Goldman sees 2010 as ‘exciting, with risks!’ | FT Alphaville

Goldman sees 2010 as ‘exciting, with risks!’

Has Goldman Sachs, beset with a public image problem, turned global economic cheerleader by way of compensation?

The bank has just released its Global Economic Outlook for next year and beyond (Title: “The Outlook for 2010/11: Exciting, with risks!”) and it looks like they’re even more optimistic on global GDP growth for 2010 than they were for 2009 — a year for which they originally forecast GDP growth below consensus (of 2 per cent) but nevertheless a touch too high at 0.6 per cent.

Here’s the thrust of the outlook, as put forth by Goldman Sachs’ economics team, headed by Jim O’Neill:

As has become the norm, at this time of the year we announce our updated forecasts for 2010, and unveil our 2011 forecasts for GDP and inflation. Our projections suggest that both 2010 and 2011 will be rather strong years—we now expect 4.4% GDP growth for 2010, and a higher 4.5% for 2011. We are above consensus for next year and, while there is no consensus as such for 2011, we suspect we are significantly higher than consensus for 2011 also. With respect to inflation, we are below consensus, despite our relative optimism on GDP.

If this is correct, the combination of better than expected growth and lower than expected inflation should be good news for financial markets. This is reflected in our equity and bond projections, and in our initial ‘Top Trades for 2010’, also released today. We are introducing eight new recommended Top Trades for 2010. As usual, these are strategic ideas that we think have high-return potential and that reflect our major macro thematic views, as set out here. We plan to add to the list as the year evolves.

Given that our regional growth outlook suggests that domestic demand in the BRICs and the wider emerging world continues to show strong leadership, while domestic demand in the G7 remains relatively sluggish, the financial market outlook is arguably even better. To be more specific, we forecast two consecutive years with global GDP growth in excess of 4%, but no increase in short-term interest rates in the US! This should be positive for risky assets, potentially sowing the seeds for fresh asset overvaluations down the road. This in turn makes us somewhat nervous about many possible risks out there, including if the Fed were to tighten earlier than we currently expect.

Goldman’s GDP forecast breakdown is as follows: 2.1 per cent growth in the US for 2010, versus consensus of 2.7 per cent, and 2.4 per cent for 2011. Japan is forecast to grow 1.5 per cent next year, versus consensus of 1.4 per cent, and then 1.6 per cent in 2011. Goldman sees Euroland GDP increasing 1.5 per cent in 2010, versus consensus of 1.2 per cent, and 1.9 per cent in 2011. The UK is forecast to grow 1.9 per cent in 2010, versus consensus of 1.2 per cent, and 3.4 per cent in 2011. China will grow 11.4 per cent in 2010, Goldman says, versus consensus of 9.6 per cent, followed by 10 per cent growth in 2010.

Add in Goldman’s forecasts for the rest of the BRICs (Brazil, Russia and India) and you get that 4.4 per cent global growth forecast for 2010, versus consensus of 3.8 per cent growth.

And just in case you think the Goldman analysts are being a touch optimistic on the GDP front, the analysts helpfully reassure you that:

Compared with this time last year, it is rather pleasing to write about our GDP outlook. Back in December [2008] , we forecast a meagre 2009 GDP growth of +0.6%. This was significantly below consensus of +2.0% but, of course (as we now know), also unfortunately probably too high. We hope not to preside over economic forecasts—and the eventual reality—of negative GDP growth in the vaguely foreseeable future.

Looking at 2010, as we have been since the Spring, when we first significantly upgraded our forecasts for 2010 for China, we remain more optimistic than the consensus. This time a year ago, we forecast global GDP growth of +3.1%. Today, we expect 4.4%.

For 2011, we are even more optimistic, despite having a modest slowdown in China and Brazil. This is due to a modest acceleration in the G7 countries, notably the UK, as well as a notable acceleration in some other important countries, such as India.

Which means Goldman’s top trades for 2010 are:

  • Top Trade #1: Short S&P 500 Dec10/Dec11 Forward Starting Variance Swap, at 28.20, Target 21. At current levels, forward variance suggests that the coming years will be as volatile as 2009. But this year was the eighth most volatile year on record, and our recent work on the 2004-template—and our models linking macro outcomes to volatility—suggests that even in a sluggish recovery, volatility can continue to decline . . .

  • Top Trade #2: Long Russian Equities (RDXUSD) at 1,645.9, Target 2,050. Our global macro outlook is still constructive for equities, particularly in parts of EM. We see a significant acceleration in Russian real GDP growth from -9.5% in 2009 to +4.5% in 2010. The Russian index has significant commodity exposure, which we like given our still constructive view on energy . . .

  • Top Trade #3: Long GBP/NZD at 2.29, Target 2.60. In the context of our ‘growth differentiation’ investment theme, one currency cross that stands out is short NZD/GBP. We are more bullish on Sterling, linked to stronger cyclical momentum in response to a large easing in financial conditions. At the same time we expect rates to rise a lot more slowly in New Zealand than the consensus . . .

  • Top Trade #4: Pay 2-yr UK Rates vs Australia 1-yr Forward at -268.5bp, Target -150bp. The UK has been far closer to the epicentre of the credit crisis than Australia. But markets expect this macro divergence to extend and the forwards price policy rates to rise much faster in Australia than in the UK. This looks too aggressive to us . . .

  • Top Trade #5: Pay 2y Rates in Turkey at 8.77%, Target 12%. Real policy rates in emerging markets are at record-low levels. This is particularly true in Turkey, where the market is pricing that real policy rates will decline from about 1.5% currently (ex-post) to about 1.0% in 12 months. Turkish growth should continue to recover strongly, while inflation normalises to about 7% next year . . .

  • Top Trade #6: Long Credit Protection on Spain, Short on Ireland, at 70.20bp, Target 20bp. After a decade of strong growth, Spain and Ireland have hit the same wall: a real estate ‘boom-bust’ that is putting public finances in the two countries under extreme duress. With greater labour market flexibility, Ireland looks better placed than Spain to outgrow its debt problems. The Irish have shown stronger resolve than the Spanish to deliver structural spending cuts. And the ‘bad bank’ solution chosen by the Irish (NAMA) represents a speedier and cleaner way to clean up financial institutions than the largely ‘behind-the-scenes’ approach taken by the Bank of Spain . . .

  • Top Trade #7: Long the GS FX Growth Current, at 103.5, Target 111.8. Growth differentiation remains a key theme in FX markets. Our empirical results have shown that currencies are sensitive to the rate at which the output gap closes, with the results particularly pronounced for small open economies and in early recoveries. This theme can be implemented in the form of our Growth Current (Bloomberg ticker: GSCUGROW). The Growth Current makes its selection of currencies based essentially on how fast countries are closing their output gaps and the basket constituents are updated on a monthly basis.

  • Top Trade #8: Go Long PLN/JPY at 32.1, Target 37.5. Polish growth is currently solid and set to accelerate. The Zloty is clearly undervalued and strong export demand, partly linked to the cheap currency but also linked to the recovery in Germany, has helped the trade accounts. In sharp contrast, the JPY is significantly overvalued and financial conditions are much too tight.

The holy vampire squid has spoken.

Go forth and trade.


And with risks.