Monthly Market Pulse: July

Macro Views

Recession Risk

US recession risk has risen. We believe the path to a soft landing remains possible, though it has narrowed. While commodity prices, inflation expectations, and shelter inflation have all continued to increase, we also see signs of necessary activity deceleration, moderating labor demand, and improving supply chains. Should a recession occur, strong private sector balances and an absence of financial imbalances may lessen the severity and duration of any economic contraction. Read More

Inflation

We believe US core PCE has peaked, as goods inflation has moderated on materially improving supply chains. However, we expect concerns over long-term inflation expectations to remain top of mind, especially as services will likely keep overall inflation elevated and broad-based. Read More

Monetary Policy

We expect the Fed to hike by 75bps in July and ultimately arrive at a terminal rate of 3.25-3.50% by year end, in line with current market pricing. Still, risks are to the upside as the Fed’s conviction in combating inflation suggests no upper limit to the policy rate. The ECB, BoE, and RBA are all likely to echo the Fed in stance but vary in pace. Read More

China Growth

Following the economic slowdown earlier this year, China’s 5.5% GDP target requires 7.2% annualized growth in 2H 2022, which is well above consensus forecasts. However, new COVID-19 waves and a weak consumption outlook skew risks to the downside. Fiscal and monetary policy support may act as key drivers of growth in the remainder of the year. Read More

Market Views

Equities

The S&P 500 dipped into bear market territory last month, reflecting market realization of more front-loaded monetary policy tightening. Prices now indicate greater likelihood of a recession in the medium-term, nearing the historical average for shallower recessionary pullbacks. As such, we think prices may grind higher over the next year, albeit with elevated volatility near-term. Read More

Credit

We think corporate credit risk is not only driven by the cost of financing, but also by the access to it. With just 4% of US high yield bonds maturing in 2022 or 2023, we do not see significant threats from a near-term maturity wall. Within the universe, we now prefer high yield bonds over bank loans due to stronger credit trends among high yield issuers and greater rate re-rating pressure for bank loan debtors. Read More

Munis

Past instances of muni yield and spread surges have seen strong subsequent performance, with returns frequently benefiting from higher starting yields and price appreciation. With an improving technical backdrop and tax-equivalent spreads relative to taxable bonds above long-term averages, we believe now is a favorable entry point for munis across the credit spectrum. Read More

Commodities

We raised our YE 2022 WTI and Brent forecasts to $125 and $130, respectively. While OPEC+ raised near-term production targets, many members have yet to reach existing targets, making any additional supply commitments less likely to be realized. We now hold a neutral view on gold as slowing Chinese growth and rising rates may provide headwinds to a fear- and inflation-fueled price breakout. Read More

Bearing the Bear

The S&P 500 has contracted -19% to date, nearly commensurate with the median peak-to-trough decline during previous US recessions. Markets may continue to search for the bottom. But we find comfort in knowing that past periods of deep contractions featuring high inflation have also displayed elements of financial overheating, which we believe are absent today. The significant valuation compression seen so far have similarities with past cyclical bear markets, driven mostly by shifting rate and inflation dynamics. Consequently, we expect any spillover economic impact will likely be short and shallow.

HISTORICAL CONTEXT ON TIGHTENING CYCLES

Recent US inflation prints have expedited the Fed’s plan to raise policy rates to neutral, potentially increasing the odds of an economic contraction. While engineering a soft landing has historically been difficult alongside high inflation, credible and transparent policy measures have lessened the risk of a severe Fed-induced downturn. Consequently, any recession due to Fed overtightening will likely be short and shallow.

Source: FRED and Goldman Sachs Asset Management.

BARELY A BEAR

The depth and scale of equity pullbacks are influenced by the type of bear market. Structural bears feature financial imbalances that take nearly eight months to rebound from bear territory and a decade to fully unwind. Event-driven bears are catalyzed by exogenous shocks with equities recovering in a year. And, cyclical bears—led by evolving inflation and rate dynamics as seen today—have found market bottom within 100 days from the initial 20% decline.

Source: Goldman Sachs Global Investment Research.

NOT ALL BEAR MARKETS ARE CREATED EQUAL

Still, making a call on market bottom is an imprecise science. History suggests that past moments of severe equity declines (1973 and 2008) were exacerbated by structural weaknesses. While high prices were apparent, those periods also saw explosive growth in fiscal spending and household borrowing, driving entrenched downturns that necessitated fiscal and monetary policy intervention. We believe those conditions are less reflective today.

Source: Goldman Sachs Asset Management.

Top Section Notes: As of June 30, 2022. “Effective fed funds rate” refers to the interest rate banks charge each other for overnight loans to meet reserve requirements. Middle Section Notes: Chart highlights three type of bear markets: Structural, Event-driven, and Cyclical. Bottom Section Notes: As of June 30, 2022. The economic and market forecasts presented herein are for informational purposes as of the date of this presentation. There can be no assurance that the forecasts will be achieved. Past performance does not guarantee future results, which may vary.

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June 2022

Catch Me If You Can

Central banks and inflation are the two main actors in a play not seen in decades. After many unexpected twists and turns, inflation has continued to be a dominant theme, fueled by tight labor markets, supply chain dynamics, and geopolitical tensions. In the US, the Fed has credibly embarked on policy tightening to rein in price pressures. Elsewhere, other major central banks also stand ready to "catch" inflation, though with different policy paths relative to the US.

June 2022

Monthly Market Pulse: June

The last market cycle was characterized by trend growth, low rates, and yield scarcity, conditions that led investors to believe that favorable risk-adjusted returns could only be found in equities. While risk assets remain instrumental to delivering forward returns, we believe market characteristics today—reflation, high valuation, rising rates—support the case for broadening opportunities to fixed income. Across the bond complex, risk symmetry has improved, yields have risen by nearly two-fold, and coupons have reset to normal levels, enhancing the relative value of bonds to equities.