In a brief Thursday missive, Goldman is out with a list of “three reasons why risk assets should worry less” and it’s sure to throw the doomsday crowd into all manner of hysterics, hysterics which that crowd will invariably mask with sarcasm in a largely fruitless effort to disguise their growing consternation with having been demonstrably wrong for coming up on a decade.
And look, regular readers know Heisenberg is prone to cynicism and skepticism, but the thing about the doomsday crowd is that they’re not really cynics. They’re pretend cynics. Because part of being a cynic is expressing skepticism towards all things which are silly and when it comes to market-related things that are silly, right there at the top of the list is the notion that we’re headed for soup lines and creative destruction.
Anyway, there are of course all manner of real reasons to be concerned about the outlook, not the least of which is the fact that the leader of the free world is a literal WWE Hall of Fame inductee who is under investigation for obstructing an ongoing investigation into whether his campaign colluded with a hostile foreign power.
That’s obviously a rather vexing issue and that same Dennison is now attempting to navigate the choppy waters of a global trade war of his own making while simultaneously attempting to stick the landing on a highly precarious economic balance beam act that involves piling fiscal stimulus atop an economy running at full employment.
Throw in concerns about tech regulation (which could conceivably imperil the fortunes of the companies that have shouldered a disproportionate share of the burden when it comes to sustaining one of the longest bull markets in recorded history) and you’ve got a veritable minefield.
Oh, and don’t forget about Iran. That’s a problem too and rather than looking forward to a resolution on May 12, everyone just assumes the worst after Netanyahu’s “Iran lied big time” presentation.
It’s against that rather fraught backdrop that central banks are attempting to stick their own difficult dismount, by normalizing policy and rolling back the accommodation that’s helped propel risk assets to nosebleed levels. That normalization is colliding with expansionary fiscal policy to create a supply/demand imbalance in bond markets that some contend will lead to a yield shock. And then there’s the Fed and Jerome Powell’s efforts to keep the U.S. economy from overheating in the face of Trump’s stimulus while being careful not to invert the curve on the way to ushering in a recession.
So those are all the reasons to worry and here, courtesy of Goldman, are the reasons not to – worry, that is.
First and foremost, the robust growth backdrop that underpinned markets throughout most of 2017 appeared to moderate in Q1, especially outside the US. But as our global economics team points out, the reasons for this slowing are partly transitory, including the timing of the Chinese New Year and unusually cold weather. Nor is it yet obvious that the well-known Q1 seasonal bias of recent years has fully normalized. Meanwhile, US growth should start to show strength from the fiscal stimulus passed in December, while our China team recently upgraded its 2018 growth outlook to 6.6% (from 6.5% previously). Brazil and India continue to grow, too, with considerable cyclical room to keep growing. Indeed, early signs of global growth stabilization may already be starting to show in high-frequency leading indicators of global activity such as the Baltic Dry Index, which rallied 40% in April after having steadily fallen by roughly 40% from December-March.
Second, concerns over excess monetary tightening – a popular question from clients of late – are probably overdone. Global markets have clearly had to absorb a large move in US 2-year yields, which recently hit 2.5%, up from 1.9% in January and just 1.3% last September. But the speed and magnitude of this move are probably now mostly behind us. With the forwards now roughly in line with both our long-standing house view of four hikes in 2018 and the consolidating “dot plot” from the FOMC, the remaining uncertainty is mostly around the net effect of fading tailwinds from easy financial conditions vs stronger tailwinds from fiscal stimulus, and the extent to which continued above-trend growth will call for more hikes in 2019 (four more, we think). Since we think current rate expectations (including our own) are pricing a non-trivial fiscal impulse, the risk of incremental repricing from here no longer seems as hawkishly skewed as it seemed to us in January. Clients also worry that QE is ending, but globally, it should more accurately be described as decelerating. And with core inflation still looking exceedingly well-anchored across DM (the 0.3%YoY jump in US measures of core inflation is due mostly to one-time base effects), we continue to doubt that DM central banks will find any “Motive for Murder”; instead, we think well-anchored inflation expectations will free policy makers from the burden of fighting too hard against the risk of a shifting Phillips curve and allow them to focus instead on reducing the risks to the expansion.
Third, several technical factors that may have been weighing on risk appetite seem likely to ease. For one, the pressure on short-term funding markets caused by the “repatriation” of cash parked in short-term credit is already well down the path to normalization. This is starting to show up in the narrowing of money market spreads, and we see few reasons not to expect this normalization to continue. Second, we suspect that the reduced market appetite for selling equity volatility, which has struggled to recover from the shock in February, and which has likely weighed on risk appetite by causing S&P volatility to persist well above that of other risk markets, will also continue to normalize. Third, now that we are well into earnings season with most companies having managed to meet or beat unusually high earnings expectations, the nervousness over earnings weakness should begin to relax alongside the increased availability of cash for share buybacks. Finally, while the above rate moves and funding dislocations likely explain why the bond-equity correlation has broken, the fading of these risks should allow the “hedge value” of long-duration bonds to reassert itself.