly in Europe.

Exhibit 2: Current Euro area recovery subdued relative to other regions and history *Spain (1977), Norway (1987), Finland (1991), Sweden (1991) and Japan (1992)

Source: Haver Analytics, Goldman Sachs Global Investment Research.

Rather than spending time on the economic factors that have driven such lacklustre growth,

it is the financial market developments that we are most concerned with here. Despite this

anaemic recovery, in the financial ‘Wonderland’ of close to zero interest rates, asset

prices have staged remarkable recoveries. As Exhibit 3 shows, equities globally have

generated annualised returns of around 20% since their lows in 2009, but fixed income

markets have also remained very strong. This is all the more so given the very low levels of

inflation, which mean the recoveries in real terms are very strong.

95

100

105

110

115

120

125

130

135

140

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27

1953195719601969197319801981199020012007

Index to quarter before recession

86889092949698

100102104106108110112114116

-12 -8 -4 0 4 8 12 16 20 24

Level GDPIndex

Euro area

UKUSAll OECD CountriesBig 5 Historical Banking Crises* (ave.)



Exhibit 3: Annualised total returns for equities, bonds and credit from 2009

Source: Bloomberg, Datastream, Goldman Sachs Global Investment Research.

Ten of the best … dramatic adjustments in financial markets:

There are many examples of significant and historic shifts in pricing across asset prices

that have occurred during the past several years. Here are just a few:

"Curiouser and curiouser!"

Since the low in the global equity market on March 9, 2009, the MSCI The World index

has risen roughly 180% in total return terms, generating an annualised return of a

remarkable 20%.

2013 was one of the strongest years on record for the equity markets. The US

managed a price return of 30% and the Sharpe Ratio of the S&P 500 ranked in the 98th

percentile since 1962.

Perhaps even more striking is that bond markets have continued to perform strongly.

Since the 2009 low in equities, the JP Morgan GBI global bond index has risen 24%.

Despite the ongoing European crisis and economic stagnation, the Stoxx 600, for

example, has managed a 14% annualised return since its relative trough in 2012. In

Spain and Italy, it has been 22% and 17%, respectively.

But, given the scale of the downturn during the Great Recession, the Europe Stoxx 600

is still roughly 20% below where it was in 2000.

Profits are unlikely to revert to their 2007 levels until 2017. The FTSE 100 is still at

levels seen in 1997.

EM markets have also been weak; despite the extraordinary growth of China, the China

onshore market is still 60% below its peak in 2007.

The collapse in government bond yields has triggered a historic search for yield. A

fixed income fund with 30% US treasuries would need 50% of its assets invested below

BBB to generate a 4% return – an all-time high.

The German Bund market has an equivalent ‘P/E’ of roughly 120x and the Iboxx

corporate bond index an equivalent P/E of 65x.

Over 60% of companies in the Stoxx 600 index have a dividend yield above the iBoxx

credit yield; less than a fifth of companies used to be in this position.

20

11

6

0

5

10

15

20

25

Equities Credit Government bonds

%



What do we make of all these records? Has the market, like the famous hare in Alice’s

Wonderland, gone mad? Does it represent a series of unstable and unsustainable bubbles?

And most importantly, where can markets go from here? These are the topics we turn to next.

2015; the fork in the road

In 2012, when we wrote The Long Good Buy, the case for equities (March 21, 2012), we

argued that equity markets were entering the best prospective period of returns for a

generation. While this part of our view has worked well, our expectation that bond

yields would generally rise and result in a significant rotation of asset return leadership

away from bonds to equities has not materialised. Instead, bond yields have generally

continued falling (albeit punctuated by short-lived sell-offs). Overall, equities have

outperformed, but equities and bonds have cycled through various phases of relative

performance as investors switch between hopes of recovery and fears of

stagnation/deflation (Exhibit 4).

Exhibit 4: US equities and bond yields since 2013

Source: Datastream, Goldman Sachs Global Investment Research.

Investors continue to analyse how a recovery to historical normality might be achieved and

when it might arrive. As growth expectations pick up, bond yields tend to rise alongside

equity markets. But these periods have not been sustained. They continue to be followed

by phases when the growth cycle weakens again – we are currently in one of these phases.

Each time this happens, investors get more worried about the limits to policy support.

As Exhibit 4 shows, for example, the period from September through to the end of 2013

was marked by rising bond yields and rising equity prices (a positive correlation between

bond yields and equity prices). As 1Q14 growth disappointed, interest rate expectations

reversed and equity prices fell alongside falling bond yields (again a positive correlation

between yields and equity prices). The start of this year through to the summer

experienced a combination of gradually rising equity prices and gradually falling bond

yields, both with low volatility (a negative correlation between yields and equity prices).

The most recent stage, starting in September, takes us back to the start of the year – global

growth indicators are slowing again (with particular concerns over Europe) and bond yields

are falling alongside lower equities.

The swings in sentiment related to growth and correlation with bonds have been

sharp, but in reality very little has changed. While consensus expectations for global

growth in 2014 were 3.7% at the start of this year, they have now fallen back to

2.1

2.3

2.5

2.7

2.9

3.1

3.3

1400

1500

1600

1700

1800

1900

2000

Sep-13 Dec-13 Mar-14 Jun-14 Sep-14

S&P 500

10 year US yield (RHS)

Equities riseBond yields rise

Equities fallBond yields fall

Equities riseBond yields fall

%

Equities fall Bond yields fall as grow th expectations decline



around 3%. This is the same growth rate achieved in 2013 and 2012. The backdrop

remains one of sub-par growth, low inflation and low interest rates.

In this context, we are now entering an important phase as investors once again question

the type of recovery that we are likely to see while markets are adjusting to valuations that

are consistent with these expectations. Views are split: some believe that lower bond yields

tell us that any recovery is going to be sub-par at best and the risks of deflation are high,

while others believe that bond and equity markets have gone too far in pricing this as the

likely outcome and see opportunities, particularly in equities. Our view fits with the

second interpretation. While growth is likely to remain weak globally, the recent price

action in both bonds and equities has priced too high a deterioration in macro

fundamentals than we think likely.

Where to from here?

In our minds, there are three very different near-term paths that economies and markets

can now follow, and that imply very different outcomes for financial markets:

Path 1 – ‘Secular Stagnation’:

Growth remains well below the previous trend and inflation and rates stay low.

Equities achieve a low return (although in areas with low valuations, it is still likely to

be reasonable in real terms). Volatility stays low.

Path 2 – ‘Great Moderation’:

Growth recovers, but is not strong enough to raise inflation pressures; technological

innovation also keeps a lid on inflation. Interest rates rise but very slowly. It is not a

‘normal’ cycle since rates inflation remains subdued, but there is at least sufficient

growth to generate profit expansion.

Equities outperform bonds. Volatility stays low. Bonds become the ‘riskier’ asset.

Path 3 – ‘Normalisation’ – a new growth engine: this is the more positive route that

markets may take. It is possible that longer-term growth is enhanced but technology keeps

a lid on inflation and the trade-off between growth and rates becomes more favourable for

risky assets. Any new strong secular drive for growth is unlikely to have an impact in the

near term, but there are various potential drivers. The stronger growth could come,

perhaps, from:

major structural reforms in places like India and Europe;

the impact of the US energy revolution; and

a significant growth driver from Chinese consumption.

In truth, the outcome may also vary by region. The US, for example, looks much more

likely to achieve a moderation than, say, Europe. Already, Europe is following a

stagnation path from an economic perspective. But even here, this need not be bad for

investors. What matters is not so much the outcome, but the outcome relative to

expectations. As we show later (see chapter titled What outcomes are the markets

discounting?), this scenario is largely priced in for Europe.

Of the three, a return to ‘normal’ – triggered by a major new growth engine – would clearly

be the most positive for equities and the most negative for bonds. But it is also the least

likely, in our view, at least in the nearer term.



Of the other two, the moderation scenario is the more positive for equity holders in absolute

terms and, barring sharp rises in interest rates or exogenous shocks, it could still last for a

long time. It is unlikely to be very negative for bond holders while inflation stays low,

central banks remain accommodative and regulation results in many ‘non-economic’

buyers. However, there are factors, both positive and negative, that may ultimately come

into play over the next few years and could also result in quite different outcomes.

Great Moderation … leading to:

There are probably two possible medium/long-term scenarios that are likely to stem from a

Great Moderation (path 2).

