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7 Reasons Why Goldman’s Clients Are Very Worried About An Imminent Crash



Over the years, the clients of Goldman Sachs have periodically found themselves on the verge of panic.

In March of 2015, we said that Goldman’s clients were most worried about the then-relentless crash in the EUR and how the resulting strong USD would hit US earnings (which, in retrospect, is ironic now that the tables have fully turned). Then In November 2015 we reported that “Goldman’s Clients Are Suddenly Very Worried About Collapsing Market Breadth” (and with good reason, the market was about to crash precisely for that reason). Several months later, Goldman’s clients were again confused – and worried – this time demanding that all their questions be answered before BTFD.

Then, in July 2016, Goldman’s clients again had a burning question: they were struggling to reconcile how extreme valuations of both equities and bonds can co-exist. As David Kostin explained one year ago, “client discussions reveal low portfolio risk coupled with concern that the rally lasts. Most investors have  been skeptical of the valuation expansion and have not participated in the 8% rebound from the post-Brexit low on June 27. Upside call buying has been a popular strategy to insure against upside risk.” Additionally, Goldman clients were very worried that this remains a market without any earnings growth, and that much of the S&P upside has been due multiple expansion: “the S&P 500 forward P/E has already expanded by 70% during the past five years, exceeding all other expansion cycles except 1984-1987 (up 111%) and 1994-1999 (up 115%). Both prior extreme P/E multiple expansion cycles ended poorly for equity investors.

While it is unclear if said clients got over their concerns and got on with the BTFD program, what we do know is that since last July, already extreme valuations have only gotten more extreme, and as a result, Goldman clients are once again very worried, this time about an “imminent equity downturn” (banker euphemism for crash).

As Goldman’s chief equity strategist, David Kostin writes in his latest Weekly Kickstart, “the question every client asks: “Is an equity correction imminent?”

He then concedes that “Of course, at some point the S&P 500 will retreat”… but then gives two (painfully laughable) explanations why not just yet. First, however, he lays out the 7 reasons why Goldman’s clients are so fearful:

  • 1. History. Many investors argue the bull market is “long in the tooth” and will soon come to an end. It has been 14 months since the S&P 500 index experienced a 5% sell-off and 19 months since the market had a correction of 10%. The last bear market defined as a fall in the index greater than 20% ended in 2009. The current bull market has lasted for 8.5 years and the S&P 500 has climbed by 260% compared with a 124% rise in earnings and a 64% P/E multiple expansion to 18x forward EPS.
    2. Volatility (or lack thereof). Realized 3-month vol is nearly the lowest in 50 years. Implied vol as measured by the VIX stands at 12, a 6th percentile event since 1990. In his recent book, Tectonic Shifts in Financial Markets, the legendary Salomon Brothers economist Henry Kaufman (with the superb sobriquet “Dr. Doom”) references the lesson of Sherlock Holmes in “The curious incident of the dog in the night-time” that what doesn’t happen matters as much as what does. Low volatility across asset classes may be masking risks that are not evident today but will be obvious in retrospect.
  • 3. Valuation. Equity valuations are stretched on almost every metric. The typical stock trades at the 98th percentile and the overall index at the 87th percentile relative to the past 40 years. Only on a Free Cash Flow (FCF) yield basis is the market valued at an average level (4.4%). But as we detailed in a recent report, the collapse in capex spending explains the FCF yield. On a cash flow from operations basis the market trades at the 87th percentile. Other asset classes are also highly valued vs. history: nominal Treasury yields (92nd), real yields (75th), and HY (75th) and IG (69th) spreads.
  • 4. Economics. The current US economic expansion just celebrated its 8th birthday making it one of the longest stretches without a recession. Only the 10-year expansion during 1991-2000 and the 9-year expansion from 1961 to 1969 had longer durations. The median length of the 16 expansions since 1921 has been 42 months. Along with the question about an equity correction, another frequent inquiry is “when will the next recession occur?” Our economists assign an 18% probability of a recession within 12 months.
  • 5. Fed policy. The FOMC has lifted the funds rate by 100 bp since it started tightening in December 2015. During prior hiking cycles, equity P/E multiples typically fell but multiples have actually expanded during the past two years. Futures imply one hike by year-end 2018 vs. our economists’ estimate of five. The uncertain pace of further tightening is a cause of much investor anxiety.
  • 6. Interest rates. Two months ago, Treasury yields equaled 2.4%, ten-year implied inflation was 1.7%, and the S&P 500 stood at 2410. Our year-end forecasts of a 2.75% bond yield and a 2400 level in the S&P 500 looked rational. However, weaker-than-expected inflation data sparked a 35 bp drop in bond yields to 2.05% and a 2% stock market rally to 2465 (+10% YTD). Looking ahead, we maintain our year-end 2017 target (-3%).
  • 7. Politics. President Trump’s fluid positions on domestic policy disputes in Washington, D.C. and geopolitical gamesmanship with Pyongyang and Beijing make political forecasting a precarious activity. One fund manager cited the “Law of Conservation of Volatility” under which there is a finite amount of uncertainty in the world. All the risk is now concentrated inside the Beltway and volatility outside of politics is close to zero. Of course, this could change at a moment’s notice.

