Moody's Talks - Inside Economics - US Bull, China Bear

Episode Date: March 31, 2023

Sharmin Mossavar-Rahmani, chief investment officer for Wealth Management at Goldman Sachs, join Mark, Cris and Marisa to cut through the uncertainty over the banking crisis and China’s prospects. The worst of the banking crisis appears to be over, but China’s economic problems are only beginning.For more about Sharmin Mossavar-Rahmani click hereFor more on Goldman Sachs Investment Strategy Group 2023 Outlook click hereFollow Mark Zandi @MarkZandi, Cris deRitis @MiddleWayEcon, and Marisa DiNatale on LinkedIn for additional insight. Questions or Comments, please email us at [e-mail]. We would love to hear from you.  To stay informed and follow the insights of Moody's Analytics economists, visit Economic View. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to Inside Economics. I'm Mark Sandy, the chief economist of Moody's Analytics, and I'm joined by my two, I think it's not tradition for me to say trusty co-host, two trusty co-hosts, Chris DeRides and Marissa Dina Talley. Hi, guys. Hi, Mark. It's good to see you yesterday. Oh, I know. We were in person. Yeah. Yeah, no, it was a little sentimental, wasn't it? Are you changing your tune? You want to come back in the office? I'll have to tell you, I really enjoyed that in person. So we all, the senior team met. yesterday at our offices in person, kind of a strategic planning kind of session, which actually was highly productive. And I kind of missed, I forgot how good that was. That was really kind of cool. I could beat up my brother, you know, sitting right next to me. Like physically beat him up,

not just browbeat him, but you know, push them and shove them. Did you see that? Did you catch that? I did. I did. It's entertaining. It was entertaining. It was entertaining. So you think we're making a mistake on virtual. We'll see. We'll see how this all works out. It's going to be interesting to see how this all plays out. Yeah. Of course,

Marissa has always, you've been virtual for quite some time now, right? You're from California. Eight years. Eight years. So you're used to this. You've adapted. We're still adapting.

Yeah. We're still adapting. So I testified in the House this week, the House Budget Committee on the fiscal situation of the country. And the most interesting thing about it, a lot of interesting things, but the most interesting things, It was four hours long, four hours long.

Can you imagine that? So, you know, every congressperson gets, and the witnesses gets five minutes, but there's a lot of Congress people. So, you know, it adds up to a lot of time. And I had forgotten that these last so long. And I did not ration my coffee intake, you know, before the hearing. I tell you, my answers were getting shorter and shorter as we went along here. It was an interesting hearing. I will say, though, go ahead.

Go ahead. What was the most difficult question? That's a tough one. But I will say this. I, and this is maybe the naive economist in me, I came away actually encouraged. You know, I think there's, yeah, believe it or not, there is, you know, a clear sense of urgency around the fiscal situation. And, you know, both sides, Republican Democrat coming at it from very, very different perspectives. but that's age old.

That's always been the case. And I thought the conversation, the discussion was actually very urban and very policy-oriented. I was a little nervous about it that it would be more politicized and people hitting each other over the head. But I didn't get that at all. So I actually felt pretty good coming out of it. I'm sure there's going to be a lot of battles here, debt ahead, given the debt limit. But it all felt pretty good. But anyway, we got a guest, Charmine.

Hello. Most of our Romani, it's good to have you on Inside Economics. Thank you for joining us. I'm certainly glad to be here with you. Yeah. And, you know, Charmine is a big deal at Goldman Sachs. She runs the Investment Strategy Group, and you're the chief investment officer for the wealth management function at Goldman.

And here's the most significant thing, Charmine. You're my cousin. You're my cousin. I know. What an honor for me. Oh, what an honor for me. I brag about you all that. You don't know this, but I brag about you all the time. Every chance I get, like, I was talking to some Goldman guys last night and I go, oh, Charmine's my cousin. And they go, oh, really, Charmine's your cousin. Immediately my, you know, that my stature rises in their eyes, you know, so it's really an honor to have you on the podcast. Charmin, can you just tell us a little bit about how your journey to, you know, where you are today? How did, how did that happen? What was? your path? To Goldman Sachs or to the industry? Yeah, just generally, I mean, you know, you have such a, you know, important position in a very significant financial, even probably the premier financial

institution on the planet. How did that happen? You know, is there just a little bit about your background. It would be interesting to hear. It's actually such an interesting question, because whenever we're trying to recruit young talent from undergraduate schools or from graduate schools, they always ask about what has been a factor, contributing factor, to what makes people successful at Goldman and how did you plan your career? And I always tell them that my path was totally random, that I ended up at Goldman Sachs completely by chance, and I ended up in the financial industry by chance. When I graduated from grad school, I was more interested in energy and energy prices were tanking.

Nobody had any interest in hiring anybody in the energy sector, whether it was in the financial sector, whether it was in consulting. And nobody was expanding that practice. It was all shrinking. So I literally took forever to find a job. And since my work had been a little bit in quantitative economics as a graduate student out at California, California, they were looking for somebody with some basic optimization capabilities. And so I ended up in finance completely by chance because the small research firm was looking for someone. And so that one thing led to another. And then when I wanted to move to New York,

I was looking at a couple of different firms. And actually one option, funnily enough, was Credit Suisse-First Boston at the time. And versus Goldman Sachs. And one of our friends said, are you crazy? You must do Goldman Sachs. How could you think about Credit Suisse First Boston? And of course, 30 years later, they had incredible foresight of direct. They got that right. It's unbelievable. Yeah. And he actually happens to be an economist and had his own economics consulting firm and very,

very thoughtful and writes interesting columns. And so it was great advice. Can I ask who? Can I ask her that? It's Erwin Stelzer. Oh, yeah. I don't know the name. Yeah.

