Goldman Sachs Looks to 2014

Terry Flanagan

Goldman’s top ten themes for 2014

Goldman Sachs economists have produced their annual list of Top Ten Market Themes which they think will dominate markets in 2014.

The following are the 10 themes from Goldman’s report:

1. Showtime for the US/DM Recovery

The economists predict that US growth will accelerate to more than 3% spurred by an acceleration in private consumption and business investment. The report said: “On balance, that should make 2014 another year in which equities and bond yields move higher together. On our forecasts, despite the outperformance of DM assets, our confidence is highest in the US and DM cyclical picture and we still favour assets exposed to that theme.”

2. Forward guidance harder in an above-trend world

In the US the Goldman Sachs economists do not expect interest rate rises until 2016 but said a gradual tapering in bond purchases will most likely begin in March. The report said: “But the broad message from a Fed led by Janet Yellen is likely to be reassurance that financial conditions will remain easy and we expect a common desire among G4 central banks to lean against the kind of rapid tightening in financial conditions that we saw a few months ago.”

The bank said the combination of still-easy policy and improving growth should be friendly one for equities and other risky assets while preventing sharp increases in long- term yields.

3. Earn the DM equity risk premium, hedge the risk

The bank expects the equity rally to continue in US and European markets despite above-average multiples. The report said: “In part, this is because moderate earnings growth should continue as top-line growth does more of the running relative to margins.”

The bank recommended strategies that involve long equity positions while protecting against the risk that US yields increase more rapidly than expected through either short bond positions, long USD positions against gold, or some EM and commodity currencies.

4. Good carry, bad carry

Goldman expects macro volatility to remain low. The report said: “As always, the primary challenge is to identify places where the reward clearly exceeds these – and other – risks. Given how far spreads have compressed, that may require moving down the capital structure and more deeply into illiquid areas than before. Parts of high yield (HY) credit and subordinated debt for banks offer some of that profile.”

5. The race to the exit kicks off

The economists expect New Zealand, Norway and Sweden to hike first within the G10 in the second half of 2014. The report said: “Within the G4, we see conditions for exit in the UK arriving earlier (but still in late 2015) than the others, and we expect more easing from the Bank of Japan – most likely in April. There is also the prospect of a further shift towards easing in the Euro area through LTROs and perhaps a deposit rate cut, especially if deflationary forces are stronger than forecast.”

6. Decision time for the ‘high-flyers’

The economists said that a number of smaller open economies have imported easy monetary policy from the US and Europe to offset currency strength and compensate for a weaker external environment. However as developed market growth improves, some of these ‘high flyers’ may reassess the balance of risks. The report said: “The currency has played an important role in the assessments of central banks in most of these places. For several of them, the ideal combination would be for rates to be higher and currencies weaker. Israel and Canada arguably fall into this camp, as perhaps do Switzerland and New Zealand.”

7. Still not your older brother’s EM…

The bank said it is unlikely that EM assets will see the same level of broad-based pressure as a tough 2013. The report said: “EM FX is the asset class where we are most cautious, and the bouts of pressure in US rate markets are likely to be reflected here most directly.”

8. …but EM differentiation to continue

The economists said next year will see more differentiation between countries with high current account deficits, high inflation, weak institutions and limited DM exposure and those which have stronger current accounts and institutions, underheated economies and greater DM exposure. Goldman said: “They may make the market less patient than in the past with any signs that others are flirting with more heterodox policy paths. And we do think there is insufficient credit risk premium priced into some higher-debt EM countries, both absolutely and compared with lower-debt EM and perhaps also the peripheral European economies.”

9. Commodity downside risks grow

The Goldman economists are forecasting significant declines (15%+) through 2014 in gold, copper, iron ore and soybeans and said the downside risk in energy prices is growing. However they warned that it is difficult to translate these downside pressures into market views. The report said: “First, we expect these pressures mostly to become visible later in 2014. Second, for iron ore in particular – where our downside view is strongest – direct trading is difficult. However, we do think the shifts in these markets add to the downside pressures on several of the commodity currencies, including the AUD (iron ore, copper), ZAR (gold), CLP (copper) and perhaps BRL (soybeans, iron ore).”

10. Stable China may be good enough

Goldman said the deep deceleration of mid-2013 has reversed and is forecasting flat growth of about 7.5%. The report said: “At this juncture, the market pricing of China’s growth prospects is negative enough that this stability, alongside an improving external impulse, may be enough to be reassuring. If the market were to relax about China growth risk, this would help improve the case for EM equities and credit, and make long USD positions more risky.”

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