« Exchanges at Goldman Sachs

Top of Mind: Dissecting the Market Disconnect

2019-08-22

For this special episode of Exchanges, we’re running our newest podcast, Top of Mind at Goldman Sachs. Hosted by Allison Nathan, a senior strategist in Goldman Sachs Research, Top of Mind examines the macroeconomic issues that are shaping the global economy. In each episode, Allison interviews Goldman Sachs experts—as well as influential policymakers, academics, and investors—on market-moving topics. The series’ latest installment, Dissecting the Market Disconnect, takes a close look at the divergence between falling bond yields and rising equity prices. Bridgewater Associates’ Ray Dalio and Goldman Sachs’ Jan Hatzius join Allison to dive into this dynamic and understand how concerned investors should really be about economic growth.       

This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
This is excellent The Goldman Sachs, when we discuss developments currently shaping markets industries in the global economy, I'm Jake Seward Global, had of corporate communications. Here at the firm. we're doing something. A little different were running. An episode of our newest Goldman Sachs Podcast called top of mind. Goldman Sachs, its ashore about macro economic.
Issues that are on the minds of our clients, hosted by Alpha Nathan, a senior strategist in the firms, research, division, Alison Interviews, Goldman Sachs experts as well influential policymakers, academics and investors on topics that are moving the markets. This episode is called dissecting the market disconnect and it dives into the diversions between falling bond yields and rising equity prices. Allison interviews, Bridgewater is Ray. Dalio and Goldman Sachs has Ian Hotsy has to examine this dynamic and understand what it tells us about the prospects for economic growth. Here's the episode, hope you enjoy it and please subscribe to Goldman Sachs in top of mine, Goldman Sachs on Apple podcast or your favorite podcast platform from common sacks research is Alison Nathan. Welcome to top of mind a podcast that explores MAC, reckon
issues on the minds of our clients. in this episode for taking a look at growth and certainty which has been. the rise given the age of the economic expansion now the longest on record and risks from trade tensions, as well as other political uncertainties like breaks it. Here's Christine Lagarde Chow woman of the International Monetary Fund and newly nominated easy president. Earlier. This year, the bottom line is that after two years of solid expansion, the world economy is growing more slowly than expected and risks are rising. Growth concerns have been at the heart of the gravest pedant. We ve seen from central banks this year and markets, and our economies alike now expect the FED to start delivering rate
as soon as this month here sped Chair Jerome Power, testifying on capital held just last week and our June. We indicated that, in light of increased uncertainties about economic outlook and muted inflation pressure, We will closely monitor the implications of incoming information for the economic outlook and would act as appropriate to sustain the expansion the market reaction to all of this has been noteworthy. Typically, when growth concerns rise, investor demand shifts towards a less risky assets. That means investors usually buy bonds, causing yields to decline and sell stocks, causing a prices to fall, or recently we generally seen the reverse with bond Niels declining, while stock prices have risen to all time highs. Many think this is because FED cuts are just protecting Hence the downturn rather than actually responding to one, but others think stocks and bonds, sending very different messages about growth, with bond and
there's more worried about recession, while equity investors are focusing on the upside of course, markets are fickle these days and this pattern in stocks and bonds has waxed remained, but the broader questions remain, how turned about growth should we really be and are fed actions which so believe have been too responsive to markets in the end, helping or hurting the growth outlet from here the answer to these quest Genes and implications for asset performance are top of mind. I first turn current legendary investor way, Dalia Foundering Code, cheap investment. Serve Bridgewater Associates to see what he makes. These developments value. Things Recent market action makes sense, but as well about an adverse environment for growth and assets ahead. We're really grappling.
question of whether there is a disconnect between stocks and bonds and whether they are pricing in terms of growth. Start values are fundamentally determined by the present value, expected cash flows and when interest rates go down, that's a positive results in the present value set. So when I look at the decline in interest rates and the move to weigh more February that policy
I look at that as a temporary, positive fact on stocks that it is a non sustainable effect on stocks for the long run, because there is a limitation as to how far interest rates can go down and how quantitative easing can work. So when interest rates go down because as the present now you of assets to rise, but it also means that there is less stimulation in the bottle because you get closer to it. strikes, approaching zero. Think of this as a stimulus that is in a bottle and its running out. So if you use it, yes, you can, you can get a kick out of the car
Let me get a kick out of the market, but the important thing shift in the world will be coming when monetary policy is not very effective when their essentially out of the stimulant the bottle, while Dalia was concerned that the FED and other central banks are running out of stimulus. He also thinks the feds shift to a more I wish monetary policy was appropriate and, if anything could have come sooner- and he doesn't give much credence to the view that the fat has been to responsive to bond market concerns, here's what he had to say on the FED. It would worry too much about each one occur to me with limited capacity to watch. and they were worried about, the combination of the fiscal stimulation and the low rates of employment and that inflation would accelerate. There were very worried about the classic cycle happening. My opinion too worried about that
and show going into year, end they over tightened, and they then did a sharp reversal. My opinion, an appropriate chop reversal, because the inflation risks and the growth rates So if you read it, but ultimately there is an error in the markets now and that affair has been overly responsive to bond market pricing. So just to clarify you don't agree with that, but you doesn't carry much weight with me. I think that people say that presume that the FED things a bond market is right and one can conjecture that the bond market see something that the FED needs to follow, or one could say that the yield curve becoming inverted. And what is this counted? In the price mean something that the FED
should be more cautious, those a reasonable statements by realistically, you have to ask what is that something that is causing the long rates to go down while economies, slowing or number reasons and then, of course, more fairly late in the cycle, we have greater wealth gap and populism. Polarity and GEO political issues, particularly with China. So if you would look at the world economy as a whole. Say that there should be An easier monetary policy and if you look at the interest rate differentials and the currency movement, and what the Federal Reserve can do its reasonable that interest rates would go down and that they would be led by the market at a faster pace than than the FED on Fox targets agreed at me.
