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Goldman Explains 'The Road To Recovery' In 1 Simple Chart

Tyler Durden's picture




 

In Goldman Sachs' view, there are three very different near-term paths that economies and markets can now follow, and that imply very different outcomes for financial markets:

 

 

Through the looking glass: Scenarios for a post-crisis world

Seven years after the start of the financial crisis, economic and financial conditions remain far from normal. In the ‘Wonderland’ of near-zero interest rates, many of the traditional relationships that have governed the way in which markets and cycles evolve have broken; the value of historical analysis has weakened.

There are three main paths from here, in our view: a ‘secular stagnation’ scenario, a ‘sustained moderation’ and a ‘normalisation’ based on a new global growth engine (driven by restructuring, the US energy revolution and/or a major consumption shift in China). The first is broadly better for bonds than equities, while the second is better for equities than bonds. ‘Normalisation’ would be very good for equities and negative for bonds.

Path 1 – ‘Secular Stagnation’:

Growth remains well below the previous trend and inflation and rates stay low.

Equities achieve a low return (although in areas with low valuations, it is still likely to be reasonable in real terms). Volatility stays low.

Path 2 – ‘Great Moderation’:

Growth recovers, but is not strong enough to raise inflation pressures; technological innovation also keeps a lid on inflation. Interest rates rise but very slowly. It is not a ‘normal’ cycle since rates inflation remains subdued, but there is at least sufficient growth to generate profit expansion.

Equities outperform bonds. Volatility stays low. Bonds become the ‘riskier’ asset.

Path 3 – ‘Normalisation’ – a new growth engine:

This is the more positive route that markets may take. It is possible that longer-term growth is enhanced but technology keeps a lid on inflation and the trade-off between growth and rates becomes more favourable for risky assets. Any new strong secular drive for growth is unlikely to have an impact in the near term, but there are various potential drivers. The stronger growth could come, perhaps, from:

  • major structural reforms in places like India and Europe;
  • the impact of the US energy revolution; and
  • a significant growth driver from Chinese consumption.

In truth, the outcome may also vary by region. The US, for example, looks much more likely to achieve a moderation than, say, Europe. Already, Europe is following a stagnation path from an economic perspective. But even here, this need not be bad for investors. What matters is not so much the outcome, but the outcome relative to expectations. This scenario is largely priced in for Europe. Of the three, a return to ‘normal’ – triggered by a major new growth engine – would clearly be the most positive for equities and the most negative for bonds. But it is also the least likely, in our view, at least in the nearer term.

Of the other two, the moderation scenario is the more positive for equity holders in absolute terms and, barring sharp rises in interest rates or exogenous shocks, it could still last for a long time. It is unlikely to be very negative for bond holders while inflation stays low, central banks remain accommodative and regulation results in many ‘non-economic’ buyers. However, there are factors, both positive and negative, that may ultimately come into play over the next few years and could also result in quite different outcomes.

Great Moderation...  leading to:

There are probably two possible medium/long-term scenarios that are likely to stem from a Great Moderation (path 2).

Outcome 1 – Equity re-rating. A long period of stable growth and low inflation encourages significant rises in equity valuations and, eventually, very low returns for a long time thereafter. In this outcome, good near-term returns in equities (relative to other asset classes) gradually push valuations up to levels that imply low long-term returns, just as with other asset classes. The performance in equities may be enhanced by further margin rises as technology constrains the returns to labour. While this extends the bull market in equities, it implies that very low returns become much more likely over the longer run.

 

Outcome 2 – Bond bubble bursts. Lower-for-longer inflation and accommodative policy could push bond and credit yields down further, creating a bubble. When an adjustment in interest rates finally happens, it may trigger a more aggressive bear market in bonds and credit; equities could also fall sharply. The risks here are significant given the extraordinarily low risk premia priced into fixed income markets. Just as with equities in the late 1990s, fixed income assets have been increasingly priced on a relative basis (against ever lower yielding government bonds). There is a growing gap risk across fixed income – and a real danger that when the risk-free rate adjusts, liquidity across fixed income will disappear.

*  *  *

Moderation is Goldman's base case but they realize the Fed is now entirely boxed-in.

