« Exchanges at Goldman Sachs

"Fat and Flat" and the Market Path from Here


Peter Oppenheimer, Goldman Sachs Research's chief equity strategist and head of European Macro Research, weighs in on the recent rally in equity markets, the "third wave" of the financial crisis, the likelihood of a global recession, and more.

This podcast was recorded on March 9, 2016.

All price references and market forecasts correspond to the date of this recording.

This podcast should not be copied, distributed, published or reproduced, in whole or in part. The information contained in this podcast does not constitute research or a recommendation from any Goldman Sachs entity to the listener. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty, as to the accuracy or completeness of the statements or any information contained in this podcast and any liability therefor (including in respect of direct, indirect or consequential loss or damage) is expressly disclaimed. The views expressed in this podcast are not necessarily those of Goldman Sachs, and Goldman Sachs is not providing any financial, economic, legal, accounting or tax advice or recommendations in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by Goldman Sachs to that listener, nor to constitute such person a client of any Goldman Sachs entity.

Copyright 2016 Goldman Sachs. All rights reserved.

This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
This is exchanged the Goldman Sachs, where people from our firm share their insides on developments currently shaping markets industries in the global economy objects. He worked globally of corporate communications here at the firm ass at prices around the world have got off to a volatile start this year, as investors raise concerns over the efficacy of policy. Manure. first, particularly the central bank level and weakening emerging markets, to discuss these trends and joined today by Peter Oppenheimer, the chief global equity, strategist and head of european Macro Research for Goldman Sachs Peter welcomed the programme. Thank you. Jake, so we ve started off the year, seeing partial rebound from the steep declines dead they in January and February. Do you see this is. of real stabilization or just a temporary lol in an ongoing period of volatility, I think, on balance the latter,
you know when we did our outlook pieces for this year. We described for equity is the environment as fast and flat facile, wide volatile trading range, with relatively flat turns, and the two main reasons for this were firstly that after Several years of key in response to the financial crisis, most equity markets had seen a major rating. In other words, the p ratios risen to quite high level is by historical standards. They weren't critically cheap. Secondly, the outlook for profit growth was moderating around. The world margins had hit a peak in the. U S, revenue growth was slow.
alongside lower nominal economic growth and low inflation. So the combination lead us to believe that it is quite difficult to get bored equity market rises in a significant way, contrary to the situation we have seen in recent years and as we move into the beginning of this year because of the intense focus on food commodity prices, the fears about the impacts- rising: U S, interests AIDS and also the focus on a China slowdown. You really seen a major decline in growth expectations, roundabout and inflation expectations now we see a bit of a rally recent weeks, mainly, I think, because what did he prices have started to pick up? People started when the law, but less Mattel risks little bit less about tell risks. There's been some better data protection in the? U S, and I think things got quite oversold, so this is all consistent. I think
With this idea, you get a volatile trading rage. I think a lot of the underlying problems that investors are worried about, slow long term growth and weak profit outlook relatively full valuations, haven't really changed, and so I think this volatile trading range is still probably the white way to look at it for this, yet so research you tie some of these questions about the stability of ass, a price too much broader story. What you call the third way explain what that means. The way that we ve been sort of thinking about things in the last year or so is that the financial crisis, which is into its eighty, also haven't really been about. One event is really being about a series of related events, where the epicenter of the risks of ridding shifted from one region to another. So few
ass, if you go back to two thousand and eight nine, the beginning of the financial crisis, was the collapse in the: U S: housing, market and sub prime, and that brought into out into a credit crunch that affected the global economy. We saw a recession globally. We saw very shortfalls in risk ass. It prices for obvious reasons, but ultimately this was stabilized through a process of very aggressive policies. In interest rates got down to zero the dollar devalued, and then we had key and that worked it had the effective stabilized. U S. Economy, financial markets responded very positively and we saw some very sharp rises in equity markets. They got to very low valuations, but it wasn't too long later a year or so that the concern started to build up again in the focus shifted to Europe. Why? Because Europe had very leverage bangs with huge exposure to? U S