Market actions makes sense amid rising growth and certainty. They actually argue that, despite very high index levels, you can see growth concerns reflected across risky assets in the performance of higher quality and defensive. there's an equity credit and commodity markets, so bond market less of an outlier than they first appear beyond hot cs. The firms chief economist says these growth concerns are overdone. if anything he's more concerned about the direction of the FED and is less convinced that the benefits of Seeing here outweigh the potential costs, namely the increased likelihood of a so called hard landing for the. U S account. me. How worried should we really be about? U S and global growth? It seems to me that the grove outlawed, while clearly not as strong as in two thousand. Seventeen two thousand aging is stopped a decent we're looking for growth in the two sand range in the second half of this year and then actually a little bit more than that in two thousand and twenty
It's no put us a touch above or estimate of the underlying trend, pace of growth judges in the one. Seventy five range sob yeah. Where were we I would say cautiously optimistic that were still going to citizens of One reason for this is the easy in financial conditions which has taken place really for most of this year and again more clearly in recent weeks, which should mean that the impulse from a financial conditions to growth is going to become somewhat more positive as the EU, Those goes on that should be visible in things like home building, where there's a very direct impact from mortgage rates and also personal consumption, where equity prices up is in So how much should the recent shift towards an even more dove aspires from the fat which has recently prompted us to assume that we are going to see some cuts this year? How much that temper concerns about growth and inflation?
appointments me doesn't really move the need on all war if we could Scott, easier monetary policy, I think, does have real effects. I think in the: U S: it's real to flee easy to generate positive impulses, because the funds rate is two point: four percent: strictly positive territories in law, the funds rage you can thereby generating and financial conditions that will have an impact on growth. And, of course, some of this is already front loaded through market pricing. Anticipating that car, in the: U S to me, it doesn't look particularly necessary to me. It actually looks like the economy's fine, even without monetary easing saw it's really not a question of whether monetary easing is effective, but whether as necessary, do you think the FED is setting out for a policy mistake by intending or signalling that there are on the verge of cuts. It's a question of costs and benefits I think when the economy is generally fine and you're
by providing a little bit more additional stimulus. The benefit is Julie, limited and its possible that ultimately, you over, stimulate the economy the unemployment rate down to a level that is too low to be sustained in the longer term, with inflation at about two percent and then you need to increase the unemployment rate overtime and historically, it's been very difficult to do that without a recession? There's never been an increase in the three month average of the unemployment rate of more than thirty five basis, points that wasn't associated with a recession, and I think, that's probably somewhat bigger issue now than it might have been an comparable in the past cause of some of the politics and some of the influence on the FED from the electoral calendar for example, we are going into an election year if they do deliver. Some insurance cuts in two thousand and nineteen, as were work, were protecting
will be much harder to unwind those adorns cuts in two thousand and twenty if it turns out not needed or maybe even counterproductive. Now, if that it was very clear cut is I think they would hike into the two thousand and twenty, but at the margin it's just going to be a harder, as you approach a probably very contentious presidential election. So do you think the market is two concerned about growth and maybe not concerned enough- that the FED could be heading. Melina counterproductive direction. Yes I am concerned about that. I think that the market is somewhat too concerned on growth markets too low inflation. I think the markets underestimating the extent to which the week, inflation numbers are driven by more special factors. I think what german Paul said at the May press conference, not the June press conference, but the main Trot press conference
about the outliers in the core pc numbers and the much stronger message sent by the Dallas FED strip mean busy and acts all of those things I thought were correct, then, and there remain correct, saw, I think, we'll see at sea, arrive on inflation a modest concerned about inflation expectations as many in the markets, partly because I think that break even inflation compensation in the market is not a great measure of inflation expectations. The service actually still look consistent with inflation expectations that are anchored around two percent. So we I mean think I have a different sense of the relative risks and therefore also a different sense of where you more like you to make a mistake. I think the dominant market view is that the feds been too slow and they continue to be too slow and they need to move expeditiously in the direction of ease policy? My view is that if they move too quickly and to aggressively than they are at risk of over, stimulating