Outcome 1 – Equity re-rating. A long period of stable growth and low inflation

encourages significant rises in equity valuations and, eventually, very low returns for a

long time thereafter. In this outcome, good near-term returns in equities (relative to

other asset classes) gradually push valuations up to levels that imply low long-term

returns, just as with other asset classes. The performance in equities may be enhanced

by further margin rises as technology constrains the returns to labour. While this

extends the bull market in equities, it implies that very low returns become much more

likely over the longer run.

Outcome 2 – Bond bubble bursts. Lower-for-longer inflation and accommodative

policy could push bond and credit yields down further, creating a bubble. When an

adjustment in interest rates finally happens, it may trigger a more aggressive bear

market in bonds and credit; equities could also fall sharply. The risks here are

significant given the extraordinarily low risk premia priced into fixed income

markets. Just as with equities in the late 1990s, fixed income assets have been

increasingly priced on a relative basis (against ever lower yielding government

bonds). There is a growing gap risk across fixed income – and a real danger that when

the risk-free rate adjusts, liquidity across fixed income will disappear.

Moderation is our central view

In our view, a continued moderation with low volatility and low volumes is the most

likely outcome, particularly for the US. While the probability of a stagnation outcome is

much higher in Europe (and already appears to be under way), this seems to be priced

into the markets already (see next section, What outcomes are the markets discounting?).

From a global perspective too, moderation is the more likely outcome, in our view.

Our global return forecasts are consistent with this. We expect equities to outperform

bonds as they have done since the relative lows in 2010, but to demonstrate much lower

aggregate returns moving forward.

In the following exhibit, we show for each starting year the relative total real return

between equities and bonds (using US data) for the next ten years. Using our forecast, we

can project the relative ten-year holding period from 2006. The recovery in the relative

performance of equities versus bonds looks set to continue, but we doubt that we will get

back to the large ex-post risk premia achieved in the 1950s or early 1990s.



Exhibit 5: Annualised excess return of equities vs. bonds over 10-year holding period in US

Source: Robert Shiller Data, Bloomberg, Goldman Sachs Global Investment Research

In our view, if we are wrong in expecting the great moderation path to dominate markets

over the next year, then the next most likely outcome is probably the derailing of the

moderation path as a result of a sharper re-rating of equities as investors are gradually

forced up the yield curve.

The next most likely exit from moderation would likely come from a rise in bond yields.

While equities would likely outperform in this scenario, at least over the medium term, it

would likely trigger higher volatility and a setback in prices across the major asset classes.

The risks to the bond market here may not stem purely from higher inflation coming

through (as in 1994 for example), but perhaps from central banks being seen to be behind

the curve as forward inflation expectations rise. Anything that pushes long rates higher

may result in enhanced ‘gap risk’ heightened by a lack of liquidity. This may become

particularly strong in the credit market.

Exhibit 6 explains the possible scenarios we will see from here. A broader description of

the stages of the crisis to date can be found in the postscript at the end of this piece.

-10%

-5%

0%

5%

10%

15%

20%

25%

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Annualized excess return 10-year holding periods GS returnforecasts



Exhibit 6: The road to recovery Scenarios for the markets

Source: Goldman Sachs Global Investment Research.

What outcomes are the markets discounting?

To assess how markets are likely to perform over the medium term, it is helpful to try

to understand what kind of outcome is already priced. While there is no perfect way

of assessing this, most measures would suggest that there has been a meaningful

decline in long-term inflation and growth expectations priced into both fixed income

and equity markets. The shifts in expectations are reflected in important moves in the

market’s required return or risk premiums.

Equities remain the only major asset class continuing to offer a high risk premium.

Put another way, the rewards for taking risk in the fixed income and credit markets

are very low. Equities, meanwhile, are implying very low future growth rates under

more normalised risk premium assumptions.

Risk premia and required returns

While it is difficult to estimate what markets are discounting without making several

assumptions, a simple look at valuations and returns gives us some sense of the risk

premium that investors are being offered.

Of course, one problem with these cross-market comparisons is that we are making

comparisons with assets of varying maturity, ranging from very short on cash, five-year for

credit, ten-year for bonds and theoretically infinity for equities. Nonetheless, these

comparisons are at least consistent over history and they yield interesting results.

Financial Crisis

• Oct 2007 – Mar 2009 Phase I: US housing / banks

• Equities underperform bonds

• Feb 2011 – June 2012 Phase II: European banks / sovereign


• Europe underperforms US

• May 2013 – Mar 2014 Phase III: EM

• EM underperforms DM

Option I: Secular Stagnation

• Low returns


• Low volatility

• Equity valuations rise

• Bonds underperform equities

• Low volatility

• Equities rise

• Bonds fall

Option III: New Growth Engine

Leading to...

Cross Roads to Recovery

Option II: Great Moderation

• Bonds collapse

• Equities fall (low returns)

Bond Bubble Bursts

• Equities rise

• Bonds stable

Equity Re-rating



Using the real cost of equity as a measure of expected equity returns (in Europe as an

example) suggests that this has actually remained quite stable since the financial crisis, at

around 6% per annum. What is most striking is the fall in the market’s ‘expected returns’ in

competing asset classes. For example, for government bonds, the real yield (yield minus

inflation expectations) has fallen from around 6% in the early 2000s to close to zero today

and there has been a similar shift in credit (here we use an estimate of the credit risk

premium, plus the real government bond yield). Meanwhile, the real expected return on

cash has collapsed from around 4% to -2%.

Clearly, these shifts reflect the severity of the crisis to a large extent and, of course, the

impact of monetary policy. But the reality is that the market seems to demand a stable

and high yield in equities whatever the real yield in the fixed income market. This, in

turn, is a reflection of the loss of confidence in long-term growth at the very least,

and perhaps the high probability put on a long-run stagnation scenario. This is also

reflected in the varying levels of risk premia across equity markets. For example, in the

case of the US, where growth expectations are higher, we estimate the ERP has fallen to

5.2%. By contrast, in the case of Europe, where investors remain more sceptical about

recovery prospects, the ERP is around 8.2%.

Exhibit 7: Implied real total return for equities remains high versus other asset classes in US Expected inflation based on five-year historical average; credit is BAA non-fin; cash is US Fed

Fund target

Source: Datastream, Haver Analytics, Goldman Sachs Global Investment Research.

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Equity Credit 10y Bonds Cash



Expectations in bonds

Looking at bonds in isolation shows a clear shift downwards in risk premia. The obvious

observation is that bond yields have fallen in many cases to record lows.

Exhibit 8: US bond yield near historic lows

Source: Robert Shiller data, Goldman Sachs Global Investment Research.

As a result of these declines, and also reflecting current strong corporate balance sheets,

credit spreads have collapsed.

Exhibit 9: Collapsing credit spreads

Source: Datastream, Goldman Sachs Global Investment Research

What is extraordinary about the movement in bond yields is the length of time for which

they have been falling and, as a result, the huge returns that they have generated. The

declines in bond yields of course did not start with the recent financial crisis and resulting

Great Recession. Yields peaked in the early 1980s alongside inflation and have been falling

ever since. While most of the declines in bond yields through the 1980s and 1990s can be

ascribed to falling inflation expectations, the more recent declines also reflect some decline

in longer-run growth expectations too.

0

2

4

6

8

10

12

14

16

18

1871

1875

1879

1882

1886

1890

1894

1897

1901

1905

1909

1912

1916

1920

1924

1927

1931

1935

1939

1942

1946

1950

1954

1957

1961

1965

1969

1972

1976

1980

1984

1987

1991

1995

1999

2002

2006

2010

2014

US 10 year bond yield

0

5

10

15

20

25

73 74 75 77 78 79 81 82 83 85 86 87 89 90 91 93 94 95 97 98 99 01 02 03 05 06 07 09 10 11 13 14

Barclays Investment Grade Barclays High Yield



The persistence of the declines in bond yields has resulted in a remarkably strong bull

market, with most government bond markets delivering equity-like returns for 30 years. As

Exhibit 10 shows, total real returns in US government bonds over ten-year holding

periods were around 8% following the peak of inflation in the 1980s; while these have

faded over time, they have remained between 3% and 4% over ten-year holding

periods up to the present. This is an achievement only matched (although not for such a

prolonged timescale) by the period around the Great Depression.

Exhibit 10: Annualised real total return of US bonds over ten-year holding period

Source: Robert Shiller Data, Bloomberg, Goldman Sachs Global Investment Research.

