Make Your Choice
Nine months into what is already the strongest rally in equities (in the US and many other countries) ever to occur in such a short period, all economic and financial analysis is focused on what to expect for 2010. But Goldman Sachs (GS), always ready to outdo everyone else, has begun to publish forecasts peering beyond 2010 and into 2011. Happily, what the guys in Goldman see is a stream of good news and well-being extending into the future.
The following are some key points from what the top Goldman analysts are saying about the next year and two:
- On the global economic outlook for 2010 & 2011, the former biggest investment bank in the world (now a bank-holding company, but still making quarterly profits in the billions) expects strong global growth AND very low inflation – the latter, despite the continuation of the Fed’s very accommodative monetary policy. Specifically, it expects global GDP to expand at a rate of 4.4% in 2010 and then by 4.5% in 2011, all this while the Fed ‘remains on hold’ (i.e. keeps interest rates at their present near-zero levels) until 2012. This, note the GS analysts, is positive for risky assets (because the zero interest rate policy will drive investors to ‘seek yield’ in equities etc.) but also has the potential to cause asset overvaluations.
- As for 2011, GS emphasizes that its expectation that interest rates will not rise by, or even during, that year, puts it at odds with the market, which is expecting interest rates to be as much as 2% higher two years hence. This is a massive discrepancy and clearly, if GS is right, the market will have to adjust its current pricing, which will ‘be benign for risky assets’, to use the understated jargon of the analysts.
- The reason why GS believes the Fed will stay on hold and inflation will remain very low, even as the economy moves into steadily higher growth rates, is that they see unemployment continuing to rise until it peaks at a level approaching 11% in mid-2011. That the Fed will not raise rates in the face of double-digit unemployment is the underlying assumption – and a very reasonable one too, given the Fed’s double mandate (price stability and economic growth) and the political sensitivity to unemployment.
There is much more – high corporate profitability in Europe, prolonged growth in China, and so on. But let me make two general points at this stage: first, a forecast in which the economy grows at a fair pace and inflation remains low used to be termed, in the pre-crash days, a ‘Goldilocks’ scenario: not too hot to stoke inflation, not too cold to choke growth, but just right. The GS outlook for 2010-2011 is super-Goldilocks, with the return of the three bears conveniently pushed into a more distant, and hence remote, future. This is, by some happy coincidence, the dream scenario for Wall Street in general and for Goldman Sachs in particular. The second point is that an economy in which corporate profits rise and asset values soar, whilst unemployment festers at very high levels, is an economy geared to making profits for Wall Street at the expense of Main Street. Anyone who believes that the American public will passively watch this happen for several more years must be smoking something – or working in Wall Street.
A very different view of the future is offered by serious professional analysts who, although active in the financial sector, do not work on Wall Street or for major financial institutions. One such, whom I have quoted before, is Dr John P Hussman – a relatively unknown fund manager who writes some outstanding analysis. Hussman is also one of John Mauldin’s friends and his work thus appears occasionally in Mauldin’s excellent “Outside the Box” weekly newsletter – as it did this past week.
Under the headline “Reckless Myopia”, Hussman admits that he has been proven wrong about the extent (though not the direction) of the current market rally. His mea culpa focuses on why he made this mistake – because he gave the mainstream investment community too much credit. He thought that it would have learned from the series of bubbles and crashes over the last decade, but nothing of the sort has happened. He summarises the current state of affairs with terrifying clarity: “We face two possible states of the world. One is a world in which our economic problems are largely solved, profits are on the mend, and things will soon be back to normal, except for a lot of unemployed people whose fate is, let’s face it, of no concern to Wall Street (emphasis added, PL). The other is a world that has enjoyed a brief intermission prior to a terrific second act in which an even larger share of credit losses will be taken, and in which the range of policy choices will be more restricted because we’ve already issued more government liabilities than a banana republic, and will steeply debase our currency if we do it again. It is not at all clear that the recent data have removed any uncertainty as to which world we are in.”
He goes on to note that, using two quite different methodologies, US stocks prove to be some 40% over-valued at current levels. It is perfectly clear, therefore, that Hussman lives in a different universe from that inhabited by Goldman Sachs. Indeed, the two states of the world he describes relate respectively to the world of Goldman Sachs and its ilk and the world of John Hussman and his ilk. You can – indeed, you must — make your choice between them, because there is no middle path.