crime relatively anemic policy responses put at that at that time. Yes, indeed, and also banks had very large exposures to sovereign debt, which had built up to very high life was particularly in the social periphery. This of Europe and, of course, that we need dominated the market focus over the next two and a half years is eventually. Invest is worried about the potential for the Euro area to break up completely in the single currency to be broken up, so that your second, why that was a second wave and interesting. They like the first wave. Ultimately, the policy response was very aggressive. It took longer in Europe because it was more com let's go as those more complicated get. Consensus in Europe can be a lot more countries involved, of course, but I welcome it you know rates got down to zero? You saw a currency devaluation and you saw Ozma equality, and that really was the turning point where things looked as if they had started to stabilize,
and again from very low evaluations, which reflected the intense concerns at the time. There was a very sharp recovery in risk ass, its around the world inequities in particular, and things started look much better again until we moved into what we describe as this third wave, where I guess initially prompted by falling commodity markets. The focus of attention started to shift to emerging economies, which of course, we are very much at the heart of the food and commodity price. Is and then that broad and doubt awesome the into concerns about that levels in em in China in particular, and the concern that, if you had needed to see very aggressive policy responses in the U S, and then in Europe, there are routes, cutie devaluations. Why should that not be the pattern in em? And if we were to see those concepts
assessments, particularly in things like a devaluation of the hour and be it could be very deflationary, a negative for the global economy, particularly because interest rates in inflation were already so low in both the. U S Europe. See first talked about this third way in October of last year. Since then, five months later, we ve seen the FED again frustrates oil. Oil continues to fall and policies. We that renewed concerns about China's economy in its resilience. Where do we stand today with regard to the thesis? Are we any closer to a normalization where we talked about this third wave? We try to describe to potential outcomes This isn't a generalization. There are many permutations in between but overruled. I guess you could think of one rather negative course that follows
wave, where the jaw down in growth, any Amis, very aggressive policy response needed to stabilize growth, is very aggressive and that really drives global growth down into another recession. and you get competitive devaluation and competitive devaluations that, I think, is increasingly the concern which has been priced into the market ticking in January of this year. The alternative scenario, which is actually the one that we believed and still believe it is the desert
was benign interpretation. Ultimately, this third wave is unnecessary adjustment of economic imbalances, justice we had seen in Europe in the U S before, unlike those previous waves, it's about de leveraging of economies and why that may be choppy for a period of time. Ultimately, it will create the basis for a more balanced, sustained economic recovery globally and gradually yoga interest rates rising. That still the view that we have, I think at the moment, where switching in market sentiment, in one or other of those outcomes. The more aggressively negative one, the potentially more benign one. The interesting thing I think, though, is that, when you are in a world of effectively zero interest rates and extremely low inflation is very difficult to be convinced is an investor of which one of those outcomes, your
moving into thus will see. Some oscillation, involving the volatile, have a most interesting again. I think Jake is that the two outcomes, the two trajectories imply almost diametrically opposite fish is deepening babbling, regular outrage, investing dip into the more negative outcome, then, in simple terms its world, where you want to be, of bonds, even at very low interest rates to be underweight of equities, which do very badly in a deflationary world want to be under way to banks and of weight of defensive parts of market and so on, whereas of course, if you move into the slightly more benign outcome where these adjustments are believed to be working,
but you're still left with very low interest rates. That's a world where you want to be selling bonds, where you would expect bond yields rise where equities are a much better place to be credit risk assets where you would want to be buying things that a lever to growth like cyclical bangs, none when you would want to be selling very defensive parts of market which have become quite expensive. So I think this sir risk of moving from one to the other is also an explanation of these volatile swings that we're getting but it's in the overall markets, but also the rotation of island rotations. It was seen an increase in the elderly. The index. Do you talk about first to ways of the global financial crisis, both in the? U S in Europe, unwounded a combination of low interest rates, Q. In currency, devaluations our emerging markets responding to the challenges they are facing. An what We see terms of further power.
