Goldman Sachs Suggests A Disaster Is Coming

( Economists at Goldman Sachs and Deutsche Bank are both saying that investors are currently underestimating the risk of the U.S. economy going into a recession, which is actually increasing the impact that a recession would have if it does indeed hit next year.

Bloomberg reported on Monday that a team of strategists led by Cecilia Mariotti and Christian Mueller-Glissmann have produced a model that shows there’s a 39% likelihood that the U.S. economy will experience a slowdown over the next year. At the same time, risk assets are currently only pricing in a chance of 11%, which is quite a major gap.

In a note the economists sent to investors Monday, they wrote

“This increases the risk of further recession scares next year.”

Binky Chadha of Deutsche Bank sees a recession happening by the third quarter at the latest next year. According to Bloomberg, he believes the S&P 500 Index will drop down to 3,250 points by that time, which would mark a 19% drop from the level it’s currently at. He then believes a rebound would be in order for the fourth quarter of 2023.

These notes from major investment banks are somewhat of a warning call to investors. Equities have rallied nicely over the last 60 days. Investors are betting, essentially, that inflation is peaking and that it will lead to the Federal Reserve Bank softening its current policies.

The strategists at Goldman Sachs did say that overall monetary policy would likely be “less of a “headwind” in 2023. That being said, the fact that global growth is slowing will put extra and continued pressure on stocks. As they wrote in their note

“Equity risk premia appear low considering elevated recession risk and uncertainty on the growth/inflation mix.”

The drawdown risk for stocks is higher amid this volatility and weak growth, combined with the current high valuations. For instance, the S&P 500 is currently trading 17.5 times its forward price-to-earnings ratio. That’s above the mark of 15.7 times that it’s averaged over the last 20 years.

In history, where recessions are able to be avoided, equities will start to rebound. When the economy does contract, though, equities typically experience an average drop of another 10% over a six- to nine-month period following the peak.

The Goldman strategists did paint some positive news in their note, saying they believed the risk for a full-blown U.S. recession in 2023 is low. That being said, they did note there are concerns regarding financial stability in addition to indicators of market stress, which include solvency risk and liquidity risk, that are increasing across all asset classes.

The strategists advised their clients to buy bonds right now instead of stocks, because there is a more advantageous risk/reward for them, and since they’ll likely be “less positively correlated with stocks later in 2023,” Bloomberg reported.

The Goldman experts say they expected the S&P 500 to end next year at 4,000 points, which would be about the same as it was at the market close last Friday. They believe that will happen through a drop in the first half of the year followed by a recovery during the second half of 2023.