He's much older now and retired and still write something for a couple of papers. and has had his own firm and sold it years and years ago. Yeah, very cool. Yeah. And so you've been with Goldman now for, well, maybe I shouldn't ask. Is that okay if I ask? I mean, probably as long as I've been. Alive, you mean.

Probably as long as you've been sorry. Okay. Feels that way. Sure. It sure feels that well. I will say 30 years. 30 years. Yep.

And I will say I get to read your work all the time. And I'm a careful consumer of it. And I think it's absolutely fabulous, you know, work that you guys do. And you've got a great team there. I mean, Goldman is pretty deep. Got a lot of really great economists throughout the company. And I, of course, I read a lot of research. And the only research I will read literally every day is the Goldman research.

I mean, it's that good. It is really, really good. So you've done a fabulous job. Okay. So there's a lot to talk about. I know you have done some recent work on the Chinese economy and its prospects. And we will come back to that because that's a great deal of interest. Probably after we play the statistics game, we're going to play the statistics game sometime down the road here. But first and foremost, top of mind is the ongoing. banking situation, although it feels a little less threatening today than it did a week ago or two weeks ago. Maybe I can ask to start the conversation. Do you think the crisis is over? Do you think this is winding down? Or how are you thinking about that? One of the key attributes of our research and what we do is to have confidence where we have some certainty and to convey the uncertainty. So in fact, the cover of our outlook this year, we called it caution heavy fog. And the message was there's a lot of uncertainty. So when it comes to this sort of mini banking crisis, we would say there's still some uncertainty. We don't really know and have transparency into the balance sheets and the deposit

outflows of small and medium-sized regional banks or some of the larger regional banks. But we do know that the regulators have a lot of insight. And if they're being more patient in terms of any liquidity measures, anything else that they're doing, or forcing, for example, thinking about what happens to First Republic, giving them time, then they must be seeing a little bit of a calmer environment. And so we assign a higher probability that the worst is probably over. And clearly, the equity market is pricing it that way as well. Yeah. Kay, Chris, is that your kind of sense of things? Do you think the worst is over as well? I'm hopeful. That's the case. But, you know, Sharman, you should know Chris is the bear among us.

So, you know, just to get that straight. Yeah, go ahead, Chris. I mean, these crises never are one and done, right? They typically have ups and downs as you're going through them. So it's possible that the worst is over. And, yeah, there could be some future failures, but we can handle them. Or there might be another shoot-a-drop. So I think we need to, I think we need to continue to remain cautious here.

And Marissa, any perspective on that? Yeah, I agree. I mean, it seems like the worst is over. It seems like it was relatively contained, but we've been surprised before. Yeah. I mean, given the policy response, you know, given how muscular that has been, where the Treasury Fed, FDIC have come in and said, hey, for depositors and failing institutions, they're basically at this point now saying those,

depositors, small, big, doesn't matter on the deposit insurance limit, they're guaranteed. Yeah. And then the bank term funding facility that the Fed established to provide liquidity to the bank so that they can borrow against their security holdings at par and then use that cash to meet their funding needs, including paying depositors. It feels like the worst has got to be behind us, right? I mean, it's hard to construct, in my mind, to construct a scenario where things go the rails again? Or am I missing something? What do you think, Sharmin? Mark, there was a very interesting

session yesterday at the Benheim Center at Princeton, and Bill Dudley was the guest speaker. And the host, the director of the Benheim Center asked that exact same question. And they did a little survey, and they asked the audience, what was this mini crisis most like? And they made comparisons to the SNL crisis, global financial crisis. going to the 80s. And the reality is that while we do believe history is a very useful guide, on the other hand, there have been significant changes since the global financial crisis. And time and time again, the Fed, the regulators have been very responsive, quick attack, just like we saw during the pandemic. And so to your point, if you go through the measures taken

and the fact that they're being very patient with First Republic and are not panicking and are not doing anything dramatic there, tells us that they think the worst is over. And obviously, one can look at the glasses, half empty, half full. And I think, Mark, the point that you raise about your colleagues, I think everybody should have a little plaque when they start speaking, glass half full or glass half empty kind of person. Because then your audience and our clients can put their comments into context, because some people just have different perspectives. But our view is, again, And once you'd never say it's 100% certain, but we would say more likely than not, whether it's 60 or 70% that the worst is over.

Right. Okay. So that's an interesting observation. So I think I would have the plaque would say glass half. What would you guys say? I'd say your glass is three quarters full. From your perspective. All the time.

And Marissa, what would, Marissa is different. Sherman. I'm not sure. I can't peg her. What would you say? I think I'm a glass half full kind of person. Yeah. And Charmine, are you glass half full or glass half empty?

Three quarters full. Three quarters full. But that's all right. We live longer. Don't worry. More optimistic people live longer. Well, also that works, right? In the context of American history for sure, right?

I mean, you can't, what's the old, is it the Buffett? Warren Buffett said don't bet against the American economy. because you'll lose, I mean, you know, ultimately. So I think it benefits to be glass half full as opposed to half empty. But that's just my perspective, just my perspective. Mark, in fact, you raise a point about Warren Buffett's observation. We have had a view of U.S. preeminence first since the inception of our group in 2001. But in fact, even when it comes to investment recommendations, we have a larger strategic

asset allocation to U.S. equities. And we reiterated that view since the global financial crisis when everybody was saying, oh, did this financial crisis deal a fatal blow to the U.S. economy? And so that actually has implications, not just for the equity allocation, but the second theme of staying invested. You're better off betting that earnings per share growth in the U.S. is very solid in the long run and you want to be invested in U.S. equities. So in fact, it does have significant implications when you're thinking about the U.S. Yeah. So what you're saying is that, you know,

all you have your view of the market can change up or down, but on average, you should be more positive about the prospects for the market because on average, U.S. economy will outperform and do well. And that would support equity prices. That's kind of the perspective. Yes, if you think, exactly, if you think about GDP growth, more often the U.S. economy is growing than in recession. And so that growth generates earnings per share growth, and the S&P 500 will, on average, follow that earnings growth. They might diverge short term, but eventually they converge.