The action. What would be the impact on markets? Will I think here there is some encouraging news in the sense that, when the emerging markets focus really started become very intense, a lot of the concern was about the impact for in commodity prices. Of course, some not all emerging economies. Big quantity produces and they would suffer from that, but also there was a legitimate concern about the size of some of the extended balances which had built up in emerging economies, and the worry going back some time now was that in a world where, U S, interest rates might start rising and those concerns a course turned out to be premature. Emerging markets that had big external liability is becoming account. Deficits, for example, would be very vulnerable to rising u S rates and they would suffer current
collapses need to raise their rights that would trigger lower growth and you get into a vicious cycle and motionless on the late. Ninety slightly very much as we saw in the late. Ninety nine is a kind of Classic M problem. The good news is that much of that adjustment for many of these countries has started to happen and is quite well advanced. So a lot of these countries did see big currency devaluations. They did see big adjustments in growth. Many had recessions, but that brought down the size of these imbalances, and I think that much less vulnerable now to some of the adjustments
If we want to see, for example, U S, interest rate starts rise more quickly. That said, the one area where you have not seen these adjustments or currency adjustments in particular is in China, because China is maintained this at a fixed exchange rate and has managed to do that for a long time, because, unlike many other emerging economies, it doesnt have external liabilities, it has huge excess savings is gonna very big card count. Surplus bought over time. Of course, as the chinese economy slowed, the concerns are that it too will need to see policy just
in the form of lower rates, perhaps a weak currency. Another thing is crystallized concerns about such a major and large and impact full economy operating very loose policies which could be very deflationary for the rest of the world, so I would say in summary, I think, a lot of the systemic risks that people might have been worried about emerging economies have moderated, but we still left, I think, with the uncertainty of how the chinese economy develops over the medium term in an environment where perhaps U S, interest rates rising and it Jody delivers, like you, ve seen in many other major economies in Europe. In the U S so Peter. When you talk about the second wave, you wrote a report some time ago. The long good bye where you predicted that risk assets would respond favourably to the policy response in Europe. How that played out well
it has played out very well remember that at the time I will, though there were many economic uncertainties as I guess you could say there are today. The difference was the valuations reach very low level, PAN european Equity, my in particular, but generally, I think that's true across equities in Europe in Particular- You know in two thousand and nine- the p multiple got down to around eight times and similar to that again in the second wave, when people really worried about the european crisis- and we argued that yeah, the economic outlook, was uncertain, but you were being rewarded for taking that risk and indeed since and if you look at the lower in two thousand and nine equity markets have made tremendous progress. U S. Market has gone up about two hundred
sent the european markets even without really any profit growth of gun. Up about a hundred percent, so the analyze returned you're talking about here over that period of time, is curious, really become the dominant policy to have really been very staggering. The difficulties that that's left a lot of markets now with less value but still relatively modest, profit growth, outlooks and that's why? we see the transition to a more of a fast and flat environment. Now, so policymakers have been worried odyssey about the risks of deflation in part, because it's very difficult to combat low oil price certainly kept inflation well below central bank targets all across the world. Do you see any reason to expect higher inflation the rest of this year and what sectors would be
fit from a shift in expectations, ran inflation rates will. As a house, we do think that the concerns about deflation, which had been mounting in recent months, have been overstated afterwards. He look at the. U S in particular, at the most recent data suggests that core inflation, excluding food and energy, for example, is around two point, two percent, so it's actually above the fit. Our talk,
and many other similar types of indicators is showing the same thing, even seeing some wage pressure and indeed some wage pressure, because unemployment continues to come down. The labour market is relatively tight with high wages and reasonable core inflation is consistent with our view as a house that interest rates should gradually rise in the. U S. Now the inflationary pressures are less evident in many other parts of the world, because output caps, a bigger, there's more spare capacity, but even in places like Europe, unemployment is coming down from high levels and you're, starting to see improvements in modest rises and wages. Rises in real incomes, and I should say again before we literally gloomy. It is worth noting that one real sense of positive surprise over the last two or three years has been the labour markets in most places. So, whereas we ve had year by year, consensus expectations of GDP growth in most places being too hot,
