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The Bear Necessities


Eight years into the "most unloved" bull market in history, many investors are asking how much longer the upswing can last. Peter Oppenheimer, chief global equity strategist for Goldman Sachs Research, discusses why identifying the peak may be less important than recognizing a bear market once it starts, and what history can tell us about the types and tenures of these declines.

This podcast was recorded on October 16, 2017.

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 2017 Goldman Sachs & Co. LLC. All rights reserved.

This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
This is exchanges at Goldman Sachs, where we discuss developments, curly shaping markets, industries and the global economy objects toward global head of corporate communications. Here, the firm. Every investor fears a bare market traditionally defined as and pull back of, twenty percent or greater from stock prices peak, but predicting one no easy task. My guest today Robin Hammer is the chief equity, strategist and Goldman Sachs Research and with his teeth the author of a new report, analyzing their markets throughout history tells us better understand, causes and characteristics Peter thanks for joining us. Thank you, Jake GRID, to be here Peter you recently published report with great title bear necessities: why did you write that right now? Because you think there's a bare market coming our way very soon or does it refer?
conversations you're having with our clients why report on their markets at this point in time will partly because, when yes in a bare market, and it's always good to stand back when things are looking ready, good to look at the sorts of things that may change that situation, and we found that in fact, trying to pinpoint the absolute peak of market doesn't off make that much sense is much more important word and by a change in the trend when it comes and what actually triggers those changes generally I think, finally were starting to see quite significant investor optimism. Global growth is strong and synchronize in a way that we really haven't seen since before the financial crisis, and we ve had a long and Strongbow market profit margins are record highs, at least in the? U S,
innovations are very high and we starting Tap Hap see the exit of Cuba, which has been so instrumental in generating the high returns it. We ve had an act, so I think all of those reasons. Why would want to look at this question now so just when everything is going great, we should worry. We least you pulling about ink about it, not be well prepared and try to understand the conditions that tend to pre exist before we actually get a bare market coming through. So unfair necessity, as you point out that this particular bull market is defined, the bear market that preceded the global financial crisis and investors have been understandably wary. They have not. Embraced fully this recovery. What was Nick about the global financial crisis in terms of the history of their markets, and how does that help explain where we are today? Yes, I think we like to describe this ball. Market is one of the most. Unless
in history. You know it's been one of the longest and strongest, but many people don't really feel it. In that way, we haven't seen the typical exuberance you often get when prices rise in a way that they have done since the worst part of the financial crisis, and part of that is because the financial crisis itself was so significant. An impact for, and the bear market that created, we describe rate, is a structural bad market because, like some others in history was really preceded by some major imbalances which on wound and had huge macro economic effects and also spillovers into financial markets, and because ever since and investors have been constantly looking over their shoulders for other potential,
tell risks the might of evolve? It's been really a very strange ball market which has come in fits and starts, and loss of that again is explained by the unwinding of the imbalances that we were seeing that preceded the financial crisis. When you look at the ball market, the unloved for market, do you see any major France's mean is the breadth and strength of the bomb get some more than others. It is in absolute terms, in fact, this has been one of the longest and strongest ball markets that we ve seen in the Post war period. Certain in the Eu but it is unusual because it's really come in different waves and that again, I think, reflects the way that the markets
responded to the unwinding of imbalances that pre existed. The financial crisis itself. We really focus on three waves, the first one, of course, with scented in the U S with the collapse of the housing market and the downturn that created in two thousand and seven to two thousand and nine has global consequences, as you saw broadening credit crunch and a very deep global recession, and the response to that was swift and very sharp in particular, through cutting interest,
it's an initially global economies responded positively and started to recover, but we had a second what you really focused on Europe. That became the second epicenter with what's now seen as these sovereign debt crisis, the banking crisis, which really plagued Europe predominant they through two thousand and ten to two thousand and twelve and justice. Things started to recover from that following also very aggressive policies in Europe. We saw a third wave which really focused on, reflected a collapse in global commodity prices and then a downturn in emerging economies, particularly around two thousand fourteen to thirty sixteen. So, although in aggregate terms. been a strong longbow market is that she come in various phases, all She looked quite alarming as they have evolved union colleagues export decades of market data. For this report and identified three different types of bare markets