The shifting expectations of future growth and inflation can be reflected in the market-

implied ‘neutral rate’. As Francesco Garzarelli and team have shown (Macro Rates Analyst:

The passing of the baton, September 18, 2014), expectations for the neutral rate have fallen

in both the US and Europe.

Exhibit 11: US neutral rate now at around 3.75%... Survey forecast for USD short rates 5-to-10 years in the future

Exhibit 12: …while the neutral rate of the Euro area is

between 3.0% and 3.25% GS estimate of EUR short rates 5-to-10 years into the future

based on long-run GDP and CPI Consensus forecasts

Source: Blue Chip Financial Forecasts, Goldman Sachs Global Investment Research.

Source: Consensus Economics, Goldman Sachs Global Investment Research.

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Annualized real return 10-year holding period

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

85 90 95 00 05 10 15

Survey long-run neutralrate

Fitted long-run neutral rate

%

2.8

3.1

3.4

3.7

4.0

4.3

4.6

94 96 98 00 02 04 06 08 10 12 14

Long-run neutral rate estimated from growthand inflation surveyFitted long-run neutral rate

%



But equally interesting is that the decline in longer-dated bond yields in both the US and

the Euro area has been much greater than the decline in neutral rate expectations. This

term premium is measured as the difference between the 5-year 5-year US treasury yield

and survey-based expectations of three-month rates 5-10 years in the future. This fall in the

‘term premium’ has been particularly sharp in Europe and reflects the combination of weak

cyclical data (particularly in Europe), policy easing and forward guidance, but also declines

in long-run growth expectations (for further details, see Macro Rates Analyst: The passing

of the baton, September 18, 2014).

Importantly, in terms of expectations, even factoring in the downgrades to the

European economic outlook, the end-2014 ‘fair values’ for 10-year yields that we

obtain through our Sudoku model are substantially higher than what the market is

discounting. As our bond strategy team argues, all told, US 10-year Treasuries are

approaching very stretched levels relative to the macro outlook.

Exhibit 13: The US 5-year 5-year forward term premium

is close to the levels of 2004-06… Survey based, fitted survey based and Kim-wright model

estimates

Exhibit 14: …while in the Euro area, the term premium is

at historic lows GS estimate of the Euro area term premium

Source: Federal Reserve Board, Blue Chip Financial Forecasts, Goldman Sachs Global Investment Research.

Source: Consensus Economics, Goldman Sachs Global Investment Research.

Expectations in equities

Since long-term growth and inflation expectations seem to have fallen in the bond markets,

it would be logical that they have fallen in the equity markets too. But just how much have

they come down? This is a difficult question to answer with confidence because it is hard to

disaggregate the relative shifts between growth expectations and the risk premium.

For example, we can try to back out these variables from a multi-stage discount model (we

do this using GSDDM) – for details, see Strategy Espresso: What the markets are

discounting and what cyclicals are telling us, October 15, 2014. If we fix the long-run

growth rate in the model and input differing bond yields, then we can infer the required

ERP. On the other hand, we can assume that the ERP doesn’t change but the long-run

growth expectations do. This is important since it follows that if the future rate of profit

growth is lower than many models assume, then the implied equity risk premium would be

lower and the relative valuation of equities less attractive than it might at first appear.

-2

-1

0

1

2

3

4

5

85 90 95 00 05 10 15

Survey based TP

Fitted survey based TP

Kim & Wright TP

%

-2

-1

0

1

2

3

4

5

6

94 96 98 00 02 04 06 08 10 12 14

Fitted 5y5y Germany term premium

%



In our DDM, we are already using quite conservative assumptions about growth.

Specifically, in Europe for example, we assume 7% pa real growth in the first five years,

during which the market re-converges to average ROE. This is a particularly mild recovery

by historical standards, owing to the relatively high starting level of margins. We then

assume 2.5% real growth of profits for the next 15 years which, although in excess of trend

growth in Europe, is not excessive in our view given the exposure of European companies

to faster growing regions in the rest of the world. Both the overall compound growth rate

from current levels (3.9%) and the long-run growth rate that we use in our assumptions

(2.5%) are well below the 5.1% trend real growth rate of earnings achieved in Europe over

the past 30 years. The reason we employ these more conservative forward estimates is that

we see margins being less of a driver in the future than in the past; we estimate that

margin expansion has contributed roughly half (2.4 percentage points) of the 5.1% real

earnings growth rate over that period (see GOAL Strategy Paper No 12: Profit Pathology,

April 4, 2014). Historically, sales grew by only 2.8%, which is still above the growth

rate that we assume moving forward.

Using valuations to back out implied growth

Using our DDM methodology, we can back out implied growth assuming the risk premium

is fixed.

Exhibit 15 does just this for Europe (Stoxx 600). It shows the evolution of the future rate of

growth assuming a fixed 3.5% ERP. Despite the recent improvement, the implied real rate

of growth consistent with this level of equity risk premium remains substantially

negative (around -4%) and clearly pricing in some form of long-run stagnation, which

we think is too extreme. Of course, it may be that the risk premium never returns to the

levels seen on average historically, or that it takes a very long time to. But even if we

assume the ERP does not revert to long-run averages of around 3.5% but converges to a

long-run average of, say 5%, the market is still implying 0% pa earnings growth over

the next 20 years. The stagnation scenario, while not fully priced, does appear to be

reflected to some degree in current market valuations.

Exhibit 15: Implied rate of growth with a constant ERP in Europe

STOXX Europe 600


-8

-6

-4

-2

0

2

4

6

8

10

90 92 94 96 98 00 02 04 06 08 10 12 14

%

Implied Growth

Historical real EPS 5.1%

0% EPS growth. Consistentwith 5.6% ERP

Implied EPS growth at 3.5% ERP



Another way of showing this is to look at the actual movements of the equity market

through this year alongside the shifts in the risk-free rate. Using our DDM, we can see what

impact the fall in the bond yield should have had on equity prices assuming the risk

premium and growth had not changed.

Since the beginning of the year, bond yields have fallen by over 100 bp in Europe – and

have also fallen in most other regions too. Using our DDM model, we can estimate that if

nothing else had changed since then, the market should be 18% higher than it is

currently, with a fair value level of almost 410. Instead, it has gone almost nowhere.

There can be only two explanations: either the ERP has risen by about 90 bp, fully

offsetting the decline in yield, or investors have offset the fall in the risk-free rate with a

decline in their assumptions about long-term growth.

We estimate that to offset the lower bond yields that we have seen (with no change

in the risk premium), growth assumptions would have needed to fall 125 bp relative

to our baseline assumption (from 2.5% real growth per annum to 1.25%). Of course,

it’s also possible that there has been a deterioration of growth expectations and a rise in

the ERP (owing to Russia/Ukraine tensions) and there are infinite combinations.

The details of these sensitivities are illustrated in the matrix below, which shows the fair

value of the market for different levels of yields and long-term growth. At the beginning of

the year, the SXXP was around 319 at the intersection of a 2.3% bond yield and 2.5% real

long-term growth expectations. All else equal, the fall in bond yields should have resulted

in a move of the fair value to the left of this sensitivity matrix. But the current value of the

market is more consistent with a level of growth that would be around zero. This would be

a radical decline compared with the historical level of earnings growth, which has been

about 5.0% per annum in real terms (partly driven by higher margins, as explained above).

Exhibit 16: Sensitivity of the fair value to growth and bond yield Stoxx Europe 600


As a further cross-check, it is interesting to look at the performance of cyclical sectors

versus more economically defensive ones. In recent weeks, cyclicals have underperformed

in most markets. In Europe, cyclicals’ relative performance leads industrial production

growth by about three to six months – the correlation between the two over the last 20

years has been around 60% with a six-month lead for equities. At the moment, the move

down in cyclical sectors implies a further deterioration in Euro area IP growth, with

the region seeing production fall by around 2%-3% year-on-year over the next few

months. Industrial output is more volatile than aggregate demand, but that is still a

significant deterioration compared with where we are now and with what our economists

forecast. Euro area IP growth is forecast by our economists to trough at -0.2% in 1Q2015

and then to rise modestly to just over 2% by 4Q2015.

