In 2018, Goldman Sachs Group Inc. is doubling down on the global economy.
“Late-cycle optimism” is the chief theme underpinning the bank’s seven top trade theses, as outlined in a note Thursday by Francesco Garzarelli, co-head of global macro and markets.
Goldman’s stance is far from “America First.” In risk assets, its strategists favour emerging markets; in foreign exchange, commodity-linked currencies and the euro are preferred.
By contrast, last year’s trade ideas were dominated by worries about the potential of newly elected U.S. President Donald Trump to disrupt global commerce.
Here are the Goldman team’s seven highest-conviction calls for 2018:
For the first time since the taper tantrum, the 10-year Treasury yield will have a three-handle in 2018, according to Goldman.
The strategists recommend positioning for four 2018 Fed hikes and a rising term premium by shorting 10-year U.S. debt — and exiting the position should yield fall to 2 percent.
A rising term premium is at odds with what generally happens during Federal Reserve tightening regimes, but Goldman says things are different this time. A combination of inflation uncertainty and a shrinking Fed balance sheet should put upward pressure on borrowing costs, especially in the second half of the year.
There are still developed-market divergence trades to be had in foreign exchange, the strategists reckon.
Goldman sees the euro-yen rate heading to 140, a little more than 5 percent higher than current levels, with a stop at 130. In the bank’s view, the euro’s appreciation this year was primarily a short-covering rally as political tail risks abated, and flows into euro-dominated assets should continue.
But be warned, the team’s major 2017 forex call — that the greenback would be a winner due to developed-market populism — didn’t hold up too well.
Continuing synchronized global growth bodes well for emerging-market economies, according to Goldman, which recommends a long position in the MSCI Emerging Market Index.
Brightening earnings growth in developing economies and the market’s relative cheapness versus U.S. stocks should push that gauge up 15 percent to 1,300, says the bank, which would exit the position in the event of an 8 percent drop from its current level of around 1125.
“We find that the relative valuation of EM to DM equity is largely influenced by the growth differential between the two regions; and we forecast this differential to widen another 60 basis points next year, which in turn should drive EM valuations to expand relative to DM by around 3 percent,” London-based Garzarelli writes.
Euro-area five-year inflation five-years forward swap rates — a favouritee market metric of former European Central Bank President Jean-Claude Trichet — will ascend to 2 percent, according to the team.
That’s a level not seen since before the 2014 oil collapse, notes Goldman Sachs, which set 1.5 percent as the stop for this trade.
The U.S. credit cycle is getting a little long in the tooth, and its emerging-market counterpart is “younger and friendlier,” Garzarelli writes.
Goldman recommends betting on dollar-denominated emerging-market debt through the J.P. Morgan EMBI Global Total Return Index and against U.S. junk through the iBoxx USD Liquid High Yield Index. The bank suggests holding about 50 percent more of the EM long position than the junk shorts and, from a starting point of 100, targeting a return of 106. Bail if it falls to 96, the team says.
This is one of the lone emerging-market asset classes that — relative to U.S. high-yield credit — hasn’t yet fully recovered from the selloff that followed Trump’s election victory.
Garzarelli recommends going long on a basket of the Indian rupee, Indonesian rupiah and South Korean won while shorting the Singapore dollar and Japanese yen.
The trade offers a positive carry of about 4 percent, and the “long leg” is diversified among commodity importing and exporting nations, Goldman says.
Industrial metals prices should keep firming amid robust trade growth and strong global activity, and Goldman sees a way to profit off this trend through foreign exchange.
A basket weighted 25 percent in the Brazilian real, 25 percent the Chilean peso and 50 percent the Peruvian sol should deliver a total return of 8 percent versus the U.S. dollar, estimate the strategists. They would exit the trade should this position fall 4 percent from current levels.
“All three currencies on the long side have reliably responded to upswings in global trade and external demand over the past two decades,” Garzarelli writes. “Moreover, each has performed particularly well in the pre-crisis decade, a period that also featured strong global growth and buoyant industrial metals prices.”
Business News December 18, 2019