Markets stocks

What Are The Odds Of A Bear Market? Goldman Drills Down

The good, the bad, the bearish and the bullish.

Will there be a US recession in 2020?

Donald Trump certainly hopes not, that’s for sure. And the November jobs report has seemingly back-burnered the domestic downturn narrative, at least for the next several weeks.

But, as noted here over the weekend, not everyone is totally convinced that the US economy is out of the woods. The payrolls blowout makes the four-month ISM manufacturing contraction something of an afterthought. But should it? The Markit gauge says things are getting better, so maybe the glass half-full crowd has it right. Or maybe not – because this is somewhat odd:

In any event, some banks are more skeptical than others. SocGen, for example, is “resolutely pessimistic” about the growth outlook next year and still has a US recession penciled in for 2020. BNP isn’t quite that downbeat, but they are below consensus and, like SocGen, expect Fed cuts in the first half.

But Goldman is optimistic. The bank is looking for above-consensus growth in the US next year (2.3% versus 1.8%). Naturally, that means they’re not overly concerned about a bear market.

“While there are many possible triggers for equity bear markets, most are a function of recessions and these are usually triggered by one of four factors”, the bank writes, in an update piece that takes a dive into recent developments influencing their “bear market risk indicator”.  Those four factors are:

  1. Rising interest rates and inflation expectations,
  2. Asset price bubbles bursting,
  3. Unwinding of economic imbalances and
  4. Exogenous shocks, such as a surge in oil prices or an unexpected geopolitical event

Clearly, the first factor isn’t an issue right now. Inflation expectations are near the lows (indeed, on Monday morning, the New York Fed said that while the outlook for prices “ticked up” in the latest survey of consumer expectations, it’s still just 2.35% on a one-year horizon and 2.52% out three years). In Europe and Japan, the situation is obviously much more benign than in the US (depending on your definition of “benign”). The point is, central banks aren’t likely to find themselves forced to hike aggressively to combat a sudden acceleration in inflation anytime soon.

So, what about asset prices? Well, Goldman notes that while government bonds are clearly stretched, and while valuation expansion has, indeed, been the driver of stock returns in 2019 (as opposed to earnings growth), no assets outside of bonds are “at bubble-like valuations”. Some would doubtlessly quibble with that, but remember, you can always (always) find some indicator, somewhere, that will suggest something is a bubble. If you couldn’t, a legion of bloggers running lucrative doomsday-themed websites would instead be serving gimlets to bankers for tips, rather than lampooning them for click money.

As for the economic imbalances bit, that’s something Goldman has touched on previously and really, it’s an interesting discussion as far as these things go. One key point is that central banks have on-boarded most of the risk, allowing the private sector to de-leverage.

“The US private sector had seen an extremely sharp increase in debt – at the time US government debt and the Fed’s balance sheet were quite low and stable”, Goldman writes, of the lead-up to the crisis. “Over the past decade these factors have reversed: the private sector has de-leveraged, making it much less vulnerable to shocks”, they go on to say, describing the following visuals and noting that “private-sector balances are generally high and healthy across most economies, making it more resistant to shocks”.


“Exogenous geopolitical shocks” (i.e., Goldman’s fourth factor) are by definition impossible to predict with any degree of specificity and accuracy. The bank essentially punts on that, before reiterating that the odds of a recession in 2020 are lower than some recent surveys suggest.

Then comes the update to the bear market risk indicator. Here, for those who need a refresher, is how it works:

In our 2017 paper, we initially looked at over 40 variables and grouped them into three categories: macro, market-based and technical indicators. To analyse the data, we applied a ‘rule’-based system to assess whether each indicator has met a pre-determined (although subjective) threshold prior to a bear market. For example, the Shiller P/E needs to be at its 3-, 6- and 12-month average and also start at a level greater than the 70th percentile, OR just start at a level higher than the 90th percentile (this attempts to capture the idea that valuation needs to be either high and rising OR very high). 

That’s the gist of it. In 2017, the bank started with five key variables: unemployment, inflation, the yield curve, ISM and valuation. They’ve since added the private sector imbalance snapshot to the mix.

After all that (talk about burying the lede!), one comes to the bank’s conclusion which … drum roll… is that the bear market risk indicator has receded to “just” 61% from 70% in late 2017. “Low unemployment, high valuations and an inverted yield curve currently present the greater levels of risk”, Goldman writes, but flags low inflation which “tends to move slowly when anchored at these levels” as supporting a more constructive view.


Do note that there are some real-world implications from this exercise. Most notably, Goldman says the current level on the indicator still suggests that investors should expect low returns.

“While the overall risk of a bear market may be moderating, this does not mean that we are likely to see a strong bull market acceleration from here”, they write, before cautioning that “we would normally expect to see such an acceleration only when the indicator falls to very low levels (sub 40%)”.

Casting further doubt on the outlook is the specter of margin compression, something that comes up again and again, even in outlook pieces from some of the street’s more bullish analysts. Here’s Goldman’s quick take from the piece (one can discern a whiff of the “Japanification” narrative, assuming that narrative has a scent):

The prospects for profit growth are constrained by the gradual slowdown that we have seen in revenue growth across the global equity markets in recent years. In developed markets the post financial crisis era has resulted in a fading of revenue growth towards the growth rates that Japan has experienced since its financial bubble burst in the late 1980s. For much of the past few years, this has been offset by strong margin growth in all major markets. But rising wages, among other factors, are starting to put downward pressure on corporate margins.

Yes, rising wages “among other factors” – factors like rising input costs tied to protectionism. And an inability to pass along those costs to consumers.

But perhaps the biggest potential headwind to margins comes from the prospective rollback of the tax cuts. And on that note, we’ll leave you with two simple charts which we’ve used before and which always comes with the usual caveat: Just because we’re predisposed to favoring the progressive agenda doesn’t mean we don’t recognize the mechanical, near-term impact when you take the pruning shears to EPS.



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