Going forward, risk assets need better data and a sustained upturn in global growth more than they need dovish central banks.
That’s the general message from a new asset allocation piece out from Goldman on Tuesday.
During the first half of 2019, markets returned to a “bad news is good news” regime, as signs of economic malaise were seen boosting the odds of monetary stimulus and thereby bolstering risk assets. That, in turn, contributed to the vaunted “everything rally”, as bonds surged on a lackluster outlook for growth and inflation, and risk assets jumped on the assumption that the worse things looked for the global economy, the more determined central banks would be to cut rates and ease policy.
“As in 2015/16, the 3-month correlation of weekly cross-asset risk appetite indicator changes has been regularly negative with macro surprises”, Goldman wrote Tuesday, on the way to reminding market participants that generally speaking, “‘bad news is good news’ regimes tend to be temporary as either the monetary stimulus runs out and weak growth eventually weighs on risk appetite or growth eventually picks up, driving more positive surprises”.
In other words, “bad news is good news” works until the news becomes so bad that monetary policy is no longer seen as sufficient to stave off a deeper downturn or else the news becomes good enough to signal that the economic storm clouds have cleared once and for all.
Goldman goes on to say that starting in April, the dynamic shifted subtly and over the past three months, fairly dramatically. Since August (when bond yields plunged amid trade frictions and an attendant growth scare) both the S&P and US 10-year yields have been positively correlated with macro surprises, indicating that “good news is good news”.
Early 2019 found TINA (There Is No Alternative) reasserting itself, as plunging yields pushed investors out the risk curve and down the quality ladder into risky assets as expectations for Fed cuts and a new ECB easing package gathered steam amid similarly dovish shifts from the RBA and RBNZ (plus multiple EM central banks).
“Another way to illustrate this is the correlation of the S&P 500 with US 10-year real yields, which has been negative for most of 1H 2019 due to the search for yield but turned sharply positive in the summer – and has been closely linked to the S&P 500 correlation with macro surprises”, Goldman writes.
The bottom line, Goldman says, is that “near-term it seems increasingly difficult for G3 central banks to surprise in a dovish direction and support risk appetite [so] better growth needs to take over as a driver”.
For their part, the bank is still risk-neutral in their asset allocation on a three-month horizon.
As far as what’s driving sentiment over the last several sessions, the bank cautions that while “a de-escalation of US/China trade tensions coupled with a Brexit deal could support risk appetite in the near term… we would need to see a more meaningful global growth pick-up, policy concerns to fade and rising inflation expectations and bond yields” in order for a sustainable rotation to take hold.
On Tuesday, the IMF slashed its outlook for global growth to just 3% in 2019. At the same time, questions continue to swirl around the viability of the “Phase One” trade deal between the US and China.
Oh, and the New York Fed’s monthly survey of consumer expectations showed the outlook for inflation three years ahead falling to 2.4% last month – that’s a record low.
On the bright side, Goldman notes that “most investors are already relatively defensively positioned, which increases the hurdle rate for negative growth shocks to drive a large ‘risk off’”.
The bank also warns that until such a time as the macro outlook improves enough to convince market participants that the global economy is out of the proverbial woods, rate shocks tied to, for example, tantrums or sudden spikes in oil prices, likely won’t be digested well by risk assets or havens. (So, when it comes to rising bond yields, “too far, too fast” isn’t desirable.)