As Kostin further adds, “investors cite the points above to justify their forecast of a looming correction. According to their narrative, high valuation leaves little room for error. A Fed tightening despite low inflation will spark concerns about the sustainability of economic expansion and lead to a jump in vol that may be compounded by a political event that in turn will spark a wave of selling. As factors reverse performance, quant funds will liquidate positions putting additional downward pressure on share prices and driving indices lower.”

So what is Goldman’s response to these 7 very valid concerns? In a nutshell, “don’t worry and just BTD” or as Kostin puts it, “because investor euphoria is non-existent, an imminent start of a long decline seems

Skepticism abounds with normal 3% mutual fund cash positions. However, a sturdy consumer accounts for 69% of US GDP and buybacks remain persistent. Firms with high growth investment ratios have durable prospects even in the event of a market hurricane.

Sturdy consumer? Strong Buybacks? Has Kostin seen either of these two charts proving that neither of these statement is true, first the worst retail sales in nearly 4 years


… or at least SocGen’s chart showing the biggest drop in buybacks since the financial crisis?  

Maybe Goldman clients should add an 8th concern: a grossly incompetent advisor.

In any event, for those who enjoy having their hand held and buying stocks which trade at the 98th percentile in valuations, hoping for even higher prices, this is who Kostin “rationalizes” his grossly wrong assessment:

Although the preceding sequence of events could happen, we view it as a low probability event in the near-term for two key reasons:

First, investors are not complacent. In Sir John Templeton’s timeless observation, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” Investors today are situated between skepticism and optimism. Few are euphoric as 27% of core managers are beating their benchmark. “Tormented bulls” best describes investor mentality. Alpha-seekers have normal cash positions (3.2% of mutual fund assets), active manager redemptions are offset by beta inflows (ETFs), and corporates continue to repurchase shares.

Second, US economic growth persists led by consumers that account for 69% of GDP. Monthly job growth has averaged 175K YTD, wages are rising (our leading indicator is a 2.7% rate), confidence is at the highest level since 2001, and household balance sheets are the strongest since 1980. For corporates, S&P 500 sales and EPS will rise by 5% and 7% in 2018. “Firms of tomorrow” with Growth Investment Ratios averaging 91% of CFO in past 3 years (vs. S&P 500 median of 17%) will grow 2018 sales and EPS by 7% and 12% and will outperform should a market hurricane occur (GSTHHGIR).

In short: yes, the market should crash, but because investors are not complacent (just don’t look at the VIX), and because the economy is so strong (just don’t look at the 10Y), everything will be fine.  Surely this optimistic bias would lead Goldman to at least expect some upside from here in the S&P? Well, no:

  • “We expect the S&P 500 will end 2017 at 2400 (-2.6)%.”

And scene.

Dear David: a) you are not even trying any more, and b) in your next weekly letter, can you please just let us know how much more Goldman’s prop desk has left to sell before it pulls the rug out of the market. Thanks.

H/T ZeroHedge

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The $2.4 Trillion Hidden “Fed Tax”

Jerome Powell’s support for the Federal Reserve’s low interest rate regime has long benefited investors, who reacted favorably to news that he would be Donald Trump’s nominee as its new chair.