And so the bias should be to be fully invested and not underweight U.S. equities. Yeah, see, Chris being the half glass or empty kind of guy, that's why he's so invested in crypto. You know, he's like deep into crypto, deep into crypto. But anyway, so the fallout. So let's go of the crisis. Let's go with the highest, the most likely scenario with a reasonably high probability is that the worst is over. You know, maybe there'll be another failure or two or three, probably if they are a small, institutions and it won't be systemic in any way, that the system is kind of nailed down given

the policy response. If that's the case, do you expect a significant or meaningful fall out of the crisis on economic growth and activity? Is this going to be a headwind to economic growth? At the margin, what could say lending standards have tightened credit availability, has been reduced, whether it's in the public markets with widening credit spreads or from bank lending. So at the margin, it will have some impact. The question is, what will that impact be? And there's a range out there. Some people are two-tenths, three-tenths.

One of the external economic research firms we look at has seven-tenths, which we think is way too high. But let's say take the midpoint of these numbers, a third to a quarter of a percent, let's say a point-3.4 percent lower. so quarters at the low end. But then on the other hand, if you think about it since that last Friday, so if you look at data since Thursday, financial conditions as measured by the S&P, as measured by interest rates, as measured, in fact, by the dollar have all eased a little bit. So the dollar is a little bit cheaper.

The S&Ps a little bit higher in tenure rates are a little bit lower. People are more and more convinced that we're nearing the end of the Fed tightening cycle. so that's going to be also a stabilization. And overall, you look at the returns in the equity market and the bond market, and they've been pretty attractive. So when you look at that in its entirety, growth will be a little bit slower than if we hadn't had the Silicon Valley and signature bank episodes. But we think that'll go by and it'll be a little bit slower. And there's enough uncertainty around the growth number and the recession probabilities that'll be so hard to discern. that two-tenths, three-tenths, four-tenths.

Like, it's sort of a little bit of false precision when we actually are not exactly sure, what are the odds of a recession, how quickly will inflation come down? So our view is that it'll be something, but hard to know exactly what. Yeah. Of course, that's kind of our perspective, right? I mean, what are we,

we're estimating down three, four-tenths of a percent. Gee, this is a year-over-year, real GDP growth, Q4 of 2022 through the Q4 of 2020, that these events that have unfolded here in the banking system will shave a 3 or 4 tenths of a percent of growth. So instead of growing, I don't know, make up the number a little bit, 1.5 percent, we're going to grow 1.1 percent, something like that. Is that right? Chris?

Yes. Our forecast was, I think it was 1.5 and now it's 1.3%. Right, right. One thing I have noticed that makes me feel even more confident that the info isn't going to be as great is the decline in mortgage rates. Have you noticed that? I mean, the 30-year fixed-rate mortgage was, I think it was over 7% before this mess. And now it feels like we're closer to 6. Is that right?

I think that's right. I thought we were still around 6.5. Well, I'm looking at the mortgage daily. Oh, okay. Yeah, the daily numbers. And they've been hovering around 6% in the last few days, the last couple of days. So that would go a long way to ameliorating some of the fallout from the. Although, yeah, I agree.

Although I think we have to be careful when we look at any of these rates in terms of the availability, right? The rate might be a good point. Right. But the tightening may be through the qualifications, right? So you just have fewer people able to get a loan, right? And you have the credit tightening through that avenue, even though the cheap. It's a bit cheaper, perhaps, for those who actually do qualify. Yeah, good point.

Good point. Hey, Charmaine, so monetary policy. So what do you think this means for the Federal Reserve and future rate increases? I don't know. I can't quite remember. Do you have a perspective on how many more rate hikes are dead ahead or any rate hikes dead ahead? We started the year with the target of five to five and a quarter. And we haven't changed that.

I know some people opted when we came into 20, 23 with stronger economic momentum, and then people change their views because of this. And now they're back up again. We're actually staying at five to five and a quarter. They will definitely pause a little bit, see if the inflation trend downwards will continue. Again, we all recognize the goods component and we understand the housing component, but are we going to see it enough in wages as well? And so our view is they'll do that and pause for just a little while, knowing that there's still a little bit left in the impact of the big rate hikes that we've seen.

Obviously, most of the impact of this big increase in rates, we've already felt most of it, let's say, towards the end of 2022, the last two quarters. But there's still some lingering impacts, and so they need to wait a little bit. Yeah. So right now the fund rate target, the key rate, the Fed controls is just under five. So it's four and three quarters to five. and you're saying, we're going to get one more rate hike here, quarter point, at some point in the next meeting or so. And then that's the so-called terminal rate. That's the highest the rate's going to get in this cycle.

Well, our view is that they're actually going to be data-driven. So they'll get their pause. And then they'll look at the data for a couple of months. And then, wait, in the report, we actually quote Chairman Powell, where he says, it's not noble if we're going to have a recession. They need to be data-driven and what for incoming? data. And we think that's very important if the chairman who actually runs the FOMC and control some of the dialogue says it's unknowable and we need to wait and see it and be data driven, our view is they're going to do one more hike and then be data driven. Yeah. And then

given your outlook for the economy, would that suggest that they, that they'll need to raise rates more at some point down the road? Or is that the end of it? Or do you think the markets seem to be thinking we're going to be cutting rates here pretty soon. Do you have a sense of that, given the context of your outlook for the economy? We don't expect rate cuts. We actually have a reasonably positive view of U.S. equities. Our target for the S&P 500 is between 4,200 and 4,300. So from current levels, that's up another 9% and for the whole year, that's up about 13% with dividends. So in the low teens. And between that and what people are earning on their cash, the deposits in money market funds and what they're earning in the bond market,

