Goldman’s not bearish, but they aren’t bullish either.
The bank remains risk neutral, according to an asset allocation update penned by Christian Mueller-Glissmann, who said that although there may be opportunities in carry and relative value, it’s best to be prudent and “selective.”
Markets are rather plainly in a “good news is bad news” macro regime, Mueller-Glissmann remarked, reiterating familiar talking points.
Goldman recently cut their subjective US recession odds for the third time in as many months. A downturn over the next year is now no more likely than it otherwise would be based on the frequency of post-War recessions, according to Jan Hatzius. “This points to further potential for rates markets to price out latent recession risk,” Mueller-Glissmann said.
The figure above shows US equities have recently become positively correlated with recession risk.
So, fading recession odds are accompanied by falling stocks, in part because market participants are concerned about the read-through for rates and bond yields (i.e., a longer stay at terminal for the Fed and higher long-end yields).
At the same time, the soft landing narrative, by virtue of becoming the shadow consensus, is probably in the price. “While a US soft landing has become more likely, it might be less of a tailwind for risky assets from here if upward pressure on bond yields continues,” Mueller-Glissmann wrote.
The bank’s risk appetite indicator is still loitering well above survey-derived measures of global services and manufacturing activity.
Interpretation is complicated in this case, though. “Despite continued positive flows into bonds, bond yields increased during the summer, in particular longer-dated bond yields,” Mueller-Glissmann said, adding that “based on historically negative equity/bond correlations, our RAI treats rising bond yields as a ‘risk on’ signal, but since the COVID-19 crisis this has not been the case — higher bond yields materially weighed on equities in 2022.”
That’s somewhat ironic. Mueller-Glissmann (and his team) have noted on countless occasions that the “historically negative” equity/bond correlation is actually a fairly recent phenomenon. An entire generation of investors was raised to believe in that reliable correlation, but it’s only been reliable for the past 25 or so years.
Anyway, Goldman’s view is that “risky assets are already reflecting a more benign macro backdrop” and the newsflow in that regard could be “less friendly” (as Mueller-Glissmann put it) over the near-term, particularly given growing stagflation risk in Europe.
“Risk premia are relatively low and our risk appetite indicator remains at positive levels, ahead of recent growth data,” Mueller-Glissmann went on. “As a result we think risky assets are struggling to digest rate increases.”
Cash remains Goldman’s only model portfolio Overweight.
“Goldman’s view is that risky assets are already reflecting a more benign backdrop…” I reckon so. I believe it’s true. Like everyone, I’ve watched the economy unfold over the past two years. I’ve backed up the money truck and dumped a load of cash on some cheap small-caps that I reckon will have significant upside in ’24. That will likely take a little longer than I expected.
Now I’m starting to think ’24 will be a much bumpier ride than I expected for my small caps. There’s enough persistent inflation in the economy to give the Fed pause (pardon the pun). There also remains in the economy substantial, loose money from Covid and from the financial blessings bestowed by Biden after he was sworn into office and flooded the country with cash on multiple fronts. He had the good intentions of signaling the start of his new leadership and to stimulate economic activity. It worked. But there was already plenty of money in the economy that was a hangover Covid.
Today we still have untold tons of cash in the economy, going about its business alongside persistent, relatively high rates. In my life I’ve never seen unemployment so low for so long. Most everyone that wants to work is working. At the same time, Europe’s economies are in the dumps. China is crashing, due to mismanagement. If any more drones fall on the Romanian shore near the Danube River in the next couple of weeks, the Russia-Ukraine war could easily become World War III at the same time that a US naval fleet is present, engaged in war exercises on the Black Sea with other NATO countries. It’s convenient, at least.
But how will the inversion of the twos and tens be resolved? They will be higher for longer. I also expect the Fed is going to have to raise rates again – maybe more than once. There’s just too much money sloshing about.
I’m not a bond guy. I don’t usually mind being patient for a short time while markets resolve their imbalances. Rocky, our cat, licks himself for comfort and/or finds a dark closet in which to rest. I expect to be right there with him for a while.