Risk free rate0.6% 0.8% 1.1% 1.3% 1.6% 1.8% 2.1% 2.3% 2.6% 2.8% 3.1%

-0.3% 353 331 312 295 279 264 251 239 228 218 209

0.1% 366 343 323 305 288 273 259 247 235 225 215

0.4% 379 355 334 315 298 282 268 255 242 231 221

0.7% 393 368 346 326 308 291 276 263 250 238 228

1.0% 408 382 358 337 319 301 286 271 258 246 235

1.3% 423 396 371 349 330 311 295 280 266 254 242

1.6% 439 410 385 362 341 322 305 289 275 262 249

1.9% 455 425 399 375 353 333 315 299 284 270 257

2.2% 472 441 413 388 365 345 326 309 293 279 265

2.5% 490 458 429 402 378 357 337 319 303 288 274

2.8% 509 475 445 417 392 369 349 330 313 297 283Re

al L

ong

Te

rm G

row

th



Exhibit 17: Cyclicals already signaling a significant further downturn in industrial output Premium/(discount on 12m forward P/E and Euro area IP YoY growth


Whatever the precise combination of declining long-run growth and rising risk premia, it is

clear that investors have priced in a much more negative long-run fundamental

backdrop, particularly for equity markets in Europe – although the same can be said,

we think, to varying degrees, across equity markets more broadly.

The requirement for equities to generate a high and stable yield even as the real yield on

competing assets falls is quite extreme by historical comparison. A very tangible way of

illustrating this is in Exhibit 18, which shows a record proportion of companies in Europe

that now have a dividend yield above the corporate bond yield.

Exhibit 18: Percentage of European companies with div. yields > corp. bond yields


-20

-15

-10

-5

0

5

10

15

20

25

-30

-25

-20

-15

-10

-5

0

5

10

15

20

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Cyclicals vs. Defensives PE

Change in IP growth vs. last year (RHS)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

% of companies with DY>CY Average



We are not making these points to suggest that the equity market is very cheap – of course,

part of the reason these apparent anomalies exist is because bond yields are so low. In

reality, if growth does indeed improve into the future, a lower ERP would be likely offset in

part by higher bond yields. But it does suggest to us that in the case of Europe, the market

is pricing a high probability of stagnation (or worse) and investors continue to demand an

unusually high risk premium to compensate for this risk.

In the case of China and other parts of Asia, this also appears to be true. Only in the US are

valuations at a level, given how high profits are, that suggests a return to growth

‘normality’ is really priced in.

In our view, it is because the market is pricing a high probability of a stagnation outcome

that the opportunity for investors remains good in major equity markets. Economic and

profit conditions don’t need to improve much in order for equity markets to generate a

reasonable real return and one well in advance of other major competing asset classes.

What works under different outcomes?

Many of the discussions we have had recently with investors have been on the themes and

styles that should work moving forward. When the macro environment globally was poor

and Europe was in crisis, many momentum strategies worked for a long time. Just as an

underweight in banks in Japan would have been sufficient for a long-only manager to

outperform the index through much of the post-crisis period in the 1990s, a similar pattern

unfolded in Europe post 2010. Equally, the scarcity of growth led to small caps generally

outperforming large and US growth stocks enjoying significant outperformance.

Much of this changed in the first quarter of this year, when there was a dramatic reversal of

many dominant momentum strategies. Since then, narrow stock dispersion and, until

recently, low volatility have made it much harder to add alpha for many investors. Moving

forward, the outlook is further muddied by the spread of the possible future outcomes.

In this section, we look to see if there are any pointers we can take from previous periods.

What works in ‘stagnation?’

When most people think of stagnation, they think of Japan, but in our view this is not a

particularly good example to look at as a guide to the market overall. Japan was very

overvalued when the stagnation started in the 1990s, a far cry from what we are

seeing in most markets today.

In their report From the ‘Great Recession’ to the ‘Great Stagnation’? (Global economics

weekly, September 28, 2011), Jose Ursua and team looked at the prevalence of stagnations

globally. They showed that episodes of stagnation are more common than many imagine,

and identified 93 episodes since 1800, 24% occurring over the past decade. While equity

returns tended to be low during these episodes, they were on average much better than

those during Japan’s stagnation of the 1990s. Exhibit 19 shows that average real equity

returns were 5% (with Japan the outlier). Nonetheless, average inflation during previous

stagnations has been higher than we are seeing today and the current situation in this

regard is more similar to Japan’s experience. Consequently, some of the lessons from

Japan’s stagnation may be relevant for us today.



Exhibit 19: Japan’s 1990s episode (O) vs. long-lasting stagnation average ( ) historical

average (+), and post-WWII average (x)

Source: Goldman Sachs Global Investment Research, Barro-Urusa (2009), Ursua (2011).

Accepting the dangers of looking for past templates, there are a couple of themes that did

work in Japan through the stagnation and are likely to be relevant in the current

environment if stagnation evolves.

1) Global exporters outperformed domestically exposed stocks in general; this of course

reflected weak domestic demand and was not primarily a function of currency – the

yen was generally strong through most of this period.

Exhibit 20: Exporters strongly outperformed domestically exposed stocks in Japan

through the 1990s


50

100

150

200

250

300

350

400

85 87 89 91 93 95 97 99 01 03 05 07 09 11 13

Exporters versus the TOPIX

Exporters versus the Domestic Sector



2) Banks underperformed.

Exhibit 21: Banks underperformed the Japan market in the 1990s


The underperformance of banks was both a function of the banking crisis and of the

ongoing weakness in the economy.

Under similar circumstances, we might see patterns play out in a similar way – global

companies would tend to do better, even more so perhaps in the case of Europe, as we

expect the euro to decline over the medium term (reaching parity against the US$ by end

2017). Banks may struggle under the prospects of poor loan growth, although in this case

the similarities are less clear. Balance sheet restructuring in Europe has been swifter than it

was in Japan and policies aimed at kick-starting bank lending are more forceful. It is also

likely that pure yield plays would perform quite well; interestingly, there was a clear pattern

of ‘value’ outperformance in Japan during its stagnation. We think the reason for this is

that the overall market remained very expensive – perhaps a less obvious point of

comparison to today. Nonetheless, if confidence about future growth and pricing falls

sufficiently, value becomes the most obvious measure of potential and we think this is a

theme that would likely be repeated if deflation and stagnation set in.

Exhibit 22: During the stagnation in Japan, there was a clear pattern of value outperformance MSCI Japan Value, MSCI Japan Growth and MSCI Japan indices


20

40

60

80

100

120

140

160

180

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Banks versus the TOPIX

80

130

180

230

280

330

380

430

480

530

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Japan Value versus Japan Growth Japan Value versus Japan Market



What works in the Great Moderation

In this environment, we would expect volatility to remain low. In addition, there are two

important features for investors:

1) Income is scarce

2) Growth is scarce

Finding growth

Given the slow recovery of most economies, even since the end of the Great Recession it

has been difficult to find growth.

This scarcity of economic growth has taken its toll on the corporate sector too. While the

damage has not been evident so much in financial losses (at least outside the banking

sector), it has had an impact on investment behaviour and, with it, confidence in future

growth. Rather than spend money on an uncertain macro future, companies have been

hoarding cash.

Exhibit 23: Cash balances of European companies are highSTOXX Europe 600 ex financials cash-to-asset ratio

Exhibit 24: Cyclicals especially appear cash rich Pure cash-to-asset rates (STOXX Europe 600 sector groups)

Source: Factset, Worldscope, Goldman Sachs Global Investment Research.

Source: Factset, Worldscope, Goldman Sachs Global Investment Research.

With less investment and lower economic activity has come less growth in earnings.

The proportion of companies in Europe, for example, generating annual earnings growth

above 10% has fallen sharply, and those generating annual sales growth above 10%

have reached a multi-year low. Little wonder that ‘growth’ has become highly prized.

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

10.0%

10.5%

11.0%

11.5%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Pure cash

Cash & equivalents (RHS)

2%

3%

4%

5%

6%

7%

8%

9%

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Cyclicals

Defensive

Commodity



Exhibit 25: Proportion of STOXX 600 companies with FY3/FY2 growth >10% has fallen for

both sales and earnings Based on FY3/FY2 consensus earnings and sales growth

Source: I/B/E/S via Datastream, Goldman Sachs Global Investment Research.

In the case of the US, companies investing for growth are now clearly outperforming (see

Exhibit 26), but this is in an environment where the economy is growing and ROE is at a

high. It also follows a long period in which companies have bought back stock and also

raised dividends.