we think that's actually a pretty positive environment. And it's unlikely that the Fed will actually be cutting rates that quickly, unless, again, something else were to happen, anything geopolitical, other factors. Sure. So the S&P 500 is at a little over 4,000 right now. Yes. And you're saying by the end of the year, your expectation is 4200 to 4300, somewhere in that range. Yeah, that's our base case. Right. And we assign 50% probability to that, but then we also assign a pretty good 20% to actually the numbers being even higher. And so that's why we would encourage people to stay invested, ride this volatility. we tell our clients the most important thing they should do is think about their long-term strategic asset allocation. What's the right amount of equities? What's the right amount of bonds

depending on the size of their portfolio? Could they do alternatives like private equity? But just so you know, we definitely do not recommend cryptocurrencies. No crypto in there. No crypto. No crypto. So are you a crypto investor? I am not, no. You are not. Yeah, you didn't strike me as a crypto investor. I'm a pretty risk-averse person. Are you following Charmine's advice about being fully invested in equity? I mean, oh, yeah. Yeah. I have a long time until retirement. I can ride out. I know you do. Yeah. Plenty of time. So that sounds pretty glass half full, you know, 4,200, 4,400, 3,300 by the end of the year. That suggests no recession, you know, deadhead. going to have a recession, you would expect the equity market to fall. But here's a question

before you explore that a little more in detail that's confused me. Like most economists, I look at financial indicators, along with a lot of other indicators, but financial indicators as a kind of a barometer of where the economy is headed. Because of course, investors are forward looking and they're trying to incorporate into their investment decisions, what they think the economy is going to be doing down the road, you know, growth, inflation, and everything else. So you look at the equity market, the $4,000 on the S&P. And by the way, I think people don't recognize this, that that is roughly been $4,000 for almost a year, right? I mean, it's up and down all around, but, you know, pretty much almost a year, it's been around $4,000. So it's basically been flat. So that doesn't

seem to, and of course, your forecast is for it to increase a little bit here through the end of the year. That doesn't suggest recession. That would be a lie recession. But then, I look into the bond market and I look at the shape of the yield curve, you know, the difference between long-term interest rates and short-term rates and, you know, 10-year yields are, you know, 3.5 percent. The two-year treasury yields at 4.2 percent. The three-month treasury bill is at 4.7 percent. That's pretty inverted. And historically, when you have that kind of inversion, that would suggest a recession debt ahead, you know, 12 months down the road. Does that, have you thought about that? Does that confuse?

you two or do you have some, how do you square that circle in your mind? So if you think about the equity market last year, right, we had a pretty significant high to low drop. You're talking about 25% roughly. And if you look at the average or the median of the equity market in past recessions, that number is factoring in a high likelihood of a recession. So one could actually argue that the equity market already priced in a recession. Not to your yield curve point, we actually have what we call our yield curve diffusion index. It's a series of yield curve inversions over different time periods. And whenever that index has hit 100, we have had a recession except for the mid-1960s.

So it has a very good success rate in terms of anticipating a recession. But the interesting thing about this yield curve diffusion index is that as you point out when you see these inversions, typically you start seeing a recession a year forward. This yield curve inversion does show an average of 13 months, but it's actually a very bimodal distribution, meaning either you get the recession very quickly when this diffusion index triggers and it triggered last summer, usually within a couple of quarters. So the minimum is five months. So typically you'd say a couple of quarters pass. And so in theory, one would have been in a recession now if you end up with the first part of the distribution. Or it's actually two years out. So we're talking 2024.

So our view is given that we didn't and are unlikely to have a recession in these first couple of quarters and looking at your numbers, you're not expecting that either. Then one would say, okay, it could be something that happens in 2024. And so rather than say we're definitely going to have it in 2024, again, we'll just look at the data and decide on 2024 later. If it looks like it's likely, then obviously the market will trade off later towards this year. Now, people will say, well, because of everything going on in the economy, are we going to have a decrease in earnings? And certainly, earnings expectations have been trending downwards. earnings forecasts have actually come down around 10, 11%. So again, without a recession around the corner,

the market has already adjusted somewhat even on the earnings side. And so our view is that it's possible that the market's already priced a fair amount of negative news. And unless a recession is imminent, then that allows for some upside, but maybe there's a recession to be seen in 2024. But we can decide on that later. Oh, interesting. Can I ask, because I am a economist and I like to go into the retail, but I had not heard about the, I've not seen or read about your yoke curve diffusion index. Can you explain that a little bit more detail? What is that exactly? Or if it's, I'm not taking any proprietary. So I'll definitely send it to you. But it's a series of indexes over weekly, monthly, three month data. And it's a series of different points on the curve. So I'll definitely send it to you.

Okay, okay, very good. So what you're saying is we dodged a bullet, a near-term bullet. I mean, if you look at the decline in the equity market back in early 2021, you look at your diffusion, your yield curve diffusion index. Those two things would have suggested. Maybe a recession is imminent. That has not happened. 2022. 2022.

Yes. So that's not happened. But based on these historical relationships, there's another bullet coming in 2020. 24 and that so potentially we could have a recession in 24 it's not it's not outside the realm of you know it's it's a scenario with a reasonable probability that we yes i see yes okay okay very good so let me ask i'm going to ask chriskin then marissa going back to my question to charmine about squaring the equity market with the yield curve how do you square those two things oh throw one more thing into the mix uh just to make it even more

complex. If you look at corporate bond spreads, you know, they've risen a little bit. That's the difference between the yield on corporate bonds and risk-free treasuries. And that difference, that spread reflects investors' concerns or not about credit risk, that the business isn't going to be able to pay back on the bond in a timely way. And so when that spread widens, that's investors saying, hey, I think these businesses are going to have problems, selling whatever they produce, profits are going to come under pressure, cash flow, and I may not get my money on time. Those spreads have been, again, they've widened a little bit in the banking situation crisis, but they remain very narrow, thin by broad historical standards. So you've got those three data

