Our latest update on debt-equity relative value opportunities and collateralized loan obligations (CLOs) requires some tinkering, which is holding up the rest of the queue. So for now, we'll skip it in place of more important and time-sensitive information: Goldman Sachs (GS) chief economist Jan Hatzius shares his latest thoughts on the US economy and interest rates, as well as Alan Brazil—a GS alumni cross-asset strategist—on US equities. Hopefully, we can address some frequently asked (weekly) questions we receive from startup founders eager to IPO their companies after the summer break.
Besides our take on debt-equity relative value opportunities, here's a quick preview of the topics we'll cover in the next few updates:
i) A major breakthrough in condensed matter physics by a group of South Korean researchers in superconductors, which is very likely to have significant practical applications in the not-too-distant future. Potentially, making desktop quantum computers a closer reality than the current advanced methods that require cooling to extreme low temperatures.
ii) Federated (machine) learning for bank stress tests — we propose a novel protocol for regulators to conduct real-time stress tests on banks without transferring proprietary financial models or sensitive data over to unauthorized third parties.
iii) The latest Argentina economic update from Miguel Kiguel and the Econviews team in Buenos Aires. Plus, Brent Donnelly‘s outlook on the US Dollar.
iv) Our featured interview with Martin Wolf of the Financial Times.
Jan Hatzius' latest view on the US Economy and interest rates
Here's what Jan had to say recently:
The biggest change we’ve made recently was to move our 12-month recession probability down another 5pp to 20% following the June CPI. Last week’s ECI/PCE/claims data were also encouraging. For H2, I think the risk of premature reacceleration (at a time when the labor market is not yet fully back in balance, e.g. job openings/quits are still somewhat elevated) is probably greater than the risk of a spontaneous slowdown, so I also have a mildly hawkish view on the rates market despite the good inflation news.
—Jan Hatzius, Goldman Sachs Chief Economist
Please note, Hatzius' personal views on the US rates markets may differ from the official call by GS analysts. For the benefit of our non-finance audience, sell-side economists are primarily concerned with producing economic analysis and forecasts. Strategists are responsible for developing client investment recommendations.
Alan Brazil on US Equities
Here's Alan's latest piece on why he's (still) short US equities. He writes:
My Rationale For Shorting Equities
The question is, why are equities markets not pricing in the current level of rates? My conclusion is that markets are not wrong; after all, markets are efficient (what else could I argue given my Ph.D. in economics from Chicago) but rather they are pricing in an improbable scenario. This is the “nirvana” scenario of much lower interest rates after the Fed cuts rates with inflation back to target and with a soft economic landing. All three must be valid for current valuations to be consistent with the level of future interest rates. And that is my reasoning for shorting equities because this “nirvana” scenario is improbable.
First, there is still the probability of a hard landing, which is unlikely but still a significant probability. Equities will crash even after the Fed cuts rates and inflation is back to target in this event. Second, core inflation could remain higher for longer given that wages are still rising look at the UPS settlement—and the housing market rebound. Third, most importantly, the Fed is unlikely to cut rates even if inflation gets back to target and there is a soft landing– 2% inflation and 1.5% real growth. Do you think the Fed will cut rates after winning the inflation battle without pushing the economy into a recession with rates in the mid-5%? Would they then say we won; let’s cut rates and drive the economy higher even though it is at full employment, risking another round of inflation? That strategy did not work out well in the 70s. Or would they, in this Nirvana scenario, say don’t rock the boat; our rate hikes worked, so why cut? Particularly given what happened in the 70s. My conclusion: Nirvana is unlikely, short equities.
My strategy for the short equity position was to buy six-month, 30 Delta puts on S&P. I placed an options trade rather than an outright with a stop because I was uncertain of the timing of the repricing, but I believe it will happen before the end of the year. Further, time value was cheap given the historically low implied vol. Options give me the luxury of staying in a trade even if it goes against me. And it has gone against me with the trade down about 2/3rds. So, I could have chosen a better entry point. But I still like the trade. In addition, I am using built-up cash from my long high yield to pay for the option.
—Alan Brazil, SOM Macro
What we especially like about Alan Brazil's work is that, more recently, on most occasions, we have opposing market views. For example, on large versus small US bank stocks, albeit with different time horizons, formats and entry levels. His original analysis and contributions are complementary to our work. We will discuss Alan's approach in a future update and revisit our long/short GS/USB stock trade idea.
So, on balance, that's 4 of us leaning towards higher US interest rates: 1 currently serving member of GS (Jan), 2 formers (Craig and Alan), and myself. We'll leave it to you to draw your own interpretations.
Richard Feynman on the Manhattan Project
Finally, here's a recorded lecture from 1975 by the great physicist Richard Feynman, in which he shares his perspective from his time at Los Alamos working on the Manhattan Project. Feynman was recruited by Robert Oppenheimer as an underling and quickly became a group leader.
There are some funny moments in there, in typical Feynman playful fashion. When he speaks, it reminds me of an old-school New York City building doorman. The more we learn about the Manhattan Project, the more apparent it becomes that the true heroes were the army folks who managed to get a group of highly intelligent and dysfunctional individuals to work together.
Our recent updates have included an attempted murderer and rapist, a self-confessed pedophile, a suspected wife-beater, and a Nazi collaborator. No, not the UK Tory politicians… the greatest scientists of the past century. We'll leave you to figure out who's who.