Exhibit 26: The market is rewarding growth strategies

Performance of S&P companies based on their use of cash


10%

20%

30%

40%

50%

60%

70%

80%

90%

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Proportion of companies with >10% earnings growth

Proportion of companies with >10% sales growth

Average porportion of co. with >10% earnings growth

Average porportion of co. with >10% sales growth

92

94

96

98

100

102

104

106

Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14

Inde

xed

perf

orm

ance

Buybacks

Dividends

CapExLong/short performance of S&P 500 quintiles based on use of cash



In Europe’s case, the depth of the recession, coupled with an existential crisis of the euro,

meant that it has been only since fairly recently that investors would pay any premium for

growth again. Through much of the crisis, investors preferred to hide in relatively ‘safe’

and defensive parts of the market. If growth was rewarded at all, it was mainly top-line

growth that tends to be more stable and predictable. Many of these kinds of companies

moved to a large premium valuation during the depth of the crisis and have reverted to

significant premiums in the drawdown of the past several weeks. In most markets, and

even in the case of Europe where stagnation has largely been priced, more expensive

defensive companies may start to underperform more cyclical global companies.

The scarcity of income

While growth may be scarce, income appears even harder to find. In effect, we live in a

world with a zero, if not negative, risk-free rate. German real bond yields, for example, are

close to zero on 10-year maturities.

Exhibit 27: The collapsing German ‘risk-free’ rate…

…now negative in real terms on 10-year maturities


Yield attracts very high valuations

It is understandable that in a zero rate world, anything with a higher yield becomes highly

prized, particularly when this environment is coupled with low volatility and low inflation

expectations. But the extent of the re-rating is remarkable. The effective multiple for

government bonds (1/BY for 10-year German government bond) is roughly 120x.

-2

-1

0

1

2

3

4

5

6

7

8

9

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

Germany Real Bond Yield

-1 standard deviation

Average

+1 standard deviation



Exhibit 28: The “effective multiple” is extremely high for government bonds… 1/BY for 10-year German bonds and 12m-forward P/E for STOXX 600


For corporate credit, at 65x, the ‘multiple’ is at its highest since 1999, from when we

have data.

Exhibit 29: …as well as for corporate credit

1/BY for iBOXX Europe Corporates and 12m-forward P/E for STOXX 600


5

25

45

65

85

105

125

145

165

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

Germany 10-year 1/BY STOXX Europe 600 NTM PE

Average Germany 10-year 1/BY

5

15

25

35

45

55

65

75

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

IBOXX Eur Corporates 1/BY STOXX Europe 600 NTM PE

Average iBOXX Eur Corporates 1/BY



As bond yields have collapsed and credit spreads narrowed, investors are struggling

to meet income requirements without moving significantly up the risk curve. Hugo

Scott-Gall and team illustrate that in order for a credit fund to generate a 4% return in the

US, the proportion they would need to invest in HY credit would be high.

Exhibit 30: US HY holding needed in portfolio % of portfolio required in high yield corp. bonds to achieve weighted yield of 4%, if various

levels are put in US government bonds


Another way of thinking about this is to look at the proportion of fixed income and equity

that would be needed in a mixed portfolio to generate a 4% return. Exhibit 31 shows that

even with as high as 30% in government bonds, we would need to combine this with a

portfolio of around 30% of equities to generate the required return. When we do this

exercise in Europe, we find that even 100% of the remainder invested in HY credit would

not be sufficient to generate a 4% return.

Exhibit 31: US equity holding needed in portfolio % of portfolio required in equities to achieve weighted yield of 4%, if various levels are put in US

government bonds; equity return based on cost of equity


0%

10%

20%

30%

40%

50%

60%

70%

80%

Jan

-09

Ap

r-09

Jul-0

9

Oct

-09

Jan

-10

Ap

r-10

Jul-1

0

Oct

-10

Jan

-11

Ap

r-11

Jul-1

1

Oct

-11

Jan

-12

Ap

r-12

Jul-1

2

Oct

-12

Jan

-13

Ap

r-13

Jul-1

3

Oct

-13

Jan

-14

Ap

r-14

Jul-1

4

Oct

-14

5% 10% 20% 30%

0%

5%

10%

15%

20%

25%

30%

35%

40%

Jan

-09

Ap

r-09

Jul-0

9

Oct

-09

Jan

-10

Ap

r-10

Jul-1

0

Oct

-10

Jan

-11

Ap

r-11

Jul-1

1

Oct

-11

Jan

-12

Ap

r-12

Jul-1

2

Oct

-12

Jan

-13

Ap

r-13

Jul-1

3

Oct

-13

Jan

-14

Ap

r-14

Jul-1

4

Oct

-14

5% 10% 20% 30%



If interest rates and inflation stay low, income and cash distribution within the equity

market are likely to remain attractive to investors. In recent months, stocks in the highest

quartile of dividend yield have outperformed the market. Of note, these stocks did not

outperform during the worst part of the crisis in Europe. They were considered to be ‘value

traps’ with dividends vulnerable to cuts; during this phase, consumer staples did much better,

boosted by stable sales growth expectations and high EM exposure (at that time a perceived

attraction). Since 2013, however, high dividend yield stocks in Europe have outperformed the

index. Growth expectations have fallen and bond yields have come down commensurately.

Exhibit 32: Relative performance of high-yield equities


It is mainly lower bond yields that have been the driver for the outperformance, as shown

in Exhibit 33.

Exhibit 33: High yield equities tend to perform better as BY fall


95

100

105

110

115

120

125

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14

Europe

US

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.095

100

105

110

115

120

125

130

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14

Europe 1Q dividend yield vs. STOXX Europe 600

German 10 year bond yield (RHS, inverted)



Looking ahead, we would expect the focus on pure yield to shift to one that captures

both yield and growth. For this reason, we favour our basket of companies that have

a reasonable yield but sufficient free cash flow growth and low enough debt to be

able to sustain dividend growth. For details on this basket, Bloomberg ticker

GSSTHIDY, see Strategy Matters: Tracking the uses of cash: Europe’s equity income

opportunity, August 4, 2014.

What works in the normalisation/growth engine?

While we see this as the least likely outcome in the near term, it would tend to result in a

much more pro-growth and risk-on performance distribution. From where markets are

currently, the most obvious reversal would be of cyclical companies, which, particularly

recently, have underperformed the markets quite sharply in most regions.

Exhibit 34: Cyclicals have underperformed quite sharply

Cyclicals: Media, general retailers, travel, leisure goods, chemicals, basic resources,

construction & materials, industrial goods & services, autos & parts;

Defensives: Food & beverages, tobacco, health care, food & drug retail, utilities


One aspect of a new global growth driver would likely be a steepening yield curve. As Exhibit

35 shows, the relationship between cyclicals versus defensive sectors against the slope of the

yield curve (shown here in Europe) is quite strong. Of course, much would ultimately depend

on what the source of the better growth is. This might have an important impact on

geographical allocations. Major supply-side reform success in Europe or a large China

consumer growth increase might benefit Europe more than the US. On the other hand, if the

global engine comes from a US energy revolution, it might benefit the US more to begin with.

86

91

96

101

106

Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14

US Europe



Exhibit 35: Cyclicals have de-rated as the yield curve has flattened and investors have

preferred longer-duration growth/defensives Premium/(discount) on 12-month forward P/E and 10Y minus 2Y German gov bond yield


Nonetheless, anything that has a meaningful impact on longer-term global growth

assumptions would both lengthen equity expectations and help bring down the equity risk

premium (ERP).

Understandably, the willingness to pay for growth depends very much on risk

appetite. We find that the premium paid for visible premium top-line growth tends to

rise in a more uncertain world, and the premium for more cyclical growth tends to

rise when investors are more confident. This of course makes sense. We can see this by

comparing the ERP to the average P/E of companies with high expected sales growth

relative to those with high expected earnings growth.

Improving growth, a turn in inflation and a fall in the ERP would all tend to support

the valuations of more cyclical growth areas of the market. Historically, the premium of

companies with high-quality stable growth (in the top bands for sales growth) relative to

companies with more margin-driven or cyclical growth catch-up has followed the ERP

(Exhibit 36). We think that as the ERP gradually normalises, the premium paid for more

cyclically driven growth companies should increase relative to the more defensive names.

