Despair, Hope, Growth, Optimism
With a title like "Are we nearly there yet?: A macro roadmap from Hope to Growth", the "analysis" could only come from Goldman Sachs. Then again, one can see why 5 years of Fed balance sheet expansionist, central-planning, leading to record stock market highs and virtually no pick up in the economy, would be considered Hope for the 99%, even if the tiny balance of the population, such as Goldman's CEO, uses the "Hope" period to get in line for multi-million condos in Miami.
This period, which is now running on its fourth year in the US, is called "reality" by those who are the happy recipients of leverageable $2.5 trillion in excess reserves/deposits, which can then be used to circumvent all prop trading rules and ramp risk higher. And yes, 4 years of "Hope" would be enough to make even the most staunch defender of central-planning ask themselves just what is going on? It would, however, explain why virtually all the growth in the past several years has been on the back of multiple expansion, and as the "Despair, Hope, Growth, Optimism" chart below summarizes, the US economy better roll over into growth or very soon someone, somewhere may finally realize what we have been saying since 2009: the Fed has broken the business cycle.
The corollary - after the hope phase, the centrally-planned economy may skip growth and optimism and proceed straight to Despair...
But back to the report, where according to Goldman, we are still in the Hope phase, where we have been for the past 4 years, even though the average length of duration in this part of the cycle is traditionally 10 months. That's some serious hope going on.
We believe that the equity market is currently transitioning from a multiple expansion driven Hope phase, where the market pays for the anticipation of future improvements to a Growth phase, where these improvements materialize and earnings become the driver of returns at the index level.
Whereas the phases can be identified quite clearly when looking at long term histories they are much harder to identify in real time. Here we outline the signs we are seeing of this transition taking place and its investment implications.
Our market forecasts for the coming years are consistent with the transition from Hope to Growth. We forecast both 14% earnings growth and 14% price return from current levels for 2014. When we look at our longer term forecasts we expect earnings growth to outpace the price return for the market in both 2015 and 2016, consistent with our view that the current growth phase is likely to be substantially longer than the historical average of 33 months, due to the slow pace of economic recovery.
We also expect valuation to hold up better than what is typically the case in the Growth phase. We expect the valuation to be supported by still very high risk premia in equities in an environment where growth improves, yields are low and macro risks are likely to be lower than what we saw in 2011 and 2012. Indeed, we see upside risk that valuation could end up exceeding our forecasts given these factors and limited return opportunities in other asset classes. In the US we have seen the multiple expand in the last couple of years alongside growing earnings.
In other words, valuation currently is not supported by reality, but there is hope this will change soon. And if not, Goldman can just run this "analysis" again in 1 year, when the hope phase will be 1 year longer, and the S&P will be at 2100 or wherever the Fed's balance sheet is at that moment..
And to really cement it is a Goldman report, the following sentence slams it shut:
Assuming that we do move into the Growth phase, what would history suggest in terms of the macro environment and the performance of assets?
As an aside, if we don't move in the growth phase, that would be perfectly acceptable for Goldman: that's where the bulk of equity returns continue to be made.
And the full Goldman investment matrix:
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