Why Goldman Sachs Cannot Be Wrong

When it comes to equities, they play both sides of the argument.

From Business Insider:

You’ve got to be kidding us, Goldman Sachs.

In recent weeks, at least four different strategists from Goldman Sachs (honestly we’ve lost count) have offered different opinions on the direction of the stock markets.  They range from extremely bullish to uber bearish:

David Kostin, Chief Equity US Strategist: BEARISH

Back in December, Kostin said he thought the S&P 500 would end 2012 at 1,250.  This officially made him one of the most bearish strategists on all of Wall Street.  And despite the monster rally in stocks since then, Kostin hasn’t budged.

Jim O’Neill, Chairman of Goldman Sachs Asset Management: BULLISH

When O’Neill published his 11 predictions for 2012, his position was that the S&P 500 was more likely to head to 1,400 than 1,000.  His call came two weeks after Kostin’s 1,250 call.

Abby Joseph Cohen, President of the Goldman Sachs Global Markets Institute and Senior Investment Strategist: BULLISH

It’s hard to think of a time when Cohen wasn’t bullish.  She made a name for herself in the late 1990’s by being bullish as the stock markets soared during the dotcom bubble.

Peter Oppenheimer, Co-Head of Economics, Commodities and Strategy Research in Europe: BULLISH

Everyone’s still buzzing about Oppenheimer’s note titled The Long Good Buy; the Case for Equities where he argued that the equity risk premium made stocks look incredibly cheap.

“The prospects for future returns in equities relative to bonds are as good as they have been in a generation,” he concluded.

The embarrassing thing for Goldman is that their uncertainty and disagreement over where markets are going reflects that the masters of the universe — no matter how well connected — are just as clueless as the rest of us.

The problem for muppets (i.e. Goldman clients) is that it is impossible to be both short and long. Muppets will have to decide whose arguments to listen to for themselves, and will have be responsible for gains or losses. The difference between the masters and the muppets is that Goldman don’t have to take responsibility for their actions. If Goldman screws up — say, by purchasing CDS from a counter-party that goes bust, like they did in 2008 — they can easily get a bailout, and  a boatload of loose QE money to turn their balance sheet around.

Underwater equities? Balance sheet full of junk? No problem for Goldman — merely “hunt elephants” (as Greg Smith put it): encourage your clients to put their money into whatever Goldman wants to sell.

Problem with regulation? No problem: just call up any of their friends in government. The friendship starts at the top.

From Firedoglake:

Certainly, Obama sucked at the teats of Goldman Sachs more than any other politician in recent times. It began for him as little-known Senator from Illinois with a razor- thin resume whose ambitions outshone his accomplishments. Obama’s eloquent, heavily prepped address to the Democratic National Convention caught not only the eyes of the Democratic top brass, but that of the big bankers. As early as the Spring of 2006, Senator Barack Obama was intimately involved with Bob Rubin and Goldman Sachs through his involvement with the Hamilton Project.

Fittingly, Senator Obama was chosen by Rubin and the Hamilton Project to give the inaugural address of the Hamilton Project in April, 2006. An excellent, seminal discussion of the Hamilton Project by Dr. Kirk James Murphy, M.D., can be found here. A video clip of then Senator Barack Obama speaking at the inauguration of the Hamilton Project in April, 2006 can be found here and here (with an excellent discussion) and here.

Obama not helpful? Is he having one of those days where he needs to pretend to be a populist to keep his muppets (i.e. voters) on board? That’s fine — Goldman can try Geithner, Robert Rubin, Larry Summers, Hillary Clinton, Peter Orszag, William Dudley, or any of the other Goldmanites in positions of power.

Muppets may not be so well-connected. Muppets don’t get bailouts, or QE slush money.

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The Only Chinese Hard Landing Will Be On America’s Head

A lot has been made of the so-called Chinese property bubble. And after 2008, when America’s subprime bubble was the straw that broke the camel’s back, who can blame those who see China as low-hanging fruit? In the hedge fund world, both Hugh Hendry and  Jim Chanos (among others) are significantly outperforming the market by shorting Chinese companies.

But the naysayers will be proven sorely wrong.

There are many differences between the Chinese situation and the American one but there is one that outsizes all the others. Over-inflated American (and by-extension, Western) property was being used as a spring-board to fund consumption. Growing home equity allowed real-estate owners to remortgage, and use their surpluses to buy boats, cars and trips around the world; i.e., living beyond their productive means. Once the property bubble burst, not only were many home-owners left underwater, but all of that excessive consumption came to a halt, with a significant negative effect on GDP. China simply doesn’t have that problem. The Chinese nation and its government are not net-borrowers but net-savers.

In addition, there is no evidence that China has the same problem with widespread securitisation that America had in 2008. The subprime bubble created huge systemic risk in the financial sector by bundling up subprime debt in mortgage-backed securities and collateralised debt obligations, and spreading it around American and European balance sheets. This made the system very fragile — as a few defaults, could lead to a global cascade of margin calls and defaults.

In fact, Chinese leverage levels are dropping.

From RBS:

Chinese firms are generally in good financial conditions. The latest data suggests that Chinese companies actually have seen their leverage ratios decline in the past three years, on the back of strong profitability and retained earnings. Most sectors have seen a decline in leverage. Property development was the only main sector that shows the opposite trend of rising leverage but it accounts for only about 6% of total loans. In fact, the average leverage ratio of Chinese companies is one of the lowest among key economies and emerging markets. At the same time, they have maintained one of the strongest profitability.