points coming out of the financial system. How do you, Chris, how do you square those things? Well, high yield spreads have gaped out, right? No, they're still, but yes, but they're still very low by historical standards. Okay. Yeah, they're not screening recession, but they are. elevated, right? Well, that's a fact. This is definitely a glass, all-empty kind of person. Just keeping it real. It has widened, but it is definitely not so wide that you would think it's really

attractive and worthy of getting invested in high yield. We monitor these markets, and you would say, yes, it's widened, but not that much to make it a particular attractive investment opportunity. So I just think it's good to put some parameters. around. Oh, yes, it's widened. I am so happy, Charmine is on my side. That's all I'm saying. Yeah, on my side. So, but Chris, how do you square that, that seeming circle in your mind? Because Chris does think there's a very high probability of recession, you know, here in the next 12 to 18 months. Yes, although I would agree further out, right? So 24, 20, end of 2023, early 2024, not in the immediate

quarter or two, right? You still have a lot of strength here. So how do I square the, oh, I think the bond market's right and equity market's wrong. So does that mean equity doesn't fit my down again? It's going to see. Equity, you think if we're going to have a recession, do we get another leg down in equity prices? And then we just haven't gotten there yet. Yes, there's a lot of volatility as you mentioned. Um, earnings may be marked down, but then, as you said, the stock market hasn't really moved. So that, you have some, uh, P.E. expansion that that's going on there. So obviously people are making different bets here and they're betting that we squeak through. But the equity market we know is can be quite volatile.

It's not a great predictor of recessions. So I would tend to follow more of the bond market. And there the signal does seem much more pessimistic in terms of the probabilities. The yield curve. The yield curve. That's right. Yeah. Marissa, do you have view on this? No offense, Charmaine, but I kind of ignore the equity market when it comes to recession and any sign about the actual economy. I mean, we've seen they can be very divorced, right, historically, just what's going on in the real economy and what's going on in equity markets.

So yes, it's maybe telling us something, particularly in certain segments of it, but I would agree I would tend to look more at the bond market and other real economic indicators. I, you know, we always talk about our probabilities of recession on this podcast. And I think I'm still around 50, but with a bias to the upside, maybe closer to 55%. But that's over the next 12 months. I don't see a recession this year. but I do agree that there's probably an elevated risk of recession in 2024. I think that if we see a recession in the next couple years, it'll be next year.

It's interesting. You say you don't really think the stock market has any sort of predictive or any significant predictive power in terms of what might be happening. But again, think about it. The financial conditions tightened way ahead of the Fed raising rates. and the bond market following, and the equity market actually led that. So the equity market was actually in this particular example that we're talking about, a leading indicator in terms of the slowdown in the economy and the risks of inflation

and the Fed having to tighten. So I think it is true that lots of times the equity market has predicted a recession, and it hasn't happened. That's true of bonds. That's true of credit spreads. But on the other hand, you would say we already had this huge, huge down draft. And so that already indicated something significant. And it's not as if we're well above the levels at the beginning of last year. So I think that's one thing to think about.

The other thing is that if we, for example, do not have a recession this year, the biggest impact of the Fed tightening would have abated. So the question becomes what will actually trigger a recession further down? And if you have enough earnings, and we're not thinking earnings are going to be double digit. We have modest mid-single-digit earnings growth. The market has maybe low single-digit earnings growth. But if you actually have an economy growing and you have global growth at two to three percent, then your S&P 500 companies will generate reasonable earnings. And then in that case, what will actually trigger a recession in 2024? So again, even though our yield curve diffusion index indicates that, one could say if one can get out of this, and you do see

wages coming down slowly, then what would trigger a recession in 2024? I think that's why we don't say it's highly likely. It so happens. The range we have in our report, and we stuck to that is 45 to 55 percent. For all your listeners, Mark, if they would like to look at the report, is actually on Goldman's website, and you're quoted in there. There's your number that you had at the beginning of the year. We have it in there. So for anybody who would like to look at and see our rationale. And I think I'm right in the middle of your range at 50%. Exactly. Yeah, exactly. And I would point out, going back to the equity market as a predictor of recession, it is very much the case that, and it's the old economist's quipped, the stock market has predicted nine of the last five recessions, for sure. But I don't think there's ever been a recession where the equity market hasn't headed south, you know, before the recession. Because investors say earnings are going to fall, and I'm out of here and take stock prices with it. And then it becomes, as you point out, I mean, there's some causal relationship there because financial conditions tighten and it, you know, contributes to the weakening in the economy.

So, but one last thing about the equity market before we move on, here's the way I kind of think about what's happened in the equity market over the last 12 to 18 months. That that large decline at the beginning of 2021, at 25 percent peak of trough decline, that felt more like PE price earnings multiple compression related to the increase in interest rates or the expectation that interest rates were going to increase. It wasn't really about investors thinking earnings were going to decline. And so that 25% is basically taking the price earnings multiple back to something that's more reasonable given where interest rates are going to be here going forward. And the stability, the relative stability in the equity market at this point reflects now the expectation, well, the worst of the rate hikes are over. You know, we're pretty close to the peak on the 10-year treasury yield. And I'm still expecting earnings growth to be

positive, not negative. Therefore, that's consistent with, you know, the flat equity market, and also consistent with no recession, that equity markets are not anticipating recession. Does that make sense the way I just articulated that? We've had a big debate internally, not just among our own colleagues in the investment strategy group, but also with David Koston, who's our chief U.S. equity strategists and Goldman Sachs in the global investment research team. And he would attribute the decline to the rise in interest rates and the expectation of increases because the equity market did decline ahead of the full increase in rates. And we actually say it was a combination and we have to attribute the decline to both factors

because if you look at the amount of focus on recession and how much people were talking about recessions, to say that everybody was focused on it and talking about it, but it had no impact on the equity market. To us, seems a little bit like a stretch. And in terms of the interesting point about the Fed tightening and what that means for recession versus the question about the equity market predicting recessions, we've had a lot of Fed tightening cycles, not all of which have led to recessions. So that's also an important factor to consider.