0

0.5

1

1.5

2

2.5

3

-30

-25

-20

-15

-10

-5

0

5

10

15

20

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Cyclicals vs. Defensives PE

Slope of the yield curve (RHS)*



Exhibit 36: The premium for companies with high-quality stable growth relative to

companies with cyclical margin-driven growth should decrease as the ERP normalises Relative P/E of high sales growth (>8% FY3 growth) vs. high earnings growth (>12.5% FY3

growth) companies


The other major beneficiary of such a shift in growth expectations would likely be the

financials. These would probably benefit from both the steeper yield curve and improved

lending growth prospects. Insurance companies would meanwhile benefit from the likely

higher bond yields and falling liabilities.

As we see it, a new growth cycle that shifts expectations back towards

‘normalisation’ would mainly benefit:

Cyclicals versus defensives;

Companies with high expected earnings growth relative to those with stable top-

line growth; and

Financials.

-1

1

3

5

7

9

11

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

P/E high sales vs. high earnings growth

Pan Europe ERP (RHS, inverted)

Macrobenchmarked ERP forecasts



The implications of low volumes and volatility

Our central scenario of moderation and recovery implies that volatility remains low for some

time. True, it has risen sharply very recently in the growth scare since September, but the

underlying trend is likely to remain low. Charles Himmelberg has argued (see Top of Mind,

Volatility: Lower for longer?, June 25, 2014) that the current low economic volatility is a

continuation of the “Great Moderation” in economic growth that prevailed from the mid-1980s

until the GFC, largely owing to the establishment of credible monetary policy. In his view,

current low asset volatility is incentivising a build-up in leverage, but regulation post the GFC

has “muzzled the financial accelerator” that amplified problems in the past, substantially

slowing the process this time around. In short, the credit cycle will play out, but not any time

soon – another reason to think that this cycle may be less ‘normal’ than those in the past.

Exhibit 37: Resumption of the “Great Moderation” % change in volatility from 1970-1984 period


In our Global Strategy Paper No. 1, Monitoring Risks: Valuation vs. Volatility part 1, October

17, 2011), we looked into the drivers of volatility and the signs that may indicate a change.

Exhibit 38: Periods of low volatility are not uncommon, but when volatility rises it tends to

do so quickly


-100

-90

-80

-70

-60

-50

-40

-30

-20

-10

0S&P 500 10-Yr UST 1-Yr UST PCE Inflation

PCE CoreInflation

Fed NationalActivity Index

PrivateSector Emp.

Growth

2011-2014

1985-2006

Volatilities of growth, inflation rates, and equity returns have all fallen from their pre-85 levels, and have fallen further during the post-crisis period.

90

110

130

150

170

190

0

0.1

0.2

0.3

0.4

0.5

65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13

Log scale, Indexed (Jan 1965=100)Realized volatility

S&P 500 (RHS)



As Exhibit 39 shows, periods of low volatility are not uncommon and they can last for long

periods, but in general, when volatility finally rises it does so quite quickly.

What are the signals that volatility may shift? Looking at historical regimes, we note two in

particular: recent volatility and valuation. The relationship between realised volatility over

the next two months plotted against current realised six-month volatility and current

dividend yield is shown in Exhibits 39 and 40. Over these short-term periods, it is clear that

there is a good positive relationship between current realised volatility and two-month future

volatility, but no relationship between current dividend yield and two-month future volatility.

Exhibit 39: Volatility is well correlated with near-term

future volatility… 2-month realised volatility plotted against the 6-month

realised volatility at the beginning of the 2-month period

Exhibit 40: …whereas the dividend yield is not 2-month realised volatility plotted against the trailing

dividend yield at the beginning of the 2-month period



Exhibit 41, however, extends the horizon and shows the realised volatility over the six-

month window from one year into the future to 18 months into the future, plotted against

current six-month realised volatility. The charts show that current realised volatility has

much less influence over longer-term risks. A regression line would still show a small

positive relationship between the two variables, but it is clearly non-linear, with all the

highest volatility episodes following periods of low rather than high realised volatility – in

other words, volatility spikes do tend to follow periods of low volatility.

In terms of signals, the current dividend yield gives a much better picture than

realised volatility over longer-term risks. A regression would show a negative

relationship with an R-squared more than twice as high as the R-squared for the

relationship of this future volatility with current realised volatility. The negative relationship

points in the same direction as the outliers in the scatter plot in Exhibit 42. Since 1973, six-

month realised volatility has never been above 22% when the dividend yield 18 months

earlier was above 3.3%.

The key observation here is that in the moderation scenario, a large spike in volatility

is unlikely to occur before the moderation has given way to some kind of significant

rise in equity valuations. While this is possible, if not likely in time, it may be many

months or years before we get there.

y = 0.5958x + 0.0503R² = 0.28

0%

10%

20%

30%

40%

50%

60%

70%

80%

0% 10% 20% 30% 40% 50%

2 m

. rea

lised

vol

. 2 m

onth

s le

ad

6 months realised vol

y = -0.0055x + 0.15R² = 0.0064

0%

10%

20%

30%

40%

50%

60%

70%

80%

1 3 5 7

2 m

. rea

lised

vol

.2 m

onth

s le

ad

Div Yld (%)



Exhibit 41: High volatility does not capture latent risks of

future volatility… 6-month realised volatility plotted against 6-month realised

volatility 18 months earlier

Exhibit 42: …whereas stretched valuations do 6-month realised volatility plotted against trailing dividend

yield 18 months earlier



Postscript: Anatomy of the crisis

This section is a description of how the crisis unfolded and how the epicenter shifted

from the US to Europe and then to EM. Understanding the causes of the crisis and

how it was priced helps us to put in context where markets are now.

The financial crisis itself has really evolved in three separate but related phases. Each

ended with an aggressive policy intervention and a sharp rebound in risky assets that

soon faded as another wave of the crisis hit. The three main phases can be described as:

Phase 1: US housing market and credit crunch (Oct 2007-March 2009) For equities globally as an asset class, this was the worst phase of the crisis; what started as a

US housing market correction culminated in the collapse of Lehman, a global credit crunch

and a deep global recession. Equities sharply underperformed other asset classes and

bonds performed strongly as policy rates were cut aggressively. The US equity market fell

nearly 40% from its peak and many other equities markets suffered worse still.

Exhibit 43: Phase 1: The US housing market Total return from October 2007 to March 2009


0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0% 10% 20% 30% 40% 50%

6 m

. rea

lised

vol

. 18

mon

ths

lead

6 months realised vol

High vol has occurred afterperiods of low vol 18 months earlier

Periods of high vol have beenfollowed by periods of low vol

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

1 3 5 7

6 m

. rea

lised

vol

. 18

mth

s le

ad

Div Yld (%)

Stretched valuations signal latent risk of volatility 18 months later

Attractive valuations have alwaysbeen followed by moderate volatility 18 months later

-70

-60

-50

-40

-30

-20

-10

0

10

20

30

Government bonds Credit Commodities Equities

The crisis



All major equity markets fell together.

Exhibit 44: US equities and equity markets worldwide fell significantly


As often is the case, it is difficult to assess the key trigger for the market rebound. This is

often related to the Geithner announcement that the Treasury could use $100 billion from

the Troubled Asset Relief Program (TARP), together with new capital from private

investors, in order to generate $500 billion in purchasing power to buy toxic loans and

assets. It was also announced that the scheme could potentially expand to $1 trillion over

time (without needing approval from congress). But this announcement came on March 23

– the market had already rebounded from March 9. Also important was the announcement

by Vikram Pandit, the CEO of Citibank, that the bank had been profitable in the first two

months of 2009 and was enjoying its best quarterly performance since 2007.

Whatever the specific trigger, the rebound in equities from this stage of the crisis was fast and

furious; the DJIA rebounded more than 20% over just three weeks. From its low on March 9, the

S&P 500 was up 30% by mid-May, over 60% by the end of the year and had risen 100% in less

than a year. As Exhibit 46 shows, the US and global markets all rallied strongly.

Exhibit 45: Global equity markets recovered from their low on March 9, 2009 Indexed March 2009=100


30

40

50

60

70

80

90

100

110

120

Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09

Index (Oct-07=100)

S&P 500 STOXX 600 MSCI EM

90

100

110

120

130

140

150

160

170

Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09

S&P 500 MSCI The World

Index(Mar-09=100)



Phase 2: The European phase (February 2011-June 2012)

Equities bounced back sharply from the post-Lehman lows. But the European leg of the

crisis soon took centre stage. Equities underperformed in this period while government

bonds outperformed sharply and credit rebounded.

