According to the GS economists, “the picture of underlying recovery is one of steadier healing than the GDP growth numbers show.” They note that payrolls data are robust, and expect that to continue. Housing data, “the most troubling soft spot in the last six months”, has also begun to improve – albeit tentatively.
Growth without inflation pressure
They still see more slack in the labor market. Although the unemployment rate itself has continued to fall more rapidly than expected, they say that the stability of wage growth measures at low levels continues to indicate that there is little sign of tightness in the broad labor market yet. “Despite the shift to above-trend growth in the US, we continue to think that inflation will only rise gradually towards the Fed’s 2% target,” they write.
Later but steeper
They have pulled their forecasted date for the Federal Reserve’s first rate hike to the third quarter of 2015 from the first quarter of 2016. Even though this is later than market consensus, though, they say that once tightening begins the pace of hiking is “likely to be steeper than the market currently expects”.
Lasting High Valuations
Lasting High Valuations
They note that, on an absolute basis, many U.S. valuations are above their long-term averages, in some cases by a substantial margin. If you compare equities to bonds though, valuation measures still look quite favorable, they say. “Both theory and evidence support the notion that the required return on equities should vary with the macro environment. And in a world where real bond yields are lower for longer than normal, we think equity valuations are likely to remain at levels that feel uncomfortable to many investors, and could move higher still,” they write.
Volatility staying low
They dismiss the idea that low levels of volatility represent an anomaly, arguing instead that it is a symptom of the current macro conditions. “As capacity constraints emerge, volatility will pick up as in past cycles,” they write. “But given our view that this point is still some way off, we think a shift in the volatility landscape is premature.”
EM Growth Slows But Relief In China
Better-than-expected performance in emerging assets, seen during the first half of the year, will be harder to repeat in the second half, they say. “With renewed compression in the risk premium in much of the higher-yielding parts of EM, we see renewed vulnerability here.” They do, however, expect China’s economy to improve over the next two to three months.
Eyes on Japan
The focus has shifted away from Japan somewhat in the light of disappointing asset performance. Goldman Sachs predicts, however, that the second half of the year has a better chance of bringing fresh focus. “As the recent inflation acceleration peaks and recedes, pressure on the Bank of Japan to take fresh action is likely to resume,” they write.
Easy on Europe
Finally, they note that rewards for risk in the euro area are substantially lower than at the start of the year. They cite a limited potential for more sovereign risk premium compression, as well as the euro area rate curve already being flat. They do admit that European valuations – in both credit and equities – still offer some premium to other markets, but it is still “easier to conceive tail risk in the Euro area than in the other major economies.”
