As risk sentiment looks set to remain sour thanks to the increasingly precarious situation in Hong Kong and the seeming inevitability of a fresh debt crisis in Argentina, it’s worth asking whether we have now clearly moved away from the “Goldilocks” regime that prevailed for most of 2019.
When growth is firming and central banks are determined to remain accommodative on the excuse that inflation shows no signs of improving and the outlook is “uncertain”, assets of all stripes can rally, especially if growth isn’t good enough to convince the bond market to price in a sustained upturn.
The problem comes in when the growth outlook darkens enough to override the good vibes from the prospect of perpetual central bank accommodation. At that juncture, bad news is just bad news (as opposed to the perverse “bad news is good news” dynamic which has defined markets at regular intervals in the post-crisis world).
We’ve variously suggested that August marked a turning point, as fresh trade escalations and the burgeoning global currency war set the stage for markets to begin thinking seriously about the notion that monetary policy will be insufficient to offset the drag on growth, especially considering how limited central banks’ ammo is after a decade of accommodation.
Considering the performance of gold, the yen and bonds this month versus the lackluster showing from equities, it’s probably not a stretch to say that “Goldilocks” is now set to go MIA again.
“YTD market performance has oscillated between two ‘Goldilocks’ scenarios, where monetary policy eases despite better growth (from Dec-18 to Apr-19 and from Jun-19 to Jul-19) and two ‘central bank put’ environments, where monetary policy eases in response to weaker growth (from Apr-19 to Jun-19 and end of Jul-19 to now)”, Goldman wrote Monday evening.
Have a look at cross-asset performance since July 29:
Goldman goes on to note that during this year’s Goldilocks months, “sentiment [was] generally risk-on but bonds also tend[ed] to perform positively given the support from central banks”.
But, when it comes to full-on “central bank put” environments, the bank cautions that “risky assets tend to suffer and ‘safe’ assets outperform”, which explains why government bonds have benefited the most and, together with US IG and gold, have enjoyed a positive performance across both “Goldilocks” scenarios in 2019 and both “central bank put” environments”.
We’ve obviously talked quite a bit about this of late. The following chart makes a similar point:
“The decline in market pricing of growth has been the main driver of cross-asset performance since the Trump tariff announcement [on August 1]”, Goldman goes on to write, in the same Monday evening missive.
The bank notes that investor positioning in bonds has run even further, especially for the long-end. Late last month, Goldman noted that flows into government bond funds over the preceding six months were the largest since 1985 in the US.
It’s not a bubble, ok?
It will come as no surprise that although most assets have performed in line with Goldman’s model-implied returns (based on a sensitivity framework tied to the factors in their risk appetite indicator) since the end of July, long-term bonds have outperformed.
Meanwhile, AAII sentiment has simply collapsed – it’s now back to levels on par with the last decade’s worst risk-off episodes.
Going forward, we’re going to need evidence that growth is bottoming out or, at the very least, that the trade war may be set to abate, which would hypothetically help support better growth outcomes down the road.