Chinese GDP (and profitability) is ballooning (and will continue to do so) because of global demand, even on the back of the recessions in Europe and America. That’s because China does everything much more cheaply, and so now controls crucial supply chains in components and products. Now that the world is flat, manufacturing such components in other places is not economically viable, so the supply chains no longer exist, and manufacturing-oriented labour markets are stagnating.

China’s good fortune is its high population levels and high population density.

From Noahpinion:

It is expensive to move products around. This means that if you have a factory, you want to locate it close to where your customers are, to avoid paying a bunch of shipping costs. Now consider two factories. The workers in the first factory will be the consumers for the second factory, and vice versa. So the two factories want to locate near each other (“agglomeration”). As for the workers/consumers, they want to go where the jobs are, so they move near the factories. Result: a city. The world becomes divided into an industrial “Core” and a much poorer agricultural “Periphery” that produces food, energy, and minerals for the Core.

Now when you have different countries, the situation gets more interesting. Capital can flow relatively easily across borders (i.e. you can put your factory anywhere you like), but labor cannot. If you start with a world where everyone’s a farmer, agglomeration starts in one country, but that country gets maxed out when the costs of density (high land prices) start to cancel out the effect of agglomeration. As transport costs fall and the economy grows, the industrial Core spreads from country to country. Often this spread is quite abrupt, resulting in successive “growth miracles” that get faster and faster (as each new industrial region starts out with a bigger global customer base). The evidence strongly indicates that agglomeration is the driver behind developing-world growth.

Looking at global population density — with American taxpayers subsidising the cost of a flat global marketplace — where can we expect productivity to agglomerate?


Of course, China does have a property bubble and a scary-sounding $1.6 trillion in local government debt. But $1.6 trillion of local government debt is still significantly less than China’s dollar and treasury hoard. The bottom line is if that China’s real estate market collapses, China can bail itself out with money it has saved from the prosperity years, not through new debt acquisition. This was the lesson of John Maynard Keynes — governments should save in the boom years, to spend in the bust years and even-out the business cycle — a lesson which seems lost on Western policy-makers, who seem to believe that you should borrow massive amounts every year.

So taking the absolute worst-case-scenario, China has plenty of leeway to bail itself out. Of course, this would mean China might decide to liquidate a significant amount of its treasury holdings — especially seeing as bonds are at all-time highs.

Could such a liquidation be the event that finally bursts the Treasury bubble, sending yields soaring and making it much more difficult for America to acquire new debt?

With 10-year yields now well below 2%, that sure looks like a bubble to me.

Why Elizabeth Warren is Wrong

I’ll be clear:

I like Elizabeth Warren. While overseeing TARP as chair of the Congressional Oversight Panel, she made the following comments:

To restore some basic sanity to the financial system, we need two central changes: fix broken consumer-credit markets and end guarantees for the big players that threaten our entire economic system. If we get those two key parts right, we can still dial the rest of the regulation up and down as needed. But if we don’t get those two right, I think the game is over. I hate to sound alarmist, but that’s how I feel about this.

Of course this consumers-first approach made her unpopular with Geithner & the rest of the mob who hold as a precept that those very “big players” are the economy, and any threat to them is a threat to capitalism, America, and the universe.

And now — as candidate for Scott Brown’s Massachusetts Senate seat — she has blown-up over the internet:


Libertarians, very amusingly, responded with this:


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Junkiefication

What does the market slump of the past couple of days show?

When the market prices in favourable government intervention (endless free cash), and the government doesn’t meet expectations the easy-credit junkies slouch into a stupor, suffering harsh withdrawal symptoms.

From BusinessWeek:

Goldman Sachs Asset Management Chairman Jim O’Neill said the global financial system risks repeating the crisis of 2008 if Europe’s debt crisis escalates and spreads to the U.S. banking industry.

“This is where the parallels with 2008 are relevant, even though I think they are being over exaggerated,” O’Neill said in an interview on CNBC today. “It was when the financial system really imploded that financial firms stopped extending credit to anybody that the corporate world had to destock and we know what happened after that. We are not far off the same sort of thing.”

More than $3.4 trillion has been erased from equity values this week, driving global stocks into a bear market, as the Federal Reserve’s new stimulus and a pledge by Group of 20 nations fails to ease concern the global economy is on the brink of another recession. O’Neill said the Fed’s plan to shift $400 billion of short-term debt into longer term Treasuries hasn’t convinced investors it will strengthen growth.

“The fear that it’s all dependent on the Fed, together with this mess in Europe, is really getting people more and more worried as this week comes to an end,” O’Neill said. “The markets have taken the latest FOMC move rather badly, which adds a whole new angle to it. It’s the first time since the global rally started in early 2009 that the markets have rejected a Fed easing.”

“As the problem in Europe spreads from Greece to more and more other countries and in particular Italy, the exposure that so many people bank-wise have to Italian debt means the systems can’t cope easily with that and it would spread way beyond Europe’s borders,” O’Neill said. “This is why the policy makers need to stop being so sleepy and get on and lead.”

Yes — of course — what the market junkies need is another hit, another tsunami of easy liquidity, money printing and endless “bold action”. Otherwise, the junkies would be left shivering in a corner, cold turkey.

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