and having to come down and alongside our labour markets, have been privileged areas. I sit markets have been resilience, so there's a sort of sectoral shift, which is important here, where we think Generally, things are improving for the consumer, in the U S across Europe and in Japan, even to some extent the margin and merging, Kids, on the other hand, there are still very severe think headwinds for areas which are very geared into global context, because it's important sensitive emphasise the scale of the cap ex boom. We sing globally in the last decade, or so much of which reflected the developments of globalization, the emergence of the bricks economies, the huge increase,
in Commodity capital expenditure over the last decade or so the super cycle field. A lot is not only happen with. It is course the big deepening of capital spending in emerging economies in places like China in particular, where there is huge amount retooling to build up the export base to meet increase global demand. So we think that's an overhaul of capacity which is going to continue to draw down on inflation in some parts of the economy and will create a drag on margins and profits for the companies facing that so over what I think. People have been too worried about deflation, but there are differences beneath the surface which are worth emphasising. What would happen if we were to see inflation expectations picking up a little bit and, of course, all prices stabilizing rising a bit would be an important part of that inflection. I think in that situation you would tend to see a bit more move towards sickle parts of the markets
ass, the defensive parts, which have generally performed very well, as people have been so uncertain. You would start fine social value stocks doing rather better than gross socks. Growth is also done very well in the world where gross has been seen to be very scarce, and I think he would also see an environment where banks, for example, would do much better, because at the moment they have suffered from concerns about
revenue opportunities in a world where your coves re flat, and indeed, in some cases, his interest rates are turning negative and it's very difficult for them to generate returned when their net interest martians being squeezed. So much so I think this potential shift from a perceived deflationary world to a what we call low inflation tight world, not a high inflation would be quite meaningful in terms of the rotation that you would expect to see beneath the surface of the major markets. Even if the oval indices were not making significant progress, and I think it's a sense of that rotation that were beginning to see in the very recent past as all price,
started to pick up on some of the macro. Data has started to improve a little bit again so Peter there, some who doubt the efficacy of policymakers today and in really fear that they don't have the tools to address some of the concerns that the markets are reflecting. We saw in fact, a really distinct fall in Japan in response to the relatively unusual step of the negative interest rates have investors lost faith in, The ability of monetary policy is that these concerns in the market, and I think this in particular, there has been a general loss of confidence reflected in the markets about the ability for central banks to make meaningful changes to growth. There's a sense that policy adjustments have avoided a disaster
Why did the depression but haven't really genuinely done enough to generate significant growth and in a sense in a perception, is reality. People believe that monetary policy works, it works and if they start believe it doesn't, it has unintended consequences and people tend to save more and they more cautious, and we may have hit that point. After all, you know we spent years getting interest rates down to effectively zero, then crossing the ruby couldn't unconventional policies in which include a key and now we're getting to the point where Europe and Japan you're getting negative interest rates, and that is creating problems for the banks, which is crazy, problems for overall levels of confidence amongst the corporates and indeed households citing you get to a point where, if interest rates move aggressively, negative people starts, that is a signal that things must be really bad and they become more cautious as a result,
which is this recital golly I like, and what you want to see and that's a little. it? Why we taken a view some time ago that for risky assets equities in particular, ironically, seeing interest rates rise, at least in the? U S, for the right reasons because throws the strong rather than inflation is picking up would actually be pretty good practice, and we find the correlation between changes in Bonn in interest rates on the one hand and equity prices on the other is not linear really does change over time, depending on the level of interest rates turnover normal world, if you like, following interest rates ten created for, according to its because people? Look at that relatives. rather out of rights when you get down to extraordinarily low interest rates and bond yields. What you tend to find is that further cuts in yields
