What's next from Goldman Sachs, via eFX
Risk-off/growth-off dynamics continue to dictate market price action thus far in 2016, with fears seemingly centered on a slowing China (December data continues to point to an ongoing deterioration in growth there), the potential for further and more dramatic CNY weakness, and the widening implications of falling oil prices, with front month crude oil trading below $30/bbl for the first time since the Great Financial Crisis. Typical "risk off" correlations have re-emerged: equities have declined, bonds have rallied and the dollar has strengthened. The S&P 500 is down 8.4% YTD, both long- and short-dated US Treasury yields are now back below pre-December-rate-hike levels with the market-assigned probability of a March hike hovering around 30%, and the trade-weighted USD has strengthened alongside (and not against) other defensive DM currencies like the JPY and EUR despite divergent monetary policy paths, with the CNY losing ground.
Using the definition we developed last year, we now find that 15 global equity indices are experiencing a drawdown again (see Exhibit 3). Last year, in August, the drawdown was short-lived. Although then equity volatility had shot up even higher than it is currently, markets quickly regained lost ground. Three months after the drawdown, the S&P had regained more than all of its lost ground, and other global markets had recovered about 2/3 of their losses. Is August the right template for thinking about current economic risks and market price action? Or, is the right template the mid-2011 time frame, when global recession concerns and a brewing sovereign crisis - both originating in Europe - were in focus? Or, perhaps is the current backdrop shaping up along the lines of the 1997 EM crisis?
As we have discussed in the past, there are several reasons why we continue to think that risks of a broad DM recession and risks of a an EM-style crisis are still manageable here. In short, the US consumer remains healthy, with the US labor market a solid basis of support. China - though larger than the affected EMs in 1997 and affected Europe in 2011 - is better positioned fiscally and financially to contain any potentially systemic and globally damaging shifts. And even the group of potentially affected EMs this time around are still fairly small, with currencies that have adjusted already, and with stronger balances sheets than in the past. If the market continues to price these risks in a wide-reaching fashion, opportunities will likely emerge.