In our view, if we are wrong in expecting the great moderation path to dominate markets over the next year, then the next most likely outcome is probably the derailing of the moderation path as a result of a sharper re-rating of equities as investors are gradually  forced up the yield curve.

 

The next most likely exit from moderation would likely come from a rise in bond yields. While equities would likely outperform in this scenario, at least over the medium term, it  would likely trigger higher volatility and a setback in prices across the major asset classes. The risks to the bond market here may not stem purely from higher inflation coming through (as in 1994 for example), but perhaps from central banks being seen to be behind the curve as forward inflation expectations rise. Anything that pushes long rates higher may result in enhanced ‘gap risk’ heightened by a lack of liquidity. This may become particularly strong in the credit market.

In other words, the Fed is desperate for higher yields to signalize a recovery and higher terminal rate, but it can't afford it as it would lead to bond market dislocations.

*  *  *

Source: Goldman Sachs' Peter Oppenheimer

 

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Wed, 10/22/2014 - 19:10 | 5365458 TruthInSunshine
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If the Fed doesn't end QE in October, despite Bullard's bullshit, they lose whatever scrap of credibility they may still hold with even the most clueless of people, and there will be a wild ride to follow in massive volatility in various asset classes (bonds will blow up) and in foreign markets and currencies.

Think about the repercussions in a thorough manner.

Wed, 10/22/2014 - 19:18 | 5365472 El Oregonian
El Oregonian's picture

But... but... but, VP Joe Bonehead said that two summers ago this was the "Summer of Recovery"....no???...

oh, so you're saying I've been lied to????

sarc off//

Wed, 10/22/2014 - 19:17 | 5365476 bunzbunzbunz
bunzbunzbunz's picture

Alright, honest opinion everyone. In one year, what do you think the price of gold will be in USD....and for bonus points, why?

Wed, 10/22/2014 - 19:23 | 5365488 bunzbunzbunz
bunzbunzbunz's picture

Also....In regards to this article, I think we have already seen a quite volatile stagnation. I think that as we hit "peak old people" and the population begins decreasing in age, we will see quite an expanse in the real economy. I think this will, at first, lead to even greater equity volatility as new companies form and old companies restructure/die. Then I think we will see a HUGE expanse in the "value" of the equity market as the money supply and velocity continue to increase. 

See isn't this more interesting than the fed/zionists/muslims/commies/faggots/other bad words???

Wed, 10/22/2014 - 21:23 | 5365906 neidermeyer
neidermeyer's picture

You're right on the mark with the "peak old people" statement ,, Obola plans to import 30M Mexican serfs ,, most in their teens thru mid adulthood years ...

Wed, 10/22/2014 - 23:42 | 5366282 bunzbunzbunz
bunzbunzbunz's picture

It's probably not Obama's plan actually...since it's been happening for a long time. And it will probably help the economy long term. Often times, economic strategies either help long term or short term. Not both.

So, economically speaking, if something seems to cause problems right now, it probably helps in the future.

Thu, 10/23/2014 - 03:16 | 5366517 rocker
rocker's picture

He just the fool in line to receive marching orders by the powers to be. Interesting, we will be the best, so they say. 

My question is......what does the best look like since we are Japan now. Hmmmm. The rest really must suck bad.

Actually, I believe we are not the best because we are in reality worse than Japan now. 

Wed, 10/22/2014 - 19:23 | 5365489 coast
coast's picture

Gold will stay right where its at until the global currency reset..THat could be two months, or two years.. I dont even look

at the price anymore, just holding it until the reset.  I like Jim Willie's views on things.

Wed, 10/22/2014 - 19:26 | 5365503 bunzbunzbunz
bunzbunzbunz's picture

So do you think the USD will stay where it is too? Or that gold will diverge as the USD moves?

Wed, 10/22/2014 - 19:51 | 5365598 coast
coast's picture

I think because of the amount of debt the U.S. has, and that BRICs are buying massive amounts of gold, that when the reset comes, it will devalue the dollar about 30%...Just my guess

Wed, 10/22/2014 - 19:27 | 5365516 i_call_you_my_base
i_call_you_my_base's picture

$2000. Forced deflationary event and crash, subsequently used as a catalyst to go full Japan-tard, USD destroyed.