What were the differentiating characteristics you identified and where did the financial crisis fall into that framework you outlined? He is so we looked back around two hundred years of day to a predominantly in the US, and we found that you could be declassified bear markets in two different types. According to that triggers and the three that we came up with what we could cyclical bear markets driven and structural. Now the cyclical ones innocence the most common and they generally about investors, worrying about a perspective decline in profits as a result of a potential recession, and nearly always they have some kind of monetary driver. In other words, a result of a tightening of monetary policy is inflation picks up late in the cycle. The second
we call event driven a really, as the name suggests, bear markets that a triggered by exulting shocks or some kind of one off factor that increases uncertainty and has a negative effect on financial assets, particularly risky ones. So this might be something like an oil crisis or a third option, GEO political tensions or conflict, and then the third type of which I already referred, which we think that the great financial crisis that we ve lived through in the last decade relates to, is what we call structural bat markets, and these are different from the cyclical ones, because they proceeded ready by major imbalances in economies and usually financial bubbles. the unwinding of these, which creates the bare market itself. Now the differences are important, because both the events and cynical driven bear markets tend to see if prices for twenty five or thirty percent the structure ones usually fish
deal more percent declines. The event driven ones are very short and Shaw. They tend to be all over and dumb within about half a year and your back to where you started within a year, assuming that, whatever exhaustion of shock has placed itself out, it's exactly and the market is adjusted to the high risk and you get some kind of readjustment of expectations, but it doesn't have brought a macro economic implications. The signal ones usually take two or three years for prices to fall to that lose they get back to where they started, usually within four or five years. The structure ones are really by far the worst, fortunately, the least common, because they tend to take usually four or five years to get to their loads and dont, get really back to their starting point pick for a decade or more so today, everyone wants to know, are, with the end of a bull market or near the end of a bull market stocks, people either seed,
to long they see prices are too high. They point to the fact we are nearing appeared of monetary policy tightening when you try to gauge possibility of an end to this ball market. Do any of those arguments hold wait? They do. I think there are some important says that we need to be aware of which would raise the risks of a potential downturn, but none of them necessarily a catalyst. So you mentioned a couple of them ready. It's been a long and strongbow market that doesn't mean to say that is going to end, but we certainly not at the beginning of it. Secondly, relations are very high. We think this is true across all financial asset markets, largely because of the extent to which lower interest rates and cutie has boosted evaluations of financial assets. It's been an interesting, pier because, while in the real economy we ve seen a lot of dis, precious wages
party moved consumer price, inflation is being very low ass. It prices across the board of increased dramatically in recent years as a result of low rates and increase valuations. That's another factor we need to take account of. Thirdly, if look it's the? U S in particular, which is really leading the global economic cycle. We are a record profits in the corporate sector, were wrecked margins and not a game which suggests that some risk that, where towards the peak of the cycle, and as you quite rightly said, chewy has been a major driver of the bull market so far, and we may now start to see an unwinding of Edward least the slowing of the monetary support that we enjoy recent years. These are all factors I think to take into account, but none of them of themselves unnecessary likely to be triggers for a market down too, and I think We found in our research is that you really need some kind of reason
to worry about an economic downturn, and that typically requires some kind of meaningful tightening of monetary policy, and the absence of inflation still in the real economy is one of the key factors which is holding back. The tightening of policy which and the economic cycle? You are able to identify those factors. Most correlated the onset of a bear market valuation was one of them. Another was unemployment. You found one when reaches the loan. A cycle along with high valuation, as they can pretend to pull back in equities, explain why that is. We want. payment is a reflection, of course, typically have a strong economy, and when you have full employment, you typically have full capacity utilization, the economy's heavily utilised. You don't have much speck capacity that tends to push prices, prices of wages, prices of commodities and other factors of product