Obviously, we've never had quite this speed and magnitude since the late 70s, early 80s. But our view is, it's not a given that we'll definitely go to have a recession. And you know our colleague's global investment research, they have a 35% probability of recession. And then at the other end of the spectrum, our former colleague and former head of the Federal Reserve Bank of New York, Bill Dudley's at 60. So here are incredibly thoughtful people at the opposite ends of the spectrum. Yeah. Well, yeah. Jan Hatsius is your colleague and the other site and he's at 35% and I was fortunate to be on a panel enough to be on a panel with him and you're very, very convincing. The same panel, though, had Larry Summers and he takes a very different perspective.

So it was a very interesting panel, you know, a very, very interesting panel. I can't wait to figure out who's right or who's wrong on that one. If you think about people who were predicting a recession last year, and that didn't materialize. So some of the loudest voices on saying that we would have a recession last year. And you remember, you did all that great work on the spread between GDP and GDI and whether what we're experiencing the first two quarters was a recession or not. So some of those voices were all saying a recession last year, and now they've just moved it forward. Yeah, that's the other problem with predicting recessions that I've always had a problem with. I mean, yeah, we're going to have a recession at some point. And if you're saying there's a recession,

you've got to pick the date, don't you? And don't you have to tell me exactly why the recession occurred because that affects everything else your, you know, all your other expectations and forecasts. And that's a, that's, people have a hard time doing. How do you do that? That's like, you know, incredibly difficult to do. But anyway, hey, let's, we're going to go back to China, but I want to play the statistics game.

And I think Charmine's going to stay, be an observer here. So, and adjudicate any disagreements materialize. So for the listener, the statistics game. is we each put out a statistic. The rest of the group tries to figure that out through questions and deductive reasoning and clues. The best statistic is one where it's not so easy that we get it immediately. That's pretty hard to do when I'm playing the game, I admit, but nonetheless. And then not too hard. I know I shouldn't show more humility. Hard for me to do, but I'll try. You got to show me up in this game today. And not so hard that we'll, we'll,

never get it. Okay. Tradition is that Marissa, you go first. So fire away. Okay. You already stole my original statistic. I know. I'm sorry about that. In the preamble leading up to the podcast. So I had to scramble for another one. By the way, mentioned that statistic, though, because it's an important one. Yeah. I was going to use 3.6%, which is the one year ahead inflation expectation out of the University of Michigan survey. That came out this morning. So that is the lowest consumer inflation expectation we've had since April of 2021. Yeah, pretty good. And it's been on a pretty good downward trajectory, and it's down from almost five and a half

percent, which is where it peaked in the middle of the summer of 2022. So good news, not too far off from what are, you know, where we think year ago inflation will be at the end of this year. We think it'll be just north of 3%. So encouraging that consumers are expecting. lower prices and that seems to be getting better, you know, month after month. Yeah. Do you have a backup statistic? I do. Okay, far away. Okay. So my backup statistic is 83.2. 83.2. Is it a survey-based measure? Is that from a survey?

Yeah. Oh, boy. Oh, so that pause. That's a scary pause. What does that mean? Either it is or it's, or is it a government. statement statistic no okay it's a from a private it's a private survey is not is it from the university of Michigan no no no no okay board nope no um okay it came out this week it did yep okay is it related to manufacturing activity? No. Jesus. Regional Fed survey?

No. No. Small business, the SFIB survey, the small business, that was last week. It wasn't this week. Are we barking up the wrong tree?

Is it, is a service? You are barking up the wrong tree. Oh, okay. It feels like we are. Is it a growth rate? No. Okay.

It's a ratio of something to something. No. Oh, my gosh. Should we know this number? Yes. Particularly Chris should know this number. Oh, is it housing related? It is housing related. Oh, is it from the, I know, it's the pending home sales number. It is the National Association of Realtors pending home sales, right? Okay. That's embarrassing, Chris. I'll have to say, that's embarrassing for both of us, actually. Which number was it from there? It's not, oh, no, he knows the numbers. It's the overall, it's the overall index. Oh, it is.

Okay. Yeah, it's the overall index for the month of February. Yeah. All right. Yeah. And I picked it because it is the, so this is measuring the number of pending home sales during the month from the NAR. And it's the highest that it's been since August.

And this is the third consecutive month in which it's risen. So suggesting that, again, perhaps the housing market has found a bottom. Things are looking up. Mortgage rates, as we just talked about, are a little lower than they were a month ago. So there might be some renewed activity in the housing market, which bodes well for the outlook as well. Yeah, that makes sense. 6% mortgage rate. That should help too.

Chris, how embarrassing is that? I look at the percentage changes. Blah, blah, blah. Index value. That's a good one, though. That was a good one. Yeah. Hey, Charmaine, do you have a view on housing and house prices in particular? Is that something that you guys focus on at all? Yes, we do on a household formation, which has been pretty remarkable for the last couple of quarters, right? If you look at some of the data on household formation, it's quite remarkable. You're talking numbers well over two million relative to, let's say, a run rate before the pandemic at around one, one and a quarter million. So yes, we do, and we look at affordability.