Wed, 10/22/2014 - 19:30 | 5365531 bunzbunzbunz
bunzbunzbunz's picture

But a deflationary event would cause the price to drop like a rock first, correct?

Wed, 10/22/2014 - 20:14 | 5365686 i_call_you_my_base
i_call_you_my_base's picture

Right, that would happen 6-8 months from now. Full disclosure, I don't have a lot of conviction about my predictions.

Wed, 10/22/2014 - 19:28 | 5365517 i_call_you_my_base
i_call_you_my_base's picture

$2000. Forced deflationary event and crash, subsequently used as a catalyst to go full Japan-tard, USD destroyed.

Wed, 10/22/2014 - 19:27 | 5365518 El Oregonian
El Oregonian's picture

$2000.00 and climbing. BUT, the PTB will try confiscating, or make it illegal to aquire for personal use. You will not be able to purchase it W/O proper Gov't paperwork.

The reason, there is nothing in the storage houses except I.O.U's.

Wed, 10/22/2014 - 19:31 | 5365528 bunzbunzbunz
bunzbunzbunz's picture

So long term, it is useless to hold unless you go underground/black market?

Wed, 10/22/2014 - 19:33 | 5365537 El Oregonian
El Oregonian's picture

Everything will pretty much be underground and black market.

I use the former USSR countries, South American countries as reference.

 

 

Wed, 10/22/2014 - 19:38 | 5365552 bunzbunzbunz
bunzbunzbunz's picture

I think you're references are a bit outdated. I can buy damn near anything I want with bitcoins without much of a margin. 10 years ago, that would have been considered a black market transaction. Now fairly large companies are doing it in the open.

Wed, 10/22/2014 - 19:34 | 5365535 Philo Beddoe
Philo Beddoe's picture

850 bucks an ounce. The Euro. Pound and Yen will be in the shitter and the 30 year will be below 2 percent. 

I own gold...but that is the way it is lookin'. 

Wed, 10/22/2014 - 19:40 | 5365556 bunzbunzbunz
bunzbunzbunz's picture

I own a smidge of silver. I would buy more for $10 an ounce. And I would buy gold for $800. I agree that's how it's looking. And just history repeating as it does.

Wed, 10/22/2014 - 19:42 | 5365570 Philo Beddoe
Philo Beddoe's picture

Agreed. But, we should look at the Euro, Pound. CAD,Yen...... priced in Gold for a bit of perspective.  The USD/Gold looks the ugliest for a gold bull. 

Wed, 10/22/2014 - 19:46 | 5365577 bunzbunzbunz
bunzbunzbunz's picture

I would love a link to historic data showing currency/ounce gold for countries other than the US. edit: Preferably going back at least to the 70's....

Wed, 10/22/2014 - 19:47 | 5365578 bunzbunzbunz
bunzbunzbunz's picture

fat finger correction.

Wed, 10/22/2014 - 19:50 | 5365595 Philo Beddoe
Philo Beddoe's picture

You and me both. People buying Gold a few months ago in Euros are OK so far.  Imagine buying Gold in Argentine pesos a decade ago? Same story on a longer horizon. The USD is the USD no way around that until that changes. 

 

Wed, 10/22/2014 - 20:06 | 5365647 bunzbunzbunz
bunzbunzbunz's picture

Agreed. I think a lot of free money went into gold, thinking that with enough speculation, you could destroy the USD.

Wed, 10/22/2014 - 20:31 | 5365738 g'kar
g'kar's picture

"Alright, honest opinion everyone. In one year, what do you think the price of gold will be in USD....and for bonus points, why?"

 

 

A better question is, at what point will gold, silver, platinum, palladium, rhodium, copper, etc, be unable to purchased for any amount of any fiat?

Wed, 10/22/2014 - 20:36 | 5365764 bunzbunzbunz
bunzbunzbunz's picture

Probably never. Since any gov wanting to preserve their currency would simply back it with something of value. Be it gold, water, fertility treatments, cocaine, or anything people at the time hold value in. If a government exists, it will be able to offer something, and all governments now know they have some power with fiat, so preserving fiat will be a priority. It has kind of been that way for a while now....thousands of years?