Exhibit 46: Equities underperformed in the European phase of the crisis


Within equities, the picture was more nuanced. The US equity market outperformed other

regions by far. Europe performed poorly and entered a new bear market while the ‘periphery’

in particular underperformed. In this phase of the crisis, equities outperformed bonds overall,

but there was significant geographic dispersion, with Europe falling most sharply. The

Eurostoxx 50 fell 29.9% from October 2009 (post the Lehman recovery) to June 2012.

Again, the recovery cannot be pinpointed to a specific factor, but is often attributed to the

comments by ECB chairman Draghi to ‘do whatever it takes’ to save the euro on July 26,

2012, followed by the swift and explicit backing of President Sarkozy and Chancellor Merkel.

The recovery again was initially sharp. The Eurostoxx 50 rose 45.1% between June 2012

and 2014, with Spain, the most heavily hit during the worst of the crisis, up 68.3%.

Exhibit 47: European markets underperformed global equities significantly in the

“European phase” of the crisis


-15

-10

-5

0

5

10

15

20

25

Government bonds Credit Equities Commodities

60

65

70

75

80

85

90

95

100

105

Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12

Index (Feb-11=100) Eurostoxx 50 MSCI the World

The recovery



Exhibit 48: US market outperformed significantly S&P 500 relative performance vs MSCI EM and STOXX 600

Exhibit 49: Periphery significantly underperformed the

STOXX 600 Average of MIB and IBEX relative perf vs STOXX 600



Much of the recovery in equity markets, particularly in the periphery, can be attributed to

the collapse in sovereign spreads. This allowed the ERP to fall from very elevated levels

and triggered a sharp re-rating in valuation. We have yet to see any meaningful recovery in

either Euro area economic activity or European profits, but the falls in the risk premium

from historic highs were sufficient to propel the markets higher.

Phase 3: The EM phase (May 2013-March 2014) It is difficult to be specific about an EM phase, as the underperformance of EM began

slowly and has been quite long-lasting. From their absolute relative peak in October 2010

(following years of outperformance), EMs had underperformed DMs by 39% up until the

recent low in March 2014. However, this long phase can be split into two parts.

The first was the period between October 2010 and May 2013. This was a period of

underperformance largely driven by the China GDP slowdown. During this period, the EM

index underperformed DM by 24% in dollar terms. However, this was relative

underperformance in a period of generally rising equity markets.

The second phase, which is perhaps more specifically an EM-focused period of weakness,

was from May 2013 through to March 2014. This includes the ‘taper tantrum’ episode and

the rise in US rate expectations that fuelled serious concerns about EM economies with

significant external liabilities. Over this period, EMs underperformed DM by 20%.

Exhibit 50: EM underperformed DMs by more than 20% in

phase 3 …

Exhibit 51: … although EM rebounded somewhat in the

spring of 2014



90

95

100

105

110

115

120

125

Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12

S&P 500 vs MSCI EM

S&P 500 vs STOXX 600

Index(Feb-09=100)

50

60

70

80

90

100

110

120

Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12

Periphery vs STOXX 600

Index(Feb-09=100)

75

80

85

90

95

100

105

May-2013 Aug-2013 Nov-2013 Feb-2014

EM vs DM

78

80

82

84

86

88

90

Mar-2014 May-2014 Jul-2014 Sep-2014

EM vs DM



Equity basket disclosure

The Securities Division of the firm may have been consulted as to the various components of the baskets of securities discussed in this report prior to

their launch; however, none of this research, the conclusions expressed herein, nor the timing of this report was shared with the Securities Division.

Note: The ability to trade this basket will depend upon market conditions, including liquidity and borrow constraints at the time of trade



Disclosure Appendix

Reg AC

I, Peter Oppenheimer, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or

companies and its or their securities. I also certify that no part of my compensation was, is or will be, directly or indirectly, related to the specific

recommendations or views expressed in this report.

Disclosures

Distribution of ratings/investment banking relationships

Goldman Sachs Investment Research global coverage universe

Rating Distribution Investment Banking Relationships

Buy Hold Sell Buy Hold Sell

Global 32% 54% 14% 42% 36% 30%

As of October 1, 2014, Goldman Sachs Global Investment Research had investment ratings on 3,649 equity securities. Goldman Sachs assigns stocks

as Buys and Sells on various regional Investment Lists; stocks not so assigned are deemed Neutral. Such assignments equate to Buy, Hold and Sell

for the purposes of the above disclosure required by NASD/NYSE rules. See 'Ratings, Coverage groups and views and related definitions' below.

Disclosures required by United States laws and regulations

See company-specific regulatory disclosures above for any of the following disclosures required as to companies referred to in this report: manager

or co-manager in a pending transaction; 1% or other ownership; compensation for certain services; types of client relationships; managed/co-

managed public offerings in prior periods; directorships; for equity securities, market making and/or specialist role. Goldman Sachs usually makes a

market in fixed income securities of issuers discussed in this report and usually deals as a principal in these securities.

The following are additional required disclosures: Ownership and material conflicts of interest: Goldman Sachs policy prohibits its analysts,

professionals reporting to analysts and members of their households from owning securities of any company in the analyst's area of

coverage. Analyst compensation: Analysts are paid in part based on the profitability of Goldman Sachs, which includes investment banking

revenues. Analyst as officer or director: Goldman Sachs policy prohibits its analysts, persons reporting to analysts or members of their

households from serving as an officer, director, advisory board member or employee of any company in the analyst's area of coverage. Non-U.S. Analysts: Non-U.S. analysts may not be associated persons of Goldman, Sachs & Co. and therefore may not be subject to NASD Rule 2711/NYSE

Rules 472 restrictions on communications with subject company, public appearances and trading securities held by the analysts.

Additional disclosures required under the laws and regulations of jurisdictions other than the United States

The following disclosures are those required by the jurisdiction indicated, except to the extent already made above pursuant to United States laws

and regulations. Australia: Goldman Sachs Australia Pty Ltd and its affiliates are not authorised deposit-taking institutions (as that term is defined in

the Banking Act 1959 (Cth)) in Australia and do not provide banking services, nor carry on a banking business, in Australia. This research, and any

access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act, unless otherwise agreed by Goldman

Sachs. In producing research reports, members of the Global Investment Research Division of Goldman Sachs Australia may attend site visits and

other meetings hosted by the issuers the subject of its research reports. In some instances the costs of such site visits or meetings may be met in part

or in whole by the issuers concerned if Goldman Sachs Australia considers it is appropriate and reasonable in the specific circumstances relating to

the site visit or meeting. Brazil: Disclosure information in relation to CVM Instruction 483 is available at

http://www.gs.com/worldwide/brazil/area/gir/index.html. Where applicable, the Brazil-registered analyst primarily responsible for the content of this

research report, as defined in Article 16 of CVM Instruction 483, is the first author named at the beginning of this report, unless indicated otherwise at

the end of the text. Canada: Goldman Sachs Canada Inc. is an affiliate of The Goldman Sachs Group Inc. and therefore is included in the company

specific disclosures relating to Goldman Sachs (as defined above). Goldman Sachs Canada Inc. has approved of, and agreed to take responsibility for,

this research report in Canada if and to the extent that Goldman Sachs Canada Inc. disseminates this research report to its clients. Hong Kong: Further information on the securities of covered companies referred to in this research may be obtained on request from Goldman Sachs

(Asia) L.L.C. India: Further information on the subject company or companies referred to in this research may be obtained from Goldman Sachs

(India) Securities Private Limited. Japan: See below. Korea: Further information on the subject company or companies referred to in this research

may be obtained from Goldman Sachs (Asia) L.L.C., Seoul Branch. New Zealand: Goldman Sachs New Zealand Limited and its affiliates are neither

"registered banks" nor "deposit takers" (as defined in the Reserve Bank of New Zealand Act 1989) in New Zealand. This research, and any access to it,

is intended for "wholesale clients" (as defined in the Financial Advisers Act 2008) unless otherwise agreed by Goldman Sachs. Russia: Research

reports distributed in the Russian Federation are not advertising as defined in the Russian legislation, but are information and analysis not having

product promotion as their main purpose and do not provide appraisal within the meaning of the Russian legislation on appraisal

activity. Singapore: Further information on the covered companies referred to in this research may be obtained from Goldman Sachs (Singapore)

Pte. (Company Number: 198602165W). Taiwan: This material is for reference only and must not be reprinted without permission. Investors should

carefully consider their own investment risk. Investment results are the responsibility of the individual investor. United Kingdom: Persons who

would be categorized as retail clients in the United Kingdom, as such term is defined in the rules of the Financial Conduct Authority, should read this

research in conjunction with prior Goldman Sachs research on the covered companies referred to herein and should refer to the risk warnings that

have been sent to them by Goldman Sachs International. A copy of these risks warnings, and a glossary of certain financial terms used in this report,

are available from Goldman Sachs International on request.

