As we reported yesterday, in its forecast of 2016 global growth, Goldman expects growth next year to rise from 3.2% to 3.6%, driven entirely by three countries: Indonesia, China and India.
This reliance on DMs has a simple explanation: Goldman expects that after three years of disappointment, the development markets are "about to turn the corner: "2016 could be the year EM assets put in a bottom and start to find their feet... there is the prospect of improved growth and better returns, even if it is not a rerun of the roaring 2000s."
Actually no, there isn't, for one simple reason: China has 300%+ debt/GDP and now the entire world is watching. In fact, as Goldman itself admits China's growth is likely about 2% (if not more) below the official, and quite bogus, 7% number. Which means it is all up to India, the same India where the first rumblings against Modi's cabinet were heard loud and clear recently. In fact, in our modest opinion, if there is one country where the global DM slump will hit next, it is precisely the one country which is growing "faster" than China.
Furthermore, as Goldman itself notes, with oil prices set to continue dropping for at least the next 12 months, the hit to oil-exporting DMs will persist, and the reverse savings glut, aka Quantitative Tightening will continue to wreak havoc on capital flows and asset prices around the globe, all of which suggests that far from a rebound in 2016 GDP, we would expect global growth to drop below 3% for the first time since the financial crisis.
DM growth aside, it is more interesting what Goldman thinks will happen to the US. This is what it says: "We expect all DM economies to grow in 2016, but the US will be the first to grow GDP demand above potential."
Which brings us to the topic of this post: if the US economy does indeed grow "above potential" as Goldman expects, what does that mean for US capital markets? According to the firm, the shift in central bank posture in 2016 will be unprecedented, and instead of the "Bernanke Put" which pushed markets from 666 to over 2100 recently while the US economy kept deteriorating, will be replaced by the "Yellen Call."
US equity upside: Limited by the ‘Yellen call’
We see limited upside to equities in 2016. Our US Portfolio Strategy team has a 2016 price target of 2,100 for the S&P 500, suggesting a very modest return of 5% (from current levels). Their framework assumes that 1) earnings per share will rise 10.1%, driven partly by ‘base effects’ in the energy sector and partly by improvements in global growth more generally, but that 2) the price-earnings multiple will fall approximately 5% (to 16.3x from 17.1x), as typically happens during rate-hike cycles. And, due to the delayed timing of rate hikes, the downside risk to price-earnings multiples is probably greater this year because the positive growth surprises that would normally accompany rate hikes are arguably behind us. Since our US GDP forecast envisions mild deceleration in 2016, equities and other risky assets will likely bear the brunt of rate hikes without the usual buffer of better growth data.
We also see a risk that the ‘Bernanke put’ will gradually be replaced by the ‘Yellen call’. The ‘Bernanke put’ captured the intuition that when the risks to growth, inflation and market sentiment are skewed to the downside and the Fed has an easing bias, monetary policy reacts aggressively to bad news. Now that these risks have receded, we expect the Fed will shift to an easing bias, implying that monetary policy will likely begin to react more aggressively to good news. The inflection point for this shift to an easing bias will arguably arrive in 2016, beyond which rallies in risk sentiment may be met by less accommodative monetary policy – the ‘Yellen call’.
While we agree with Goldman that multiple contraction is long overdue, we fail to see where earnings growth will come from, especially if, as Goldman also said recently, companies are now punished for buying back their own stock which in turn is the main driver pushing EPS to record highs in recent years. In fact, just like global GDP growth, we expect EPS to continue declining in the next year now that margins have peaked, if companies indeed are raising wages. Because with revenues set to drop for 4 consecutive quarters, there is simply not enough growth, either in the global economy or on corporate income statements, to justify being bullish about either.
Still, there is a modest chance Goldman is right, and that "bad news will be bad news" again. If that is the case, selling in November and going away for the next year may be a good idea because if there is anything the world will have over the next year, it is a lot of bad news.