Wed, 10/22/2014 - 19:19 | 5365482 coast
coast's picture

You forgot to mention what will happen if the fed does end QE  :-)    And dont you think they can find a way to get money in the markets witjhout anyone knowing about it?   I dont know, just wondering

Wed, 10/22/2014 - 19:23 | 5365496 gatorengineer
gatorengineer's picture

they have left HFT alone for a reason, but that assumes that they will all be good HFTs.....

Wed, 10/22/2014 - 19:28 | 5365522 bunzbunzbunz
bunzbunzbunz's picture

HFT's follow statistics while adhering to loss limits. So once the statistics say down, the HFT's also push down. I would assume there are also HFT's that test behavior to stimulous. Perhaps injecting 1 million into a small cap trade to form a theory as to how injecting 1 billion into a large cap would behave.

Wed, 10/22/2014 - 19:49 | 5365588 kaiserhoff
kaiserhoff's picture

Congrats.

  That's the poorest understanding of HFTs I've ever seen,

   or thought possible;)

Wed, 10/22/2014 - 20:01 | 5365632 bunzbunzbunz
bunzbunzbunz's picture

Thanks bud. Please correct me where I'm wrong.

Wed, 10/22/2014 - 20:04 | 5365641 bunzbunzbunz
bunzbunzbunz's picture

Sorry...If you are taking HFT literally, obviously my statement makes no sense. I was speaking within context using HFT as slang for HFT algorithms. Still please, fill my head with more knowledge if you can.

Wed, 10/22/2014 - 20:08 | 5365656 bunzbunzbunz
bunzbunzbunz's picture

Waiiiiit....You don't think they only use HFT for front-running do you?

Wed, 10/22/2014 - 19:25 | 5365500 bunzbunzbunz
bunzbunzbunz's picture

Yes....everything we know that they are doing, they want us to know about. That's what is so funny about all the fed hating. They want you to hate or like them for the things they make public. Hate/anger/disbelief is all part of the game.

Wed, 10/22/2014 - 19:26 | 5365510 kaiserhoff
kaiserhoff's picture

Still some juice coming out of Europe and Japan.  Most of that will come here.  Would you buy Greek bonds?

The real wild card is interest rates.  They have to return to market rates, but it has them scared shitless.

Thank you Ben Shalome, and the Jack Ass you rode in on.

 

Wed, 10/22/2014 - 20:21 | 5365711 bunzbunzbunz
bunzbunzbunz's picture

Interest rates on the current debt can't go up, that's true. But what is the average rate the gov currently pays on currently held debt? Seriously, help me find that info. If the gov is paying an average of 5% on all outstanding debt, then rates can go up a bit...

Wed, 10/22/2014 - 21:21 | 5365880 Potomac Oracle
Potomac Oracle's picture

Coast,

 

They'll simply debit/credit accounts the same way they creditied/debited accounts to create the trillions for the bailout. C'mon, it's a shell game of pluses and minuses on a spread sheet and the Fed can 'balance" its reserves anyway it wants to maintain its inflation and FFR targets.

Wed, 10/22/2014 - 23:47 | 5366290 bunzbunzbunz
bunzbunzbunz's picture

Well. Yeah....COme on now. Every economy is a shell game. Even those based on barter and commodities. Do you know how old shell games are?

 

Thu, 10/23/2014 - 04:43 | 5366573 StychoKiller
StychoKiller's picture

Where's the path where the $ loses Reserve-Currency status and where will it lead to?

Wed, 10/22/2014 - 19:12 | 5365462 Stoploss
Stoploss's picture

Did anyone have to be hospitalized as a result of this stroke of "genius"??

Wed, 10/22/2014 - 19:29 | 5365520 kaiserhoff
kaiserhoff's picture

"Great Moderation" would be a good name for a FEMA re-education camp,

  if you have a taste for absurdist humor.

Wed, 10/22/2014 - 19:12 | 5365466 buzzsaw99
buzzsaw99's picture

there is no market and they damn well know it

Wed, 10/22/2014 - 19:24 | 5365495 BandGap
BandGap's picture

Fuck that, the world has the Fed by the nuts with something called "pension funds".