Jerome Powell’s support for the Federal Reserve’s low interest rate regime has long benefited investors, who reacted favorably to news that he would be Donald Trump’s nominee as its new chair.

Economists argue that those “unconventional monetary policies” helped the US economy avert a major depression following the 2008 financial crisis and have kept it afloat since then.

However, we couldn’t however find a single estimate of the costs of those policies.

That should come as no surprise. Free market economists have been essentially banned from academia, governments and the banking system, all of whom have a direct interest in masking the costs of public sector involvement in the economy.

So we did a “back of the envelope” calculation on our own, which suggests that ongoing Fed market manipulations equate to a $2.4 trillion annual wealth distribution from savers to borrowers.

The rest of this article is technical, and relates to the calculation of these distortions, which we refer to as the “Fed Tax”, and which the new Fed governor may, or may not address during his mandate.

However, the key takeaway for most readers is that this wealth redistribution (12.9% of GDP, almost as much as the $2.6 trillion Americans will pay in personal income taxes this year) is significantly hiding the scale of the US government’s involvement in the economy.

This in turn is making it impossible for policy-makers, researchers and voters to measure the costs and benefits of these wealth transfers.


First a word of caution. These calculations were made on the back of an envelope, in a Montreal basement, by a non-economist.

As such, although we believe $2.4 trillion to be a useful working estimate of the Fed-managed annual wealth transfer from US savers to borrowers, considerable refinement and nuance is needed to come up with a more precise result.

Readers who have better ideas regarding methodology are invited to contact the writer or to comment below.

To determine the scale of Federal Reserve’s hidden manipulations we start by estimating what interest rates would be in a free market* and then we subtract the level they are at are right now.

We then multiply the difference (which equates to how much interest rates are being suppressed) by all outstanding debt in the US economy. **


As we noted in a recent article, history suggests that the Fed’s and US government’s current interventions, could be depressing interest rates by at least 5.0 percentage points across the yield curve.

To get an idea of where interests rates would be in a free market environment (with a currency backed by gold and little inflation, credit risk or taxes on the interest), we cite the example of British consuls. As Richard Sylla and Sydney Homer note in their magisterial work A History of Interest Rates, consuls were perpetual bonds that yielded between 2.5% and 3%*** during much of the 100+ years that the British Empire was at its peak.

To give an idea of what 30-year US Treasuries (which have similar long-duration characteristics as British Consuls) would trade for in a free market, you’d start with the level their current yields are at (approximately 3%)**** in today’s managed economy.

You would add an inflation compensation premium (say 2%+, which investors would surely demand if there was no Fed money printing to buy up excess debt), a risk premium to account for the US government economy’s current record debt levels (of at least 1%) and compensation because interest payments are currently taxable (at a marginal rate of say 2% percentage points, or 25%), which they were not during the time of the British Consuls.

So, a theoretical minimum US Treasury yield in a free market environment under rough current economic conditions would be 3% + 2% + 1% + 2% = 8%.

This suggests that Fed manipulations are currently depressing yields on US 30-year Treasuries by 5 percentage points (8% – 3%) throughout the yield curve.

If we apply that rate to all $47.9 trillion in US non-financial debt, as per the Fed’s second quarter Z.1 Flow of Funds report, that suggests that government manipulations are transferring $2.4 trillion each year from savers to borrowers.



* Estimation of a free market rate of interest (which would vary depending in part on how much inflation, credit risk and taxation there is in the system) implies a free US currency market. This would put constraints on the Fed’s ability to tax savers by printing money, because if they did so, savers would abandon the dollar and instead opt for alternate, sounder currencies.

This rate should in no way be confused with Knut Wicksell’s “natural” rate of interest (which refers to an economy with stable prices) or the Federal Reserve’s “neutral” rate of interest (which refers to a rate that neither is neither expansionary or contractionary in an economy with 2% inflation).

** We assume that the interest rate distortions will occur throughout the yield curve.

*** We use gross, rounded approximations in this estimate, to make the calculation easier for the laymen to grasp.

**** We are rounding here. Actual rates on the day of this was written were 2.8%, the
approximate mid-point of the rough 2.5% -3%, range of the British consuls during minimal inflation and sovereign risk periods.

