We are rounding home towards 2018 and with that in mind, Goldman Sachs has published its top trade ideas for the new year. Goldman’s overall mantra for 2018 is “Late-cycle optimism”, and its seven trade picks all stem from that notion. Goldman’s bets are not very US-centric, and include shorting ten-year US Treasuries in advance of four rate hikes in 2018. It also says to go long the Euro, and emerging market credit (it is not favorable on US credit). Asian currencies will also do well, while metals seem like a good bet on the back of a strong economy.
FINSUM: This gives a good approximation of Goldman’s views, but we feel they are slightly over optimistic. Although the tightening cycle in the US may emerge.
A lot of people are worried about a big market fall, but what would get us to that point? While there was a big warning out of China last week, the most realistic catalyst for a bear market seems like a US recession. Well, the ten-year Treasury, a historically good indicator of economic direction, is signaling that a recession very well may be on the way. According to JP Morgan’s head of fixed income at JPM Asset Management, the ten-year yield should currently be over 3% given this stage of the economic cycle, but it is currently pinned at only 2.3%. “Under the surface, growth has picked up globally and inflationary pressures have picked up, but you aren’t seeing the 10-year rise a lot”, says JP Morgan.
FINSUM: An inverted yield curve is a big warning sign for the economy, and while we aren’t there yet, weak ten-year yields are troubling in an otherwise bullish environment.
These comments were a real eye-opener for us and they should be for all investors. While the Chinese central bank, or the PBOC, is usually quite tight lipped in commentary, the bank let out some worrying statements this week. The PBOC thinks the market might be ready for a so-called “Minsky” moment, or a flash crash that comes when markets nosedive under the weight of huge buildup in debt. The bank was specifically talking about Chinese assets, and the comments, which came from the PBOC’s governor, seem to indicate that the bank thinks China’s economy is on an unsustainable path.
FINSUM: We have been saying for weeks that markets will need a catalyst to start a big correction or bear market, and a full-blown China meltdown would surely do it.
The financial system does not seem short on risks at the moment, and the media won’t stop warning people about them. However, beyond ultra-high valuations in seemingly every asset class (bar oil and some commodities), a new risk has emerged: concentration. Following on the back of his warning about clearinghouses, White House economic adviser Gary Cohn, has just warned that post-Crisis regulations have created a risk from the increased concentration of the industry. Cohn said more and more activity was flowing through a smaller amount of firms, posing risks to the financial system.
FINSUM: The idea of asset managers not being “systemically important” is, in our view, preposterous. Can you even imagine the repercussions if BlackRock or Vanguard went under? There are certainly heightening risks stemming from increased concentration.
None other than Gary Cohn, former COO of Goldman Sachs and now top White House economic adviser, has just warned on the growing threat of a new systemic risk. Cohn is very concerned about the growth and risk of clearinghouses, which have expanded thanks to their new role clearing swaps. Cohn remarks that as “we get less transparency, we get less liquid assets in the clearinghouse, it does start to resonate to me to be a new systemic problem in the system”. Cohn, who warned on clearinghouses while at Goldman, joins BlackRock and JP Morgan in warning on their risk. However, he has more sway on directing change now that he is in the White House. FINSUM: Cohn knows more about finance than anyone in his position in recent memory, so this is a risk to take seriously.
Goldman Sachs and JP Morgan are thinking about the next financial crisis, a lot. The banks are both now offering a structure to enable anyone to bet on the next crisis. The pair are making markets in special derivatives that allow investors to bet on high-risk banks bonds that would get wiped out if a lender runs into problems. The products, known as total return swaps, will soon be traded by other banks as well. The derivatives are based on Tier 1 notes, or bonds designed to protect the public from a taxpayer-funded bailout. They yield about 4.7%, or 10x more than a senior bank bond.
FINSUM: With the big surge in markets and the uncertainty surrounding valuations, there is some logic to this. However, banks are a lot better capitalized, and we doubt they will be at the center of the next crisis.