Goldman Sachs On How To Navigate The Slowdown
Remember when a week ago the world was slowing down? Apparently all it takes to forget reality is for Europe to sweep the fact that its banks are insolvent under the rug courtesy of a systematic farce conducted by the very system the banks are part of, rendered even more "credible" since as of today it appears no banks will fail the stress test. On the US earnings front, a materials company beating reduced expectations and a chip maker having just record the best quarter in its history (what growth next for Intel: 80% margins? 90%? every household in China buying an i7 980 for their 7th toaster in their 5th house?), even as global trade is paradoxically stalling following an all time record month for Chinese trade? Americans may be unemployed and homeless but they sure like their iPads and their fast PCs. Either way, to remind readers that despite the latest market run up on no actual positive economic data, here is Dominic Wilson, Director of Global Macro & Markets Research at Goldman, with advice to clients on how to navigate the "slowdown."
Global Market Views: Navigating the Slowdown
1. Over the last few weeks, it has become clearer that the US economy has been slowing. It is this theme that has dominated markets lately, not earlier European sovereign fears. We have long had a view that 2010H2 would show significantly softer US growth. But for early in the year, US data generally proved better than expected and markets traded along those lines. As a result, we have been slower to reposition for this shift than we would have liked even as the market has moved closer to our own long-standing views. We think that there is still room to position for slower US growth. But with systemic risks overpriced, already-high levels of concern about Europe and China and a solid earnings season ahead we are currently doing so more on a relative than an absolute basis.
2. For all the legitimate focus on the European sovereign story, the broad macro backdrop to the last two months of market pressure in hindsight looks simpler. The last two months has delivered fairly consistent disappointments in the US data from housing to payrolls to the ISM surveys. Global PMIs peaked in April. Our new improved GLI (we revamped it a few weeks ago, a process we carry out roughly every 4 years) now shows a clearer peak in March of this year (having bottomed in February 2009) and moderation since then. Global data remains consistent with robust current growth. But disappointments are disappointments. Against that backdrop, markets have until recently done what they often do when faced with this kind of news, until recently pushing equities (cyclicals in particular) lower, hurting commodities and related currencies and pushing bond yields up.
3. In relative terms, the market has also indicated that a shift in its worries from European sovereign risk towards US slowing began some time ago. US bonds have outperformed and the spread between Eurozone and US 2-year yields is back to January levels, having round-tripped a 50bp move; the SPX has been a laggard to both European and EM equities lately (even in USD); US consumer and housing-related areas have led the way down, with our Wavefront Housing and Consumer Growth baskets giving back the year’s gains; and even against the EUR, the USD has lost decent ground. In most cases, this represents a significant reversal from December to April when positive US surprises (absolute and relative) drove many markets.
4. The shift in focus to a US slowdown – and the argument that deflation not inflation is the major risk for the G3 – should not be surprising and has been a core part of our 2010 outlook. From a trading perspective, the problem has been that for several months, US news was continually ahead of expectations, a dynamic that was arguably the key market theme between December and April (and one we traded). But the basic problems that our US forecast has always flagged – and which are largely unconnected to sovereign fears – have become more visible. We still expect final demand to grow at just 1.5% in the second half as the inventory boost fades and fiscal policy becomes a drag. At the same time, the policy debate has shifted in ways that make a rapid response less likely. Jan Hatzius and team have been beating the drum louder about our 2010 views and the growing risks to 2011 in a number of important pieces over the last few weeks.
5. In the very near-term, there are some important offsets to this backdrop. First, sentiment shifted sharply negative and expectations have clearly fallen. Deflation risk (something we had to consciously raise for most of the last 12 months given our long bond bias) is now routinely on the agenda. So the near-term hurdle on the macro news is lower and we have seen some reversion in the data recently. Second, US earnings season is kicking off. Current earnings should be reassuring, so guidance will be in focus. But the market is heading into the season with more fear than has been true for several quarters. Third, there are signs that Q2 GDP growth is coming in stronger than expected in several places. Globally, things are slowing, but as Kevin Daly and Alex Kelston have showed, deceleration is coming from what look like stronger levels of Q2 growth than many expected. So here too the market may have to process better current news even as it worries about the forward path.
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