European Union: Disclosure information in relation to Article 4 (1) (d) and Article 6 (2) of the European Commission Directive 2003/126/EC is available

at http://www.gs.com/disclosures/europeanpolicy.html which states the European Policy for Managing Conflicts of Interest in Connection with

Investment Research.

Japan: Goldman Sachs Japan Co., Ltd. is a Financial Instrument Dealer registered with the Kanto Financial Bureau under registration number Kinsho

69, and a member of Japan Securities Dealers Association, Financial Futures Association of Japan and Type II Financial Instruments Firms

Association. Sales and purchase of equities are subject to commission pre-determined with clients plus consumption tax. See company-specific

disclosures as to any applicable disclosures required by Japanese stock exchanges, the Japanese Securities Dealers Association or the Japanese

Securities Finance Company.



Ratings, coverage groups and views and related definitions

Buy (B), Neutral (N), Sell (S) -Analysts recommend stocks as Buys or Sells for inclusion on various regional Investment Lists. Being assigned a Buy

or Sell on an Investment List is determined by a stock's return potential relative to its coverage group as described below. Any stock not assigned as

a Buy or a Sell on an Investment List is deemed Neutral. Each regional Investment Review Committee manages various regional Investment Lists to a

global guideline of 25%-35% of stocks as Buy and 10%-15% of stocks as Sell; however, the distribution of Buys and Sells in any particular coverage

group may vary as determined by the regional Investment Review Committee. Regional Conviction Buy and Sell lists represent investment

recommendations focused on either the size of the potential return or the likelihood of the realization of the return.

Return potential represents the price differential between the current share price and the price target expected during the time horizon associated

with the price target. Price targets are required for all covered stocks. The return potential, price target and associated time horizon are stated in each

report adding or reiterating an Investment List membership.

Coverage groups and views: A list of all stocks in each coverage group is available by primary analyst, stock and coverage group at

http://www.gs.com/research/hedge.html. The analyst assigns one of the following coverage views which represents the analyst's investment outlook

on the coverage group relative to the group's historical fundamentals and/or valuation. Attractive (A). The investment outlook over the following 12

months is favorable relative to the coverage group's historical fundamentals and/or valuation. Neutral (N). The investment outlook over the

following 12 months is neutral relative to the coverage group's historical fundamentals and/or valuation. Cautious (C). The investment outlook over

the following 12 months is unfavorable relative to the coverage group's historical fundamentals and/or valuation.

Not Rated (NR). The investment rating and target price have been removed pursuant to Goldman Sachs policy when Goldman Sachs is acting in an

advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances. Rating Suspended (RS). Goldman

Sachs Research has suspended the investment rating and price target for this stock, because there is not a sufficient fundamental basis for

determining, or there are legal, regulatory or policy constraints around publishing, an investment rating or target. The previous investment rating and

price target, if any, are no longer in effect for this stock and should not be relied upon. Coverage Suspended (CS). Goldman Sachs has suspended

coverage of this company. Not Covered (NC). Goldman Sachs does not cover this company. Not Available or Not Applicable (NA). The

information is not available for display or is not applicable. Not Meaningful (NM). The information is not meaningful and is therefore excluded.

Global product; distributing entities

The Global Investment Research Division of Goldman Sachs produces and distributes research products for clients of Goldman Sachs on a global

basis. Analysts based in Goldman Sachs offices around the world produce equity research on industries and companies, and research on

macroeconomics, currencies, commodities and portfolio strategy. This research is disseminated in Australia by Goldman Sachs Australia Pty Ltd

(ABN 21 006 797 897); in Brazil by Goldman Sachs do Brasil Corretora de Títulos e Valores Mobiliários S.A.; in Canada by either Goldman Sachs

Canada Inc. or Goldman, Sachs & Co.; in Hong Kong by Goldman Sachs (Asia) L.L.C.; in India by Goldman Sachs (India) Securities Private Ltd.; in

Japan by Goldman Sachs Japan Co., Ltd.; in the Republic of Korea by Goldman Sachs (Asia) L.L.C., Seoul Branch; in New Zealand by Goldman Sachs

New Zealand Limited; in Russia by OOO Goldman Sachs; in Singapore by Goldman Sachs (Singapore) Pte. (Company Number: 198602165W); and in

the United States of America by Goldman, Sachs & Co. Goldman Sachs International has approved this research in connection with its distribution in

the United Kingdom and European Union.

European Union: Goldman Sachs International authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority

and the Prudential Regulation Authority, has approved this research in connection with its distribution in the European Union and United Kingdom;

Goldman Sachs AG and Goldman Sachs International Zweigniederlassung Frankfurt, regulated by the Bundesanstalt für

Finanzdienstleistungsaufsicht, may also distribute research in Germany.

General disclosures

This research is for our clients only. Other than disclosures relating to Goldman Sachs, this research is based on current public information that we

consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. We seek to update our research as

appropriate, but various regulations may prevent us from doing so. Other than certain industry reports published on a periodic basis, the large

majority of reports are published at irregular intervals as appropriate in the analyst's judgment.

Goldman Sachs conducts a global full-service, integrated investment banking, investment management, and brokerage business. We have

investment banking and other business relationships with a substantial percentage of the companies covered by our Global Investment Research

Division. Goldman, Sachs & Co., the United States broker dealer, is a member of SIPC (http://www.sipc.org).

Our salespeople, traders, and other professionals may provide oral or written market commentary or trading strategies to our clients and our

proprietary trading desks that reflect opinions that are contrary to the opinions expressed in this research. Our asset management area, our

proprietary trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views

expressed in this research.

The analysts named in this report may have from time to time discussed with our clients, including Goldman Sachs salespersons and traders, or may

discuss in this report, trading strategies that reference catalysts or events that may have a near-term impact on the market price of the equity

securities discussed in this report, which impact may be directionally counter to the analyst's published price target expectations for such stocks. Any

such trading strategies are distinct from and do not affect the analyst's fundamental equity rating for such stocks, which rating reflects a stock's

return potential relative to its coverage group as described herein.

We and our affiliates, officers, directors, and employees, excluding equity and credit analysts, will from time to time have long or short positions in,

act as principal in, and buy or sell, the securities or derivatives, if any, referred to in this research.

The views attributed to third party presenters at Goldman Sachs arranged conferences, including individuals from other parts of Goldman Sachs, do

not necessarily reflect those of Global Investment Research and are not an official view of Goldman Sachs.

Any third party referenced herein, including any salespeople, traders and other professionals or members of their household, may have positions in

the products mentioned that are inconsistent with the views expressed by analysts named in this report.

This research is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be

illegal. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of

individual clients. Clients should consider whether any advice or recommendation in this research is suitable for their particular circumstances and, if

appropriate, seek professional advice, including tax advice. The price and value of investments referred to in this research and the income from them

may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.

Fluctuations in exchange rates could have adverse effects on the value or price of, or income derived from, certain investments.

Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and are not suitable for all investors.

Investors should review current options disclosure documents which are available from Goldman Sachs sales representatives or at



http://www.theocc.com/about/publications/character-risks.jsp. Transaction costs may be significant in option strategies calling for multiple purchase

and sales of options such as spreads. Supporting documentation will be supplied upon request.

All research reports are disseminated and available to all clients simultaneously through electronic publication to our internal client websites. Not all

research content is redistributed to our clients or available to third-party aggregators, nor is Goldman Sachs responsible for the redistribution of our

research by third party aggregators. For research, models or other data available on a particular security, please contact your sales representative or

go to http://360.gs.com.

Disclosure information is also available at http://www.gs.com/research/hedge.html or from Research Compliance, 200 West Street, New York, NY

10282.

© 2014 Goldman Sachs.

No part of this material may be (i) copied, photocopied or duplicated in any form by any means or (ii) redistributed without the prior written consent of The Goldman Sachs Group, Inc.

gs - goal - adventures in wonderland

Documents