Back in November, when it was laying out its (five out of six wrong) Top Trades and predictions for 2016, Goldman strategists forecast that because the “US will be the first to grow GDP demand above potential” the stock market party would be over and that the “Bernanke Put” would be replaced with the “Yellen Call.”
Specifically, this is what Goldman predicted:
We 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’.
We did not see things this way and said the following:
“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.”
We were right not only about earnings crashing (Q1 EPS is now expected to plunge -8.7% compared to a consensus increase in December), but also about global growth slowing down (Altana Fed’s latest Q1 GDP forecast is 0.6%, nuf saif); Goldman was wrong.
We also said the probability of “bad news being bad news” again is slim to none. And, as Yellen just confirmed following the Shanghai Accord that shall not be named, bad news is once again good news, much to the delight of 18 year old hedge fund managers.
So, nearly give months later, here is Goldman again admitting its call for a “Yellen Call” was wrong, although the central bank-incubating hedge fund does not give up, and instead merely pushes back its forecast to the second half. From Charles Himmelburg:
Global Markets Daily: The ‘Yellen call’
In our “Top 10 market themes for 2016”, we argued that the ‘Bernanke put’ might gradually be replaced by the ‘Yellen call’. Recall, the ‘Bernanke put’ was the idea that meaningful declines in market sentiment would be met with aggressive monetary action, thus providing a buffer to downside risk. Our notion of the ‘Yellen call’ was the converse of this – that with labor markets approaching full employment and core PCE inflation rising towards target, meaningful rallies in market sentiment would likely be met with a more robust withdrawal of policy accommodation. And this, logically, would tend to buffer or ‘cap’ the upside potential for risky assets.
It hasn’t happened. Market conditions have been considerably more volatile and uncertain than we expected over the first quarter. While we correctly anticipated the downside risk to oil prices and cautioned that this would likely weigh on credit spreads (#4 of our top 10 risks), we nonetheless failed to appreciate how widely this shock would reverberate throughout the global economy – and, with it, drag down risk appetite among all risky assets.
Actually what Goldman failed to anticipate is the very same thing that Yellen has failed to anticipate: in a world as centrally planned as this one, where markets are only up due to constant central bank intervention (and now we know for a fact that the PBOC is also directly manipulating stocks) is just how reflexive the central bank – market relationship has become. And, furthermore, any time “good news is good news”, at least on paper, and stocks tumble, the market finds a very quick way of tumbling even more to stun central bankers out of their inactivity and prompt them right back in. With all central banks currently all in on market manipulation, and thus economic micromanagement, there is simply no way out. The Fed is starting to grasp this; Goldman will too soon enough.
Conitnuing with Goldman’s note:
The oil price sensitivity of global risk sentiment (and hence global growth risk) is now clear to see. Over the course of Q1, oil prices first fell by over 25%, then staged a straight-line back to new highs on the year that briefly exceeded $41/bbl (WTI fell from $36.76/bbl on Jan. 4 to a low of $26.21/bbl on Feb. 11; it closed yesterday at $38.32). Risky assets – notably credit, equity and equity vol – traded this move with an unusually high beta. Spreads on the BAML HY credit index widened by nearly 180bp, an unusually sharp sell-off that we judged to be considerably in excess of the changes in fundamentals implied by lower oil prices. Equity prices also fell harder than warranted by fundamentals, although from higher valuations, and hence to less obviously ‘undervalued’ price levels.
Well of course they did: market participants understand and know that fair values without central bank support are materially lower and nobody wants to be the last one holding the bag to find out just how much lower. Yes: the more central bank intervention, the bigger the crash in the end, because with every trillion in central bank liquidity injected, the more disconnected from fair values risk assets become. And the market knows this!
So having been so grotesquely wrong, what does Goldman think will happen?
Where to from here? Were it not for this rocky path of risk sentiment since Jan. 1, we think it is likely that the ‘Yellen call’, having already been exercised in December, would now be posing a material headwind for risky assets (especially in equities, given their higher sensitivity to discount rates and current fullness of their valuations).
Oh, so if the market had not crashed when the Fed said it would hike rates, everything would be ok. Well… brilliant!
But what a difference a quarter makes. Downside risks to global growth visible in Q1 economic data (and still priced, despite the recent rally in risky assets, in global interest rates) have clearly risen to the forefront of Chair Yellen’s concerns. In a surprisingly dovish speech presented to the Economic Club of New York on Tuesday, Chair Yellen emphasized downside risks to the US economic outlook stemming from slower global growth. She cited this weakness, coupled with the FOMC’s “asymmetric” capacity to respond to economic shocks, as the key reason for the Committee’s lower path for the funds rate in March (“Yellen Comments Emphasize Downside Risks”, US Economics, March 29, 201).
Chair Yellen’s dovish tack was unmistakable. While she acknowledged that core inflation had risen “somewhat more” than she expected in December, this was heavily qualified with her view that it is “too early to tell if this recent faster pace will prove durable”, and that, given the risks to the outlook, it would be appropriate to “proceed cautiously in adjusting policy”.
This adjustment says to us that the risk to risky assets stemming from the ‘Yellen call’, in other words, is temporarily postponed. In particular, we do not expect the ‘Yellen call’ to be reactivated until the second half of the year, by which time our economics team expects that US growth will have pushed unemployment rates lower and core inflation rates higher. This will likely justify a resumption of rate hikes in the second half of the year, and likely at a pace faster than is currently envisioned in the ‘dots’ offered by FOMC members. But, between now and June, risky asset markets have been given a reprieve.
Then again, it is possible that Goldman is just wrong. Again.
Perhaps sensing the muppets’ rage if they are all piledriven once more, Goldman provides a useful test to determine if at least this time it will right: that test will be the market’s reaction to tomorrow’s payrolls. Goldman says that as of this moment “good news should be good news for risky assets” – well, tomorrow’s NFP will demonstrate that: if payrolls come in above the 210K consensus, then stocks should surge… assuming Goldman is right.
Put differently, with monetary concerns temporarily sidelined, good news should be good news for risky assets. Tomorrow’s economic calendar will provide an interesting test. We expect US data to be moderately stronger than expected. Consensus forecasts expect nonfarm payrolls to rise 210k vs. 220k for GS (from 242k last month) and ISM manufacturing to rise to 50.5 vs 51.0 for GS (from 49.5 last month).
Alternatively, if payrolls miss big, then the market should tumble. We’ll know if Goldman, which two months ago said to short gold, will finally have at least one correct call.
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