This piece is so utterly simplistic as to be useful. Who the fuck puts this on a PowerPoint? I'd throw shit if I ever saw this in a presentation.

Wed, 10/22/2014 - 19:24 | 5365501 gatorengineer
gatorengineer's picture

needs two more boxes, 1) total and other collapse, and 2) a unicorn shitting mint skittles.....

Wed, 10/22/2014 - 19:28 | 5365515 Ban KKiller
Ban KKiller's picture

Prudential? Fuck you.

Yeah, juvenile....

Wed, 10/22/2014 - 19:50 | 5365550 Really20
Really20's picture

The truth is that we cannot have perpetual growth without either damaging the environment or creating new technology. At this stage our ecological footprint is far beyond what is healthy or acceptable, just to boost GDP figures and keep the capitalist system one step ahead of the debt which is the fount of all the money within (even if such rises in GDP, like our high health care costs, in no way contribute to an improved standard of living). GDP includes all consumption, whether good or bad for the standard of living.

The economy needs rebalancing around what is good for the standard of living rather than for corporate profiteers and bankers. Our GDP should be significantly lower than it is now, to be achieved by using more public transport (reduces consumption of oil, automotive, mining, smelting, electricity, etc.) and buying less iCrap (reduces consumption of excess consumer products and all of their inputs). Thereafter, it must adjust to a lower level of secular growth (about 1% annually) while still being able to maintain high standards of living by reducing the profits of shareholders and increasing the share given to labor.

The objective of increasing the labor share while decreasing the share of corporate profit, in order to reduce GDP and GDP growth to a sustainable level while ensuring the continuance of a high standard of living, could be achieved by making all large corporations self-managed by workers, with corporate boards elected primarily by workers rather than shareholders or the state and new workers' councils for major divisions of large enterprises. This would help to ensure a higher labor share and lower profit share of gross domestic product. Furthermore, in order to avoid previous debts from eras of growth which create high profits for the owners of capital while the rest are in a state of distress, the banking system that we have now should be replaced with one based on sovereign credit money, free of debt and created by the Treasury, not private banks. The defense industries should be nationalized, in order to ensure that they are under the control of the people and not war profiteers.

In spite of this, our standard of living would not lower. For example, consider the 1960s when GDP per capita was significantly lower nowadays. In those days most people had hope of decent wages and a secure retirement, with two-income households existing by choice and not by necessity. Nowadays GDP is higher, but people work harder and harder just to earn enough to pay off our perpetual debt (which the current monetary system is predicated on) and buy more iCrap to allow the remainder of the capitalist economy to do so. This has got to stop.

Wed, 10/22/2014 - 19:38 | 5365555 taketheredpill
taketheredpill's picture

 

 

 

No scenario where Equities collapse?  Thanks Goldman!

 

Now Feck Off!

Wed, 10/22/2014 - 19:44 | 5365571 bunzbunzbunz
bunzbunzbunz's picture

Well, they can only collapse so far before money, in whatever form, goes back into buying the assets they were based on in the first place....so eventually. Up again. BTFD is never wrong...It's just a matter of how big the dip may be. 

Wed, 10/22/2014 - 20:00 | 5365628 Dead Man Walking
Dead Man Walking's picture

Gubbermint needs low rates forever, otherwise they may have to cut spending....

Wed, 10/22/2014 - 20:15 | 5365691 RaceToTheBottom
RaceToTheBottom's picture

I wonder if this is representative of what you get from them as a paying Muppet?

 

Wed, 10/22/2014 - 21:46 | 5365971 Bemused Observer
Bemused Observer's picture

You forgot "Path 4"...where everyone says fuck this and tries to sell their positions at the same time when they realize there will BE no growth like there was, and what they have now is probably the best they're gonna do, so they want it NOW before it goes 'poof' again like it did a few years ago.
Investors are skittish herds.

Thu, 10/23/2014 - 03:48 | 5366539 CHX
CHX's picture

Fed will stay in between the rock and a hard place, as rates will drift lower towards 0 until "something" breaks for good... Or rather, we know it's all broken already, and the paper scotch holding it together will rip.

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