"The Probability Of A Recession Is Rising": According To Goldman, This Is As Good As It Gets

On Thursday, in the aftermath of some of the strongest retail sales numbers in the past year, the Atlanta Fed raised its Q2 GDP Nowcast to 4.8%, one of the highest estimates for current GDP in series history.

Various sellside research analysts followed suit, hiking their GDP estimates to the mid-3% range, and in some case, such as Goldman, 4% or more. The buoyant economy has prompted recent confidence prints to hit near all time highs...

... while Trump tweeted that the US economy is now the "greatest ever" with "the BEST jobs numbers in 44 years."

And while there is little doubt the US economy is firing on all fours, the main driver behind this is the recent fiscal stimulus, which as extensively discussed, produces a sugar high in the early innings - funded by hundreds of billions in additional debt - only to lead to a painful hangover in time.

It's no surprise then, that according to David Kostin, the main topic dominating the Goldman chief equity strategist's recent meetings with equity investors is "The duration of the current US economic expansion."

And here, unfortunately, Goldman believes that "this is as good as it gets" with Q2 GDP set to print a local high, and slowly but surely fade from here as the boost from the Trump fiscal stimulus fades.

As Kostin writes, "the current state of the US economy is strong" and details: 

Most economic data released this month have exceeded consensus expectations. Payrolls, unemployment rate, ISM manufacturing and non-manufacturing indexes, JOLTS job openings, NFIB small business optimism, and retail sales all posted positive surprises. Our US MAP index of economic data surprises stands at its highest level since January

Ok fine, Q2 GDP will be a barnburner: that is hardly a surprise as after all, the economy had to show something for the upcoming avalanche of debt issuance. The question is what happens next?

Here, Kostin answers that Goldman's economics team expects annual average economic growth to modestly decelerate but remain above-trend through 2019. At that point the US economy will gradually slowdown to trend, growing by 2.9% in 2018 and 2.2% in 2019 compared with an estimated trend pace of 1.8%.

Worse, while the US economy is enjoying its sugar higher for now, the build up of imbalances means that strength now is at the expense of recession risks - with even more debt - rising in 2019 and 2020, just before the next presidential election. According to Goldman, the probability of a recession rises from just 4% during the next 12 months to 18% during the next two years and 32% during the next three years (corresponding to 2020).

Meanwhile, the real risk remains offshore, and while business activity in the US remains robust, growth in Europe and the rest of the world has been slowing fast as even the ECB admitted last week. Meanwhile, the latest Chinese data was "shockingly weak" according to Rabobank analysts...

... a direct consequence of the collapse in shadow credit growth inside the country.

What does this means for risk assets? According to Goldman, absent any major shocks, "growth will support a 3% rise in the S&P 500 during the next six months to our year-end target of 2850. We forecast the index will climb another 5% to 3000 by the end of 2019 and reach 3100 by year-end 2020."

As for the other key question asked by Goldman clients, "what are the implications of rising interest rates on share prices and valuations, Goldman answers the following:

The path of interest rates – short-term, long-term, and slope of the yield curve – represents the second major line of questioning from equity investors. GS economics forecasts the FOMC will tighten two more times during the second half of this year and four times during 2019, lifting the fed funds rate by 150 bp to 3.4% by year-end 2019. Meanwhile, long-term yields are projected to rise by a more modest 65 bp to 3.6%, resulting in a steadily flattening yield curve during the next 18 months.

Conventional wisdom suggests that higher interest rates result in lower equity prices. Empirically, however, during the past 20 years equity valuations and returns have often risen alongside higher interest rates... History suggests that the equity risk premium (ERP) can decline by enough to offset rising interest rates as long as inflation remains centered around 2% and 10-year Treasury yields remain below 3.5%. When Treasury yields are below 3.5%, inflation is often relatively low and rising interest rates typically reflect improving economic activity. These conditions are constructive for equities and represent our baseline forecast for 2018. However, as bond yields approach 4%, the growth-inflation mix embedded in interest rates could weigh on equities.

Additionally, Kostin reminds us that it is not just the level of the 10Y yields, it's how fast it is moving, something Russia tested out in April when it shockingly dumped half of its TSY holdings as we learned yesterday, explaining the sharp spike in yields in the second half of the month.

Here is Kostin discussing the impact of the rate of change in yields on equities:

In addition to the level, the pace of changes in Treasury yields matters for equities. Stocks have historically been able to absorb a moderate pace of interest rate increases. Equity returns have been weak when rates rise by more than one standard deviation in a month relative to the trailing three years. A one sigma monthly change translates into 20 bp currently. The relationship holds regardless of whether it is inflation- or real-rate driven. GS Economics forecasts nominal bond yields will climb by 65 bp in 18 months (an average monthly increase of just 3 bp!).

He is right: as a reminder, the sharp spike in April yields which every pundit had a carefully crafted theory for except the correct one, that Russia was liquidating half of Treasury holdings, ended up hammering stocks. The good news is that we now have a template of what might happen when one (or more) nations start dumping US paper. The bad news is that China has observed the outcome, and if Beijing really wants to hurt the US - both economy and capital markets - it knows just what to do.