and it's this sort of rise in prices, which tend to lead to a tightening of monetary policy which ultimately starts to slow economic growth and raise concerns about the potential down. it is also the case that in the U S in particular when unemployment is reach very low levels, just small right is in unemployment of needy, always preceded recessions. So, when you go, to a very low level of unemployment. As we see now in the U S, and in some other parts of the world is used, a sign that we should start to be alert to the potential for unemployment to adopt a bit. At a time when inflationary pressures are picking up and that raises the risk of a potential slowdown and activity as monetary policy tries to get out of the curve right so similarly, point out that high readings in the major manufacturing surveys tend to correlate with falling equity,
it. Is this a matter of supply, simply outpacing demand, or do you see signs of that today will regained its somewhat related to the point about unemployment, when everything is well and manufacturing, surveys are showing that economies being fully utilised. The probability is that over some months you start to slow down Now a slow down in growth doesn't mean badge growth. But it's important emphasised that in anticipate free markets, like equities is not just the level that's important, but the rate of change this second riveted and very often when you get a slowing and the pace of growth. the time when inflation expectations, a monetary policy, a tightening its that combination to get, With ready, pre existing high valuations that raised the risks,
and indeed in many parts of the world. We are seeing very strong growth right now, and that is to be applauded. That's a good thing. We have a current activity indicator: Goldman Sachs proprietary indicator which looks at the pace of global growth and that's currently pointing to run foreign half percent the best growth that we ve, seen in the most balanced growth since a financial crisis began and ninety percent of the countries that we cover a seeing growth above their trend, but typically that suggesting that oh, time things will get less good and that's the point where we need to be alert to those risks. As we revert to the mean at some stage right so today, for of your five factors of flatter yield her included, are all signalling bear market. But the fifth seems to hold the keys. listen you that before why
Well, I should say that the other four not telling us that we are about to have a bet market, but the risks associated with Miss, certainly rising. Inflation is important here, because you asked at the beginning Jake about the differences between this impacts. Previous cycles, that we see and I think that you, one of the most dramatic differences between this economic cycle. Previous ones, is the absence of tradition, inflationary pressures in that the inflation we ve observed is rather more be. financial assets, as interest rates have collapsed and we ve seen quantitative easing coming through than we have seen inflation. Yet in the economy- and there may be some very good structural reasons why inflation is staying low. Obviously, innovation and technology and disruption, and many industries is keeping prices down. We sing still the effects of glow
position, which is having a damaging effect on everything, from wages to generalise prices, and some of this disinflation is very positive. It's giving a boost to consumers and keeping grow strong, and if we can maintain this combination of decent global balance, growth with very low nation, then that would be a very healthy environment for, in particular equity markets. But it is worth noting that Walt Growth is finally normalizing to the sort of pace we were seeing before the financial crisis. So far, inflation expectations and importantly interest rates have not And we may find that just small rise in interest rates from these levels, as inflation expectations finally pick up, is something that, at the very least, damn fence returns now and financial markets and equities and it worse.
she triggers some kind of correction. So you mention globalization technologies, some of the factors keeping inflation low watch investors be watching too intense, when inflation may start to rise, and when we may see those warning signs when I think gain what simple and here is really expectations, inflation expectations have remained incredibly low and one of them for that is that expectations about growth continue to be pretty sanguine and that's allowing the market to continue to price a very model passive tightening of interest rates. Even in the U S where the economy has been good, strongly now for a number of years. I think what we need, to be very vigilant off is evidence that we finally seeing wage precious picking up, because that could feed through into lower margins in the corporate sector, and also into more generalised rise in inflation expectations
no ordinarily. None of that would necessarily be a bad thing, obviously, in some way rising wages could be helpful, but, given now hi evaluations in markets and given that the financial markets are still pricing very low and stable interest rates and adjustments in those interest rate, expectations could well trigger some kind of poor back in financial markets and if interest rates are ready, the key. What we would like you see in that situation is less at prices across the board adjusting downwards, and it would be an environment where most financial markets will quite Heidi correlated. It would be difficult to protect from that kind of an adjustment some prominent commentators, including Nobel Prize Winner, Robert Schiller are saying that the indicator that you been outlining here line particularly well with previous bear markets So why would anyone given the circumstances put money into the market? Is it just lack of alternatives or lack of water?
