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Beware of a head fake, warns Goldman Sachs

Beware of a head fake, warns Goldman Sachs

When it comes to investing, a head fake is an increase or decrease in market performance that is quickly followed by a shift in the opposite direction. And with the market bouncing off recent lows, that’s exactly what the analysts at Goldman Sachs are warning could soon occur as investors realise they became too excited too soon.

Over several months we have highlighted the need for investors who fear recession to keep an eye on New Zealand. The so-called canary in the coal mine. New Zealand began hiking rates earlier than Australia and the economic similarities ahead of those rate increases meant some insights about Australia’s economic reaction and the property market response might be gleaned from New Zealand’s experience.

With the benefit of 44,000 employees, and a global footprint, Goldman Sachs has understandably taken the idea a step further, seeking to draw lessons about the prospects for a soft landing, and the terminal policy rate, from nine countries that have hiked earlier in the current cycle.

With the exception of New Zealand, however, most of the countries studied – those that began to tighten policy aggressively by October 2021 – are emerging market, Latin American (LatAm) and Central and Eastern European (CEE) economies.

On average, the “early hikers” have increased their policy rate by nearly 700 basis points.  For those same countries, Goldman Sachs’s Financial Conditions Index, which is a weighted sum of a short-term bond yield, a long-term corporate yield, the exchange rate, and a stock market variable, has tightened by 400 basis points.

Are these countries in recession?

Importantly, none of the nine economies show clear evidence of recession, and perhaps more importantly the unemployment rate mostly continues to decline. One must then wonder, if Australia’s worker shortage is caused by the returning home of foreign workers who were not permitted to receive JobKeeper, what is causing the labour shortage in those countries to which the workers returned?

Goldman’s believes a possible recession could be occurring in two of the early rate hikers: Peru and Chile.

Factors driving the broad resilience

Goldman’s also believes there are three factors that are driving the broad resilience generally being experienced despite more aggressive rate hikes. 

The first is strong household balance sheets are supporting the drawdown of excess savings and still rapid consumer credit growth, which in turn is fuelling driving demand.

Secondly, Goldmans believes pent-up labour demand has supported job growth in several economies.

And finally, the continuation of the reopening phase of the cycle is spurring growth.

Given these influences will remain in force for at least another quarter or two, their implications remain globally relevant.

Despite the 44,000 people at Goldmans, they are unable to reach a conclusion as to whether a soft landing is assured, stating, “It is unclear whether the early hikers are now on track for a soft landing that brings down inflation without a recession”, adding, “On the negative side, there is little evidence that labor market overheating has begun to reverse, and exchange rates have generally depreciated.”

On the positive side, however, Goldman notes, as we have done in a recent video, supply chains are healing, and core inflation appears to have peaked in most economies.

Goldmans concludes by noting consensus inflation and policy rate expectations for early hikers have continued to increase through 2022. Goldmans expects the terminal policy rate will overshoot official estimates of the nominal neutral rate by around 550 basis points in the average early hiker, although the projected overshoot is smaller in New Zealand, their only Developed Market economy.

It seems the fact the early hikers are not Developed Market economies and that it is still too early to know if a recession will eventuate means little can be gleaned from Goldman Sachs’s addition of eight more countries to NZ’s early hiking ranks. Goldman’s cautions “against overextrapolation.”

However, Goldman’s notes the general resilience among this group supports their forecast no major economy will enter a monetary policy-driven recession over the next year.

If they are right, we can at least expect a few things:

  • No recession and persistent inflation (albeit peaked), as well as persistent strength in the drivers of inflation, suggest upside risks to the terminal policy interest rates central banks arrive at, and therefore
  • The recent rally in equities may be a head fake. Something we have been warning is a possibility over the last week or two.

Remember what we have been urging investors to consider: It’s one thing to celebrate a peak in inflation, but it’s way too premature to conclude inflation has been beat and is now heading interminably to the U.S. Federal Reserve’s target of two per cent.  With stock markets prone to impatience, I wouldn’t be surprised if the market turns lower amid the realisation investors became too excited too soon.


Roger is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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