are actually accompanied by rise in the so called risk premium? As people see, this is an indication that there is less growth in future, a more risk of deflation, and so your oval cost of equity, which is the discount right at, doesn't actually come down and you'd get set of negative effects, and I think we ve seen some of us He talked a lot of sophist, get investors everyday factor in New York to meet with some of them today, in those relations! Where do you get the most pushed back on your views of where we are and in the markets today? Well, say in general, interesting late, I dont think the very strong consensus vs out there and I don't think, there's a lot of very strong conviction. I would say anywhere there are times when you go around and you get a very good sense that their views that very strongly held common views in the marketplace, whether it be about currencies or the direction
Just rates or markets at the moment I think, there's a lot of confusion and it really reflects a lot of the issues that we have been discussing. We do get pushed back on our view that things are not as bad as the market surprised that economic activity, at least in the U S in particular, but even in places like Europe, are doing. Ok and the risks of deflation probably overpriced the view that we have that interest rates can rise moderately, that the economy strictly in the. U S is sufficiently robust beer to sustain that. I think is seen to be quite controversial now, so that is quite positive in a way I think people have become quite gloomy, partly because they have seen a lot of volatility. It's difficult to see what
a strong growth is gonna come from. There is still a lot of unresolved questions about things related to em in China that we ve been discussing, and also because there are other difficult price risks. Many them political now which people are having to contend with. so Peter that hearing from investors, there's array your views, but not a lot of conviction at Goldman Economy, here basically have to take a view, and they ve said recession is relatively unlikely and twenty sixteen. What are the risks to that view
well, one of the things it's important to emphasise is the risk. Is that without getting at recession globally from here is we think very unlikely, because if it were to be triggered say by the slow down in China, the trade flows and not sufficiently large to trigger a recession? We thinking in places like the? U S: Europe, for example the EU s exports to China about roughly one percent of GDP, and although it has been a lot of focus on the manufacturing, slow down globally, manufacturing is awfully around ten percent of GDP in the? U S, and maybe fifteen percent or so in Europe is not negligible, but is not big enough of these big consumer market? Yes, exactly that being said, and I think this is a bit of risk. People may not be sufficiently focused on the corporate set in the corporate. Such is very different from the economy itself, so, for example,
if we take the european markets, where you may have fifteen cent, exposure of manufacturing to GDP Overall, we estimate nearly fifty percent revenues of companies in the quota corporate sector are involved in manufacturing, today more exposed than the economy. We talked about. China entered is also an energy that is when you see up relative to the economy. So too is exposed to emerging markets again, for example, in Europe around roughly seven percent of revenues for the stock. Six hundred the broad european index is exposed to China directly and over twenty percent to emerging markets as much more than is the case for the broader economy, so highly single markets at some lonely and risks to the answer. Yes- and I think that's where would answer that question- that the risk of proper be greater in the corporate sector than they are brought in the economy Peter. Thank you very much for joining us. Thank you. That concludes this episode of exchanges.
in fact, I'm Jake's, you are, we hope you join us again. Next, on the spot, gas was recorded on March knife, two thousand, sixty all price references and market forecasts correspond to the date of this recording this pod cash should not be copied, distributed, published or reproduced in whole or in part. The information contained in this package does not constitute. Research or recommendation from any Goldman Sachs Entity to the listener. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty as to the accuracy or completeness of the statements or any information contained in this podcast and any law
Ability, therefore, including in respect of direct indirect or consequential loss or damage, is expressly disclaimed. The views expressed in this podcast, or not necessarily those of Goldman Sachs and Goldman Sachs, is not providing any financial, economic, legal, accounting or tax advice or recommendations in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by Goldman Sachs too. That listener, nor to constitute such person a client of any Goldman Sachs Entity,
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