quality and thereby raising the risk of a hard landing, or maybe not twenty twenty, but at some point not in the not too distant future. Yonder's offers some are concerned about mt of political pressure on the FED, which poses a threat to its independence. So, obviously the other fact you're here has been the white houses. Pressure on facts to keep rates low or cut further. How much do you think that and a factor do you think there is reason to be concerned about the independence of the fat? Was Skype, some reason to be to be concerned in the pressure has been very overt and the desire to appoint political, loyalists too, fat positions has definitely been there There has been talk about firing. Org, morning. Paul. It's a little unclear how far that that went, but in all of those Things are, of course, threats to the
independence of the of the federal reserve- and I think that the FED is still independent, still does act independently. I dont think that chair Paul and his colleagues take orders from the White House. However, I also think that there is a sort of an indirect avenue for pressure on the FED the goals, the other bond market, because clearly the bond market is responsive to medical chatter and reports of much more dullish appointees for the Board of governors or demands for four rate cuts and to the extent that the everyone see, puts more weight on bond market pricing in setting its own policy. I think that is the way in which the political pressure can actually have some impact so for me, this is another reason to be somewhat sceptical that we should be putting all that much weight on about marker pricing and to be a bit more resistant to the idea that the fetch it basically just
what the bond markets pricing. So what would this slightly more optimistic outlook mean for the sustainability of the broader rallies who scene and pretty much everything this year? Even if growth holds up, as our economists expect, Goldman Sachs me search thinks we're still likely to see two February and a broader bond rally prevail at that won't do much to boost stocks going forward, acquaint our chief, you as equity strategists David Karsten, whose he is growth and Paul Again certainty, keeping equities moving sideways through your end, as for positioning our strategist recommend stay the course in defensive, highquality assets, radar advice, rebalance existing portfolios with an eye towards safer suffocation and potentially Addison that are less popular and provide intrinsic diversification, such as gold and chinese assets, both of which are somewhat controversial these days so is now. the time to start reducing risk. What do you recommend for investors in terms of positioning at this point, as were we're heading towards all of these risks?
It really is. How does one reduce risk because they going to any one asset during this period of time increases risk people think that going to cash reduces ray. That's only risk it. A standard deviation type of way, but when you have a negligible interest rates below either the inflation rate or the nominal GDP growth rate, and you pay taxes on that, but you're not gonna, get any return on that. You go to add what age do you go about? What is risk may risk is best dealt with by diversifying cash over the long run is the worst performing asset, last and therefore the riskiest ass, a class if you're looking at return it just as less volatility too. So I think what we look
at this in the years ahead. We asked to think about. Where is there a good diversification? I think that the world now is very low reached war. What I mean by that is, everybody is owning assets and there's been quite a bit of leveraging of those assets through company by bad. your private equity and so on? So I think that were relatively late in the cycle and if they're only leverage long and then I think the question is what is a good Sorel dot out? So I think asian, asked the case, and I think that there are areas that are not adequately Versify back a diversified portfolio, for example. I think that gold and China,
are two areas that are under waited and have more merit in portfolios. Just even by talking about GO makes it sound like while that's a cookie, after all, this in alternative currency, think of it as a currency when you think about What currency you would want in this. The monetary system at overly indeed in which there is going to be greater political and taxing risks on capital that there's some merit behind having some position in gold by way of example, as China is important place to diversify into it in that, I think, is very controversial. Now investors are not used to it being in their portfolio. I think it s there's put too much emphasis
what's conventional and cap waited measurements in my history, I watch that in that sector there just not comfortable being in markets. having been an already once they go into those markets, quickly get comfortable being in that market, the institutional and ass there. For many years, I can remember when pension funds, for it was written? to go into equities from bonds. I think China is like that. They're big markets now in market capitalization, the equity market. Second, to the US market, the bond market, including the government corporate bond market in China II, U S. Market is just beginning to open up and then, if you're going to say diversification, where are the competitors that my road, your your chair and the geographic diversification and the size of markets, being so long?
large relative, your position and where there is growth and so on, China, and I think that if people look back on it in time, say I didn't have any exposure to China to begin of the twenty first century, when China is the second largest colony wrong fast in their capital markets. Growing fast you'd have to say something is wrong with that, though fame is diversify well and assets under waited and not have a lot of intrinsic diversification, and that I do well in the type of environment describing that's what will be the This episode, amid all of this uncertainty, only one thing is certain economic data, FED developments ahead. That should provide some clarity on the outlook for growth and markets will be top of mind. I'm alpha Nathan and I'll see you next time.
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Transcript generated on 2021-09-18.