Questions or comments about this article? Leave your thoughts HERE.

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The Yield Curve Hasn’t Been This Flat In 10 Years. Recession Ahead?

Whenever we see an inverted yield curve, a recession almost always follows, and that is why many analysts are deeply concerned that the yield curve is currently the flattest that it has been in about a decade.



Whenever we see an inverted yield curve, a recession almost always follows, and that is why many analysts are deeply concerned that the yield curve is currently the flattest that it has been in about a decade. In other words, according to one of the most reliable indicators that we have, we are closer to another recession than we have been at any point since the last financial crisis.

And when you combine this with all of the other indicators that are screaming that a new crisis is on the horizon, a very troubling picture emerges. Hopefully this will turn out to be a false alarm, but it is looking more and more like big economic trouble is coming in 2018.

The professionals on Wall Street take the yield curve very, very seriously, and the fact that it has gotten so flat has many of them extremely concerned. The following comes from Business Insider

In the past, including before the Great Recession of 2007-2009, an inverted yield curve, where long-term interest rates fall below their short-term counterparts, has been a reliable predictor of recessions. The bond market is not there yet, but a sharp recent flattening of the yield curve has many in the markets watchful and concerned.

The US yield curve is now at its flattest in about 10 years — in other words, since around the time a major credit crunch of was gaining steam. The gap between two-year note yields and their 10-year counterparts has shrunk to just 0.63 percentage point, the narrowest since November 2007.

If the yield curve continues to get even flatter, it will spark widespread selling on Wall Street, and if it actually inverts, that will could set off total panic.

And with each passing day, even more “experts” are warning of imminent market trouble. For example, just consider what Art Cashin told CNBC the other day…

Investors may want to take cover soon.

Art Cashin, UBS’ director of floor operations at the New York Stock Exchange, says a “split personality” is manifesting itself in the stock market, and it could hit Wall Street where it hurts at any moment.

“We’ve been setting record new highs, and often the breadth has been negative. We’ve had more declines than advances,” Cashin said Thursday on CNBC’s “Futures Now.”

When the financial markets finally do crash, it won’t exactly be a surprise.

In fact, we are way, way overdue for financial disaster.

Since the last financial crisis, we have been on the greatest debt binge in human history. U.S. government debt has gone from $10 trillion to $20 trillion, corporate debt has doubled, and U.S. consumer debt has now risen to nearly $13 trillion.

Debt brings consumption from the future into the present, and so it increases short-term economic activity at the expense of long-term financial health.

But we simply cannot continue to grow debt much, much faster than the overall economy is growing. I have never talked to anyone that believes that our debt binge is sustainable, and I doubt that I ever will.

The only reason why we have even gotten this far is because interest rates have been pushed to historically low levels. If the average rate of interest on U.S. government debt even returned to the long-term average, we would be paying more than a trillion dollars a year in interest on the national debt and the game would be over. Unprecedented intervention by the Federal Reserve and other global central banks has pushed interest rates way below the real rate of inflation, and that has bought us extra time.

But now the Federal Reserve and other global central banks are reversing course in unison, and global financial markets are already starting to decline.

The only way we can keep putting off the next financial crisis is if we continue our unprecedented debt binge and if global central banks continue to artificially prop up the financial markets.

Of course more debt and more central bank manipulation would just make the eventual financial disaster even worse, but that is what we are faced with at this point.

Most people simply don’t understand the gravity of the situation. Nothing was ever fixed after the last financial crisis. Instead, we went on the greatest debt binge that humanity has ever seen, and central banks started creating trillions of dollars out of thin air and recklessly injected that hot money into the financial system.

So now we are in the terminal phase of the largest financial bubble in human history, and there is no easy way out.

We basically have two choices. We can have a horrific financial crisis now, or we can have one a little bit later.

Usually the choice is “later”, and that is why our leaders have been piling on the debt and global central banks have been recklessly creating money.

But it is inevitable that our bad choices will catch up with us eventually, and when that happens the pain that we are going to experience is going to be absolutely off the charts.

