Goldman Sachs: “Mr Market” wrong in recession warnings

Goldman Sachs is betting “Mr Market” is wrong in its recession warnings. While sliding stocks, declining long-term bond rates and higher credit yields are sounding the alert, the New York-based bank’s economics team, led by Jan Hatziusis, is more confident about the outlook for the developed world.

Their model, based on a series of economic and market indicators, points to just a 25% risk of recession in the industrial economies in the next four quarters and 34% over the next two years.

Both undershoot the average risk of the past 35 years despite the recent fears of financial markets.

The probability of a slump in the US is just 18% and 23% over the two time frames respectively, while the eurozone threat is greater at 24% and 38%, according to Goldman Sachs.

“The recent market weakness should provide good risk-adjusted opportunities for those brave enough to defy Mr Market’s gloomy prognosis about the world economy,” Mr Hatzius and colleagues said.

Their prognosis is aligned with that of Bruce Kasman of JP Morgan Chase, who says the probability of a US recession in the next 12 months has grown, yet is still only about a third.

Of course, economists don’t always get it right.

Former US Treasury Secretary Laurence Summers recently noted that the IMF failed to predict 220 recessions between 1996 and 2014.

Goldman Sachs bases its current call on a model of 20 economies dating back to 1970 and featuring indicators such as output growth, equity prices and house-price changes.

It defines a recession as a year-over-year decline in growth per capita.

Of those it studied, the UK faces the lowest recession probability at 3% in both the next year and the next eight quarters, according to the model.

The likelihood of contraction is 42% in Japan for the next four quarters and 62% over two years. Oil-rich Norway’s chances top 80% in both cases.

Goldman Sachs isn’t completely bullish.

It said last week it now expects the US Federal Reserve to raise its benchmark interest rate next in June rather than March and last week cut its 2016 forecasts for 10-year bond yields in the US, Germany and Japan.

So how to align the markets with the model?

Goldman Sachs notes in the case of the US, several past panics failed to trigger a US recession.

Among them, the 1987 stock market crash, 1994 bond market sell-off, 1998 collapse of Long Term Capital Management, 2002 blowout in corporate credit and 2011 eurozone debt crisis.

“In each case, at least some financial markets were priced for significant recession risk,” the economists said in the Goldman Sachs report.

“This created significant investment opportunities for investors willing to adopt a more constructive view,” according to the report.