This is a very good way of pushing things look better than mine. We still have risk free, rides, government, bond yields or policy rates at close two hundred and seven in real terms, and there is a necessity in the requirement to get in January to return, and if you got a company strong growth, with still very very low interest rates, there's a willingness to move up the risks of into assets like equities. And although the evaluations in absolute terms are high things like p ratios or sickly, adjusted p ratios a high relative to history, You still got a relatively attractive income that they generate compared to what you can get if you lend money to the governmental put your money into an interest bearing deposits. So there is still some relative valley there and his Lomas invest is still believe that growth can be sustained,
That value is still attractive. The hunt for yield the harbour you absolutely quantitative, easing- was icy, historically unprecedented policy and its office The unwinding of asset purchasing by central banks, rising interest rates will be similarly unprecedented what will you be watching to see how resilient markets are, as key begins to unwind an important component? is a game valuation I mentioned earlier that we can think of the last decade is an environment to significant disinflation in the real economy, wages and consumer prices, even commodity prices. At a time when asset markets across the board, have done very well by markets, credit equities, both India and emerging markets, but a good deal of that has reflected the impact of quantitative easing, pushing up
relations- even here in the? U S, for example around forty five percent of the return to investors since the low in two thousand and eight or nine has come from valuation expansion. Multiform p, multiple is going up in the case of the european equity markets, for example, where earnings have actually been much weaker than in the? U S: corporate earnings, growth valuation expansion is counted for about seventy five percent of the return that equity investors have enjoyed. So there is a big question about the reversal of this quantitative easing depending on how quickly it happens, whether that pushes down devaluation component of the return with it pushes, for example, p motive was lower and not at the very least reduces the return available and in the worst case scenario at she pushes down prices
So I think that Cuba is going to be important, as we see it gradually and wind over the course of the next several months and years, going back to your three types of their markets. Venture and their markets will hard to predict. They set up the table, but between us, structural, their market and a cyclical their market, which is more of a risk at the moment. In my mind, the second one is more likely and that's rather depositing, say because structural, Burma. I scared it really scary, at least of the area no. Why do I say this will as the earliest structural bear markets really need to see major imbalances on winding. They tend to result in very
deep and long, intractable, recessions and typically their associated with financial bubbles and in many respects, I think the period since the financial crisis has seen a lot of those sorts of imbalances on wind or, at the very least, some of these imbalances being shifted away from the private sector. Will the corporate sector towards the official sector, which means that they can be managed much more carefully? Think the structural by market is much less likely when we ve looked at the indicators that we put together previously some of the conditions for a more sickly what type of bad market are in place, but again the key thing that is not yet in place is that lies, inflation expectations which will push up interest rates sufficiently to a level where investors really start to worry about a major economic downturn. I can picture investor right now. Listening to this long
caution of bare markets saying well gosh, I'd like to go back a little bit before this sniffing correction. What can you tell us about how bear markets typically behave and how investors can protect themselves were advised to give to the clients? You're talking to with. This is a very interesting question Jake, because one of the slight encouraging things that we found looking at their markets in the past is that trying to predict the peak of the market is a very difficult thing to do in your extremely lucky, but secondly, may not be that much work. doping is much more important to try and identify when the trend changes rather than what the particular day of the peak of the market would be given exam. We found that on average, in the U S and investor who might be clever, and recognise that a bare market is coming and sells everything just three months before the peak loses on average the opportunity to see about a seven percent rise,
typical rise. You see in writing for the very lucky kicks him, and that's interesting me about the same size as the fool you get in the first three months of decline. So someone he said a pause out three months early is relatively speaking. Pretty much same position is someone he stays full invested and wait until the bare market at she starts in order to tell. But the second factor, which is quite interesting, is that in equities. bear Mark is very, very rarely start with a precipitous collapse. Inequities that takes them all way down to the thirty percent or so that they finally tent What really ways happens is that you get increased volatility around the peak and typically, what we describe as a their market balance, that is to say all bear markets, tend to start with a correct
and then very sharp rebound before you get a more persistent decline. So at least theoretically this typically assiduous and opportunity to sell them kids around that time, assuming that is that you can recognize in real time that the balance is not just the end of a small correction, but is rather the start of something more severe, and that's the complicated thing, because many times towards the peak of the market, when you do get a correction, people here is a great buying opportunity, which is in a sense why you get that counts, but conniving when you get a shot, correction and abounds, but some of these border conditions that we ve been describing are in place gives you a bit more confidence that this is. it is an opportunity to be lighting up on risk. Peter that's fascinating thing, You very much for joining us. Thank you, Jake! That's all for this purpose. exchanges of Goldman Sachs, I'm Jake Seaward, we
be join us again next time the spot gasters recorded on October, sixteenth two thousand, seventeen 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 represent
or warranty as to the accuracy or completeness of the statements or any information contained in this podcast and any liability, 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
Transcript generated on 2021-10-13.