And we think the fact that Kay Schiller home prices have come down is a positive several months in a row. Do you think further price declines or are we close to the end of the price declines, do you have perspective? What's very interesting in the data is that it is so dispersed. So we look at all these averages. But the reality of it is prices are coming down much more in the West Coast than in the East Coast. and then you have some of these states which are doing much better. And the population moves and immigration all are affecting the different market. So I think generally there's going to be less upward pressure, more downward pressure,

but also I think it'll be definitely varying by the spread among regions will be great as it has been the last, I don't know, let's say, a few quarters. Yeah, yeah, yeah, yeah. We do these repeat sales indices where we track actual transaction and create indices. And just to your point, national, house prices are down. And how about I'm not taking your statistic, Chris, down 2% from the peak back last summer. But in San Francisco, the Bay Area, it's down 10 to 15, depending on where in the Bay Area you're looking. That gives you a real sense of it. And actually in the pending home sales report,

if you look at it by region, the West was the only region where pending home sales fell. Oh, is that right? In every other region, yeah. Okay, that would be consistent. Interesting. Hey, Chris, what's your statistic? I was going to go with housing, but I'll go 42. 42.2. 42. Oh, another 42.2. Statistically, that came out this week. Yes. Is it derived?

It's derived. So it's a ratio of something to something. It's a difference between. It's a difference. Is it a percent difference? Is it the jobs plentiful minus jobs hard to get from? No. Oh, no.

That's a really good, good. Yeah, that's a good one because that's got to be pretty close to that 42. point. Is it coming from a survey like that, Michigan? It's coming from Michigan, University of Michigan. And another one. Oh, is it the difference between conference boarded in Michigan? Oh, that's masterful, I'll have to say. That was masterful. There's a cowbell. Yeah, there you go. You want to explain, Chris? Sure. So it's the difference between the conference board, consumer confidence survey and the University of Michigan Consumer Sentiment survey, conference board was actually up from February to March, from 103.4

to 104.2. The Michigan was down, right? So they moved in different directions. They have different focus. So the conference board really focuses more, I would say, on the labor market. So it does suggest that consumers still feel some strength in the labor market. That's creating some of that confidence. University of Michigan tends to focus on stock market gas prices, more pocketbook issues. So there's some weakness there. The difference is interesting just because historically, when these two measures have diverged, we have had recessions. So it's not at the largest differential, but it's quite elevated. So it does suggest that there might be some of that tension between what consumers feel in terms of labor market, which tends to be lagging, and what they're feeling

elsewhere in the economy, which might be more forward-looking in terms of their spending. Right. Have we ever had a situation where we've had this wide gap and it's closed because Michigan has risen and conference board has remained stable? Or is it always been the opposite? Oh, I should take a look. I'd be curious. Yeah, just really curious.

That would either support your view or my view. Sharmeans view. So, okay. All right, I got, I got one more statistic and then when we're going to move on, I hope this isn't too hard. 3.3%. That's Moody's Analytics, house price index, you're over your growth break. No. Well, maybe.

That is. He said that with a lot of confidence. Is it really? Okay, but that's not. Is it really? February to February. Yeah. Sharmin, did you see how proud he was of coming up with that answer?

He was so proud. I'm sitting here saying, no, that's not the one. That's not the one I was thinking of. That's funny. But that's good. That's really good. Well, and obviously, sequentially, it's declining, right? But because it said strong price growth a year ago, it's still up on a year-over-year basis.

But that's going to change pretty soon, isn't it? Yeah. Yeah. Another month or two. Okay. All right. How about your home in Pennsylvania? How's that doing, Chris?

Probably better than your crypto portfolio. I'm just, you know, no? I don't know. Crypto portfolio is doing pretty good. His back up again? Okay. It's zero and still zero. Okay.

Okay. Fair enough. Fair enough. Okay, no, no. But in all. Another 3.3. In all seriousness, I had another 3.3% in mind. Is it an income measure?

It's an income measure. Gosh, Marissa is on fire. My gosh. Yeah. Disposable income? Disposable income. And what is it? You know, just give me a little bit more.

Real, real? Real, very good. Real disposable income. Year over year. Year over year. Yeah. Oh, that's perfect. That's teamwork.

Yeah, 3.3%. So this is important going back to recession because, you know, real incomes, real after-tax incomes are now rising. And after falling pretty significantly in 2021 through the first half of 2022, and that's on top of a lot of still available excess savings that households built up during the pandemic, particularly among high income and middle income households. So it feels like to me that consumers have a lot of kind of financial firepower here, at least in aggregate.

I mean, I'm glossing over the distribution. Yes, low income households are under a lot of pressure and yes, they're borrowing against their cards. And I would expect some weakness there in spending. But for middle income, high income households, it feels like they've got, a lot of firepower there. And that's obviously key to any recession. It's hard to see how an economy goes into recession if consumers are doing their part. So just a reason for a bit of optimism.

Okay. So what do you think, Charmaine? What do you think of that? I'm so glad I didn't participate. I wouldn't have even come close on any of them. Yeah, we have a lot of fun with this. So let's turn back to China. And then I know you're running out of time.

maybe we'll talk for the next 10, 15 minutes about your perspective on China. And here I'll have to say, maybe this is just my take on looking at the work relatively quickly. Here you have a glass half-empty kind of perspective. Your views of China are that it's going to struggle here. Do I have that roughly right? You have that completely right, dead right. Yes, that sounds great.

We actually wrote a report in 2013 about emerging markets in general. And we said emerging markets when the tide goes out, referring to the Warren Buffett expression and saying that basically the tide has gone out on emerging markets. They have major structural fault lines and they didn't deal with them when they had their goldilocks periods after China joined the WTO. So let's say from 03 or 405, et cetera, over that window. And then we did a report on China. In early 2016, we published it, and we said, walled in China's great dilemma. And the message there was that China has no great options in terms of do they increase debt to maintain growth? What do they do in the property sector? How can they boost consumption? What do they do with their state on enterprises? Do they actually follow through on reforms? And that all of these measures would slow down growth. And would they be willing to make the short-term trade off for the long term. So even though people say China's very focused on the long term, actually,

it seems that they, over this window, they wanted to avoid the slowdown shorter. And we then decided that we should update that report that was published at the beginning of 2016, because our view was actually that the outlook was worse than when we published that report and that people were underestimating the significant headwinds that China faces. And so we wrote this report, middle kingdom, middle income, that China will not become a high-income country and that they face significant headwinds, everything from demographics to too much debt, to stalled reforms, to too much investment in property and infrastructure, which will result in rising debt and defaults, which means then the central government will have to absorb this, to obviously very significant

