Jan Hatzius and his economic team released a very bullish note yesterday regarding the global economy. It was a relatively dramatic change for an economic team that had been fairly bearish for several years now. Hatzius describes why they have recently changed their position:
“The most significant shift in 2011 and 2012 is likely to be stronger growth in the US. Five years ago, our US economic outlook was very pessimistic….Even one year ago, we still had a below-consensus view and predicted a slowdown in GDP growth to a belowtrend pace in 2010. The reason for this was that the improvement in GDP growth in late 2009 had been due to temporary factors, namely the inventory cycle and the impulse from the 2009 fiscal stimulus package. With underlying final demand still stagnant, we thought that growth would slow through 2010, as indeed it has
That was then. Now, however, we expect a substantial acceleration in real GDP growth over the next two years to a 4% pace by early/mid-2012.
What has changed? Most strikingly, the performance of underlying final demand, or ‘organic growth.’ Chart 2 shows real US GDP growth both including and excluding the short-term effects of inventory swings and fiscal stimulus.”
Why such a sharp acceleration? Our best explanation is that the pace of private-sector deleveraging is slowing in an environment of somewhat lower debt/income ratios, improving credit quality and moderating lending standards.
Although they’ve turned more constructive Hatzius and his team also maintain that there are risks. Specifically, they still believe the balance sheet recession will persist, unemployment will remain high and that it will generally feel like a recession on Main Street. The low inflation and adequate final demand environment will remain conducive to growth:
“It is important to emphasise what we are not saying. We are not saying that the US economy will now embark on a V-shaped recovery. We believe that the drag from inventories and fiscal policy will still keep real GDP growth at a moderate pace of 2½% in the next couple of quarters. And even the 4% growth pace that we expect for much of 2012 is still quite moderate relative to typical post-war recoveries. We are also not saying that deleveraging is over. Indeed, private-sector debt/income ratios are still likely to decline further. But it is the pace of deleveraging—which corresponds to the level of the private-sector balance—that matters for GDP. As the pace of deleveraging slows, the private-sector balance falls, and this implies a positive impulse to GDP growth.
Finally, we are not saying that the economy will feel good from a ‘Main Street’ perspective. We only expect a gradual decline in unemployment as growth moves above trend, to 9¼% by the end of 2011 and 8½% by the end of 2012.
Because there is so much slack, inflation is likely to stay well below the Fed’s ‘mandate-consistent’ level of just under 2%.”
Their targets for most asset classes are extremely bullish with expectations for 20%+ equity returns and double digit commodity returns:
The best ways to play it? Goldman’s 5 favorite trades are as follows:
1. Short $/CNY via 2yr NDFs currently 6.41, expected return 6%: The current account positions in the US and China remain at the core of the global imbalances debate. We remain of the view that $/CNY has an important role to play in the rebalancing process.
2. Long US Banks (BKX) – at 44.8, target of 57, expected return +25%: The improving US outlook, stronger loan growth, declines in credit losses and a gradually steeper yield curve should all be supportive.
3. Long US High Yield Corporate spreads (Selling protection on the CDX 15 index) – at 528, target of 450, expected return of 8.7%: Better macro conditions, improved fundamentals and a positive view of future defaults suggest that the current level of HY spreads is still elevated relative to fair value.
4. Long Nikkei 225 (NKY) – at 9988, target 12,000, expected return +20%: The Japanese equity market has underperformed other major markets. But, despite the disappointing ‘alpha’ of Japanese equities over the years, the market displays significant ‘beta’ to the improving global industrial cycle.
5. Long a Basket of Crude, Copper, Cotton/Soybeans and Platinum (‘CCCP’), expected return 28%: After a decade of high commodity prices, we are most positive on these markets as they exhibit the largest structural supply constraints.