Curiouser and curiouser in global Wonderland

FEELING confused about the global economic outlook? Goldman Sachs says economic and financial conditions remain “far from normal”.

FEELING confused about the global economic outlook? Goldman Sachs says economic and financial conditions remain “far from normal”, and the “Wonderland” of near-zero interest rates in the major economies is distorting the way economic cycles normally evolve.

To highlight the degree of uncertainty, Goldman Sachs chief global equity strategist Peter Oppenheimer outlines three possible scenarios for the post-global financial crisis world: “secular stagnation”, “sustained moderation” and “normalisation”.

The first two scenarios are basically low-growth outcomes where inflation and bond yields stay low, forcing investors to keep hunting for higher yields in equities, although sustained moderation would imply some improvement in economic growth and company profits.

“Normalisation” would need a new global growth engine, driven by business restructuring, the US shale gas energy revolution and possibly a major shift towards consumption in China. That would be good for equities and a negative for bonds.

Goldman Sachs leans towards sustained moderation as the most likely scenario, although that would not be entirely bad for equities, as they should continue to outperform bonds, albeit with much lower absolute returns than enjoyed since 2010.

“This global moderation may continue for some years,” Oppenheimer says. “It is likely to end as a result of either the bursting of the ‘bond bubble’ as interest rates finally start to rise, or significant further valuation expansion of equities, reducing long-term (potential) returns.”

On a positive note, Oppenheimer says financial markets seem to be pricing in a growing probability of stagnation, particularly in Europe. That means economic conditions might not have to improve much to imply upside potential for equities.

“If, as we expect, growth expectations stabilise, the perception of a ‘risky’ asset might shift to fixed income, given that risk premia are so low and yields have overshot fundamentals.”

Also, and there’s much debate on this, Oppenheimer argues that the multi-year trend of low volatility is likely to continue, despite the recent spike. “With low macro volatility, it is unlikely that market volatility will rise significantly and in a sustained way until valuations become stretched,” he says.

Goldman Sachs isn’t the only major brokerage with a slightly positive global outlook.

Andrew Garthwaite, global equity strategist for Credit Suisse says investors are “too pessimistic on growth”, as “many tactical indicators point to high levels of pessimism” on equities, and “a range of market indicators have over-discounted the economic slowdown”.

He notes that net long positions on S&P 500 futures have fallen to two-year lows, net selling from US company directors is near a three-year low, net buying of shares by corporates is rising, and Credit Suisse’s “equity sentiment indicator” is near a two-year low.

In Europe, “domestic demand indicators have held up much better than industrial indicators, suggesting a possible rebound as destocking ends, bank lending proxies have improved, and much of the external shock from Russia and China has been felt,” Garthwaite says.

And investors’ demand for European cyclical versus defensive equities is the lowest since 2009, while in the US, the market is expecting US manufacturing orders to fall to a level consistent with zero US GDP growth — too pessimistic, according to Garthwaite.

Notwithstanding the Federal Reserve plan to end its bond-buying this month and start lifting interest rates next year if economic conditions allow, Garthwaite argues that massive money-printing in Europe and Japan means that monetary policy globally will become looser, not tighter.

Tuesday’s 11 per cent jump in volatility on Wall Street’s S&P 500 futures shows that financial markets remain jittery.

In Australia, the S&P/ASX 200 has bounced 5 per cent in the past week, having earlier fallen 10 per cent from a six-year peak on August 22.

The market is now waiting to see how much bond-buying the European Central Bank does this month. The results of its “stress tests” of European banks on Sunday will also be key, and after that, attention turns to next week’s Federal Reserve meeting.