geopolitical headwinds. And people really underestimate the structural issues, labor productivity. As a very good example, people think it's an incredibly productive labor force. It's actually a particularly uneducated labor force in aggregate when you're talking about the numbers. And the fact is that when you look at a ranking of whatever source you want to use, World Bank, governance indicators, OECD data, whatever source you'd like to use, you actually can see it's a particularly not well-educated workforce that will mean much lower labor productivity. The debt is significant. It's not an opinion. It's sort of a fact. And so as we look forward, our view is China's GDP prior to COVID. And we just like to look at the data taking out

these few years. Average 7.7. Our view is starting with 2023 for the next 10 years. It's going to be about 3.5 percent, ending at 2.5 by the end of 2032. So that means that half the growth rate. rate. So investors need to think about what that means in terms of growth and earnings per share growth. Exporters. So if you're Australia, if you're Brazil, if you're Saudi Arabia, if you're European luxury goods, all people need to think about a much slower growth economy. And what does that mean for their sales? And obviously, what does that mean for their funding capability from a geopolitical perspective with what they want to do with the military? Yeah, it's a, pretty sobering. And you think about all the negatives here, and you did great job in that paper

going through them from the demographics, the decline in the working age population, all the way now down to the tensions between China, the U.S. and other Western nations and kind of the de-globalization that's going on. I don't know if you use that word, but I'm putting words in your mouth. I mean, we're kind of pulling away from each other. And, of course, that's a lot. And, of course, hurts everybody, but China is so such an open economy that's got, it's going to hurt China a lot more than, you know, an economy like the U.S. is more insular. Now, you put that paper out, there are, you know, folks out there, China Bulls that, you know, take a very different perspective. What, what's the, like, the most significant pushback that you got? Like, someone saying, no, you're

wrong. And here's the reason why. What is that reason? Because it's just, it's so compelling to me, your argument. I'm having a hard time thinking the other, the counter here. Have you heard a good argument on the other side of this? Well, I could tell you that since you mentioned Larry Summers, he actually gave incredible feedback and thought it was a very thorough, very balanced, very well-researched report. And we actually, I don't know if you actually look at the report, you'll see all the different people across different spectrums that we spoke to, including bulls and bears. So we have spent a lot of time with those who are bullish on China to go through their arguments and what has changed and what hasn't changed. So for example, somebody might say,

well, China actually continues to like small businesses. But the facts are from a private versus public sector, the Chinese Communist Party is getting much more involved in the private sector. And the return on assets, the profitability, the profit margins are substantially greater in the private sector than in state-owned enterprises. So that itself tells you something. The fact that, for example, Chinese growth has outpaced that of the U.S., let's say roughly since the beginning of the MSCI index by, let's say, high single-digit, 7%, 8%, yet the earnings per share has been the exact opposite. US with slower growth has far outpaced in terms of earnings per share growth. If you look at the MSCI China Index, actually from a price perspective,

since inception is negative. If you look at the performance of earnings and market pricing since the trough of the global financial crisis, China's returns are a quarter of that of the U.S. So think about assets compounding at 16, 17 percent versus something that's sort of low mid-single digit. It's just incredible. So when people who are more bullish make statements, for example, they're quite vocal people who say China has a more educated population. That is just factually not correct. People can talk about, for example, how different countries treat people when it comes to governance, when it comes to social issues, when it comes to environmental issues, China just doesn't

compare to the U.S. So when people make these statements, they're assertions. They're not factually based. And there's some people who have higher profiles and go out there and make these statements and people hear them. But whenever we show the data, objective facts, not a glass half full, half empty, but the actual facts,

people actually tend to agree with our general observations. Yeah, and it has enormous implications. I mean, you know, in terms of global growth, but also, as you point out, in terms of commodity prices, right, for everything from oil to coal to metals and minerals, agricultural products. So that has very significant implications around the world if China's going to experience that much slower growth.

Yes. And it also has implications. If you think of GDP per capita in China versus the U.S., China's GDP per capita is below the poverty level of the United States. People forget that. It's a large economy, but it's a poor economy. And so they need continued growth. And if they're achieving growth at these lower levels, what does that mean in terms of

their ability to fund education, to fund social social? security to do things that would enable them to actually become a high-income country. And it's just they're in this trap. That's why we said walled in. They have no great options. We said that in 2016. And now they have even less with a much greater focus on military expansion, which again, crowds out other investments.

And that's one thing that worries me a bit is, you know, China is a very diverse place. The demographics are quite diverse. and you can kind of manage that diversity and thought in culture when things are going well, when your economy is growing quickly, when your incomes are rising, when wealth is increasing and people are getting homes and didn't have homes before. But that's a lot more difficult to manage, you know, when your economy is struggling for an extended period of time, especially in a non-demic, this is increasingly China feels less democratic, certainly less democratic, you know, can debate to what degree, but it is certainly

less democratic today than it was, you know, 10 years ago or maybe even 20 years ago. It's hard for people to find an outlook to express their frustration and to change things. And that even adds to it. So the concern is, you know, what does it mean for kind of the internal stability of the country, but also what it means in terms of their geopolitical perspective? You know, this goes to the China, Taiwan kind of issue. Because as we've seen around the world, and the most obvious case study here is Russia and Putin, the leadership will use external threats as a way to kind of try to manage their internal populations and the stresses in their internal population.

Is that something that you think is a reasonable scenario to consider? Is that something that you feel like that might be an issue here as well? Obviously, geopolitics is not our expertise. So we talk to people who are much more knowledgeable than we are. And we actually have a lot of information in the report on the headwind from a geopolitical perspective. And we actually outline all the different national security strategies that different countries have put forth.

There's a great exhibit in the report where we take the U.S. and its allies