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Is Financial Argmageddon Bullish For Stocks? One Bank’s Surprising Answer

Everyone knows that after nearly a decade of capital markets central planning by the world’s central banks, “good news is bad news.”



Everyone knows that after nearly a decade of capital markets central planning by the world’s central banks, “good news is bad news.” But did you also know that financial armageddon has become the most bullish catalyst to buy stocks? That’s the understated take-home message from the year ahead preview by Macquarie’s Viktor Shvets published last week. It is also the conclusion that One River Asset Management’s Eric Peters reached in his latest weekend notes.

While we will have much more to comment on Macquarie’s rather macabre 2018 preview, which is arguably one of the most honest, comprehensive, and objective predictions of what to expect from the “central bank/market confidence boosting nexus”, we will highlight the one argument that has served to promote countless BTFD algo-driven stock rips, summarized in the following blurb, which is a sublime explanation by Viktor Shvets the worst things are, the more you should buy:

If volatilities jump, CBs would need to reset the ‘background picture’. The challenge is that even with the best of intentions, the process is far from automatic, and hence there could be months of extended volatility (a la Dec’15-Feb’16). If one ignores shorter-term aberrations, we maintain that there is no alternative to policies that have been pursued since 1980s of deliberately suppressing and managing business and capital market cycles. [T]his implies that a relatively pleasant ‘Kondratieff autumn’ (characterized by inability to raise cost of capital against a background of constrained but positive growth and inflation rates) is likely to endure. Indeed, two generations of investors grew up knowing nothing else. They have never experienced either scorching summers or freezing winters, as public sector refused to allow debt repudiation, deleveraging or clearance of excesses. Although this cannot last forever, there is no reason to believe that the end of the road would necessarily occur in 2018 or 2019. It is true that policy risks are more heightened but so is policy recognition of dangers.

We therefore remain constructive on financial assets (as we have been for quite some time), not because we believe in a sustainable and private sector-led recovery but rather because we do not believe in one, and thus we do not see any viable alternatives to an ongoing financialization, which needs to be facilitated through excess liquidity, and avoiding proper price and risk discovery, and thus avoiding asset price volatilities.

Translation: central banks remain trapped by the mountain-sized bubble they have blown with years of QE and ZIRP/NIRP, and once volatility returns, and risk assets plunge, CBs will have no choice but to scramble right back and prevent the pyramid from keeling over and undoing a decade of fake “wealth creation” which was pulled from the future to the tune of $15 trillion in central bank asset purchases, which while still rising is about to go into reverse in just over a year’s time. 

If that’s not enough, here is One River’s Eric Peters, with the exact same conclusion:


“The market has an accident, the Fed returns to QE, slashes interest rates, bonds surge, stocks recover,” said the CIO, high atop his prodigious pile, alone. Staring into the distance. Squinting, straining.

“The correlation between bonds and equities remains negative, the risk parity equity/bond portfolios are dented but not destroyed. And we descend to the next lower level in real interest rates. US bond yields turn negative. In essence, we prolong the paradigm that has driven markets for a few decades.”

Far below, economies hummed in harmony, capitalists collecting their expanding share. “A continuation of this paradigm is what everyone believes. And I just doubt that outcome so sincerely.” Hidden within the distant economic whir, labor strived, struggled. Their wage growth anemic, their children indebted, career prospects uncertain.

“It has taken time, but the political context for a regime shift is now established; populism is evident in recent elections. And the academic context for a seismic economic policy shift is in place too.”

The extraordinary response to the global financial crisis prevented depression. But the price of salvation is proving to be as profound as it is impossible to precisely measure — unexpected election outcomes, political paralysis, an isolationist America, de-globalization, fake news, opioid epidemics.

And connecting it all, a corrosive, woven thread; injustice, unfairness, inequality, hypocrisy, distrust, endemic, growing. “We are on the cusp of great change, the old paradigm is set to shift,” he said, at altitude, the air crisp, clear.

“The market has an accident, monetary policy is seen to be bust, the models have been wrong, we have to change what we do, we can’t go down the same route, we need to move to a different policy mix. Fiscal expansion, infrastructure, labor over capital. We’re moving to something that may be great for the economy, but no good for asset markets. New Regime — end of story.”

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