Folk wisdom holds that the counting of “Mississippis” can help estimate a storm’s distance by judging the time between the flash of lightning and thunder. Similarly, many market observers in 2019 believe they have witnessed cyclical warning signs which start the countdown to the next recession. Last August brought a surge of Google searches for the term “recession” in the same week that the 2–10 year portion of the US Treasury curve inverted. In our view, the inversion was no telltale flash of lightning.
We believe recession is not a foregone conclusion. Recent lightning flashes include sluggish global growth, mired manufacturing, and the just-mentioned inverted curve. We expect a modest global expansion to be sustained in 2020 by the stability of the consumer, committed central banks, financial condition tailwinds, and improved visibility on persistent geopolitical issues such as Brexit, trade, US impeachment, and elections.
Consequently we would emphasize in this Market Know-How:
- Sticking to the plan, by maintaining strategic asset allocation
- Alpha-oriented, bottom-up strategies over pure beta
- Income-oriented investing and alternatives in light of moderating returns and occasional bouts of volatility
This material is addressed to an audience familiar with macroeconomic data, market dynamics, industry trends and other broad-based economic and market conditions. For further information, please consult an authorized financial advisor. This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. Views and opinions are current as of December 2019, and may be subject to change, they should not be construed as investment advice.
Macro
The global expansion should continue with near-trend growth as most economies rebound modestly from 2019’s deceleration. Disparate political trajectories and weak inflation keep global central banks at the ready.
GROWTH
We expect global growth to remain uneven, unimpressive, but expansionary and around trend. Our base case calls for global growth of around 3.4%, as trade tensions ease, manufacturing bottoms, and consumers remain healthy. While global recession risk has generally risen, the containment of inflation and relative absence of financial imbalances should limit recessionary catalysts.
INFLATION
In the US, we look for gradual wage growth improvement and tariff-related price pressures to nudge inflation higher, though still insufficient to alter the Federal Reserve’s (Fed) reaction function. European core inflation has been stuck around 1% and should rise very slowly over the next few years. In Japan, inflation continues to disappoint, and without a supportive Bank of Japan any progress would likely be fragile and short-lived
MONETARY POLICY
After a series of “mid-cycle” cuts, we expect the Fed to stay on the sidelines in 2020, attempting to minimize the politicization of monetary policy. Under Christine Lagarde’s leadership, we expect the European Central Bank to undergo a period of consensus-building and hold the deposit rate at -0.5%.
POLITICS & POLICYMAKING
The range of US election outcomes remains wide and the partisanship deep. Prospects for meaningful legislation in 2020 are remote, with policymaking likely limited to the realm of executive action and order. With lower risks from a “hard” Brexit, European political risk should moderate over the course of 2020.
RISK
US election year dynamics elevate the relative importance of policy uncertainty, economic growth, and consumer confidence. Any shifts in macro data will likely be received with an amplified market response given the potential impact on political outcomes. We also expect improved clarity regarding Chinese growth, trade negotiations, and Brexit timelines, though each is sure to impact markets in
2020
Source: GSAM. As of December 2019. This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities. The economic and market forecasts presented herein are for informational purposes as of the date of this document. There can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this document. Past performance does not guarantee future results, which may vary. The economic and market forecasts presented herein have been generated by GSAM for informational purposes as of the date of this document. They are based on proprietary models and there can be no assurance that the forecasts will be achieved. Please see additional disclosures at the end of this document.
Split Decision
Elevated economic policy uncertainty (EPU) has become standard across the globe, though implied volatility (VIX) has not followed suit. Many investors expect volatility to rise as it converges to higher EPU, but in our view this trend may persist. Broad expectations for contained global inflation and central bank responsiveness appear to be holding volatility down, while the unrelenting volume of headline risk elevates EPU. In other words, few signals, plenty of noise.
Source: Bloomberg and GSAM.
Labor Pains
Many economies are experiencing improving labor markets and stable household fundamentals. An early warning sign of a change in trend is the “three-to-four-tenths rule,” which associates the risk of recession with an increase in unemployment. For example, historically a 35 basis point increase in the US headline unemployment rate over a three-month period has always been associated with a recession. In Sweden, that same increase portends to only a coin flip’s chance of recession.
Source: Goldman Sachs Global Investment Research and GSAM.
False Positives
In 2019, the ISM Manufacturing Index entered contractionary territory. While goods-producing firms constitute 43% of the S&P 500, manufacturing only accounts for 10% of nominal US GDP. As such, manufacturing weakness may be more pronounced in the market than in the economy. Since 1990, an ISM reading below 50 has preceded a recession only 30% of the time. A periodic dip below 50 is relatively normal, while below 45 has proven to be more problematic.
Source: Bloomberg and GSAM.
Top Section Notes: As of November 30, 2019. ‘US Recessions’ refers to periods of two or more consecutive quarters of negative GDP growth. Middle Section Notes: As of November 30, 2019. Analysis shows the likelihood of a recession to occur in G10 economies within a 6-month period following an undershoot of the structural rate of unemployment and a 35 bps increase in the three-month moving average of the headline unemployment rate relative to a local trough. ‘Recession’ is standardized globally to be defined as negative year-on-year per capita GDP growth, though each country may have varying definitions. Analysis is based on data from 1948 through 2019. Bottom Section Notes: As of November 30, 2019. ‘GDP’ refers to Gross Domestic Product. These examples are for illustrative purposes only and are not actual results. If any assumptions used do not prove to be true, results may vary substantially. Please see additional disclosures at the end of this document. Past performance does not guarantee future results, which may vary.