Comments

Captain Nemo d… Sat, 06/16/2018 - 10:48 Permalink

Thank you Goldman. Now most people will move appropriate fractions of their their assets accordingly based on detailed calculations. Oh wait, it is easy. Any fraction of zero is zero. If you are investing others' money, who cares. Carry on.

Endgame Napoleon silverer Sat, 06/16/2018 - 12:33 Permalink

You just do not understand, Silverer: The 101 million American citizens out of the workforce, many of whom voted for Trump, do not count. The 95 million US citizens out of the workforce in May did not count, either.

The 78 million gig pieceworkers do count; they count as “employed.” They count as employed, even though most gigs and most full-time jobs do not cover the cost of unsubsidized rent that devours over half of the earned-only income of millions of underemployed, non-welfare-eligible citizens.

When big governent does not pay it, do the rent payments of the non womb productive count as stimulative spending?

Another group that counts as “employed” is the 42 million womb-productive food stamps recipients who all work part time. To qualify for the EBT program, and for all of the other welfare handouts that this group gets, including free rent and refundable child tax credits up to $6,431, they have to stay under the income limit.

Many of these are the “employed” illegal aliens who report their income, or some of their income, to get the welfare for womb-productive sex that accrues when they have US-born kids.

With all of this spending by the womb-productive “employed,” including by the dual-earner parents with two spousal incomes who got a doubled, non-refundable child tax credit, we should see higher SS reporting, not SS actuaries pointing out the falling revenues.

Overall tax revenues have been falling in this fabulous, rocket-ship-to-the-moon of an economy.

This is puzzling since, when there is a lot of full-time employment of taxpaying citizens, tax revenues rise due to all of the worker bees, owing taxes, rather than collecting & spending what is owed by government to the womb-productive crowd of citizens & noncitizens for the fruits of their sexual activity when they work part time to stay under the income-limit threshold for welfare.

Many of the needs-the-job mommies in the dual-earner households who got non-refundable child tax credits, too, are just working part time, taking the jobs in the safer, posher areas of cities to add keeping-up-with-the-Jones’ income to the household. It does not add much to tax revenue, but it does keep wages down for women who have no spousal income and no welfare access.

In reply to by silverer

wisehiney Sat, 06/16/2018 - 10:55 Permalink

Dump those treasuries you dumb ass chinks.

I'll buy em up on the cheap.

Will love the higher yield.

And the flight to safety shortly thereafter.

MrNoItAll Sat, 06/16/2018 - 11:02 Permalink

The probability that Goldman is lying is 100%, this year, next year and the year after -- if they're even around by that time, which I hope and believe they will not be.

leeholsen12 Sat, 06/16/2018 - 11:03 Permalink

I understand goldman needs you to keep sending them your money, but it 100% chance of recession in next threes years and also next two years.

 

every time the fed has raised rates to where they have projected over the next 18 months, a recession has followed. add to that, worldwide liquidity extractions, trade war/disputes and ever increasing government and personal debts; and you will have a recession.

 

only real questions are when(2019 or 2020) and how bad will it be next time as none of the issues causing the 2008 recession have been resolved and many have become bigger issues.

 

 

Winston Smith 2009 Sat, 06/16/2018 - 17:07 Permalink

"The Probability Of A Recession Is Rising"

Dumb. That's always true. It has been since the last recession.

Anyway... globalists of the world UNITE! NOW is the time to crash the phony, manipulated, massively debt dependent world economies! Trump is making far too many waves and some of his nationalist policies might actually succeed!

"Network - The World Is a Business, Mr. Beale"

https://www.youtube.com/watch?v=V9XeyBd_IuA

Let it Go Sat, 06/16/2018 - 19:50 Permalink

During the last two and a half years central banks and countries around the world have added more fuel to the fire which has postponed the day of reckoning. This has made all of us thinking the market was about to turn south looking rather silly and underlines the fact that trying to time events is both confusing and complex, this is especially true when it comes to the financial part of our lives.

When it comes to economics, this means it is best not to have a great deal of faith in our economic system which is severely flawed. Central banks can stack the deck but when it gets too high and begins to fall they may not be able to control the direction or who it will crush. The article below explores the idea that thinking the economy will adjust and grow its way out of many problems we have tried so hard to ignore deifies what history has taught us.

 http://Hard-landing Scenario Remains Very Possible.html

everything1 Sat, 06/16/2018 - 20:15 Permalink

Didn't they run this same piece last week.  We need recession to flush it all down and start over again.  With rates up that will work fine, bailouts and giveaways, not sure if that is a permanent solution though.

Still, I doubt the debt matters anymore, it's the high level corruption more than anything that seems to take countries down hard from economic perspective.

Their is plenty to go around, it's just that greed, power, etc. is the root problem.  Their are countries that don't have this kind of corruption nobody is recession proof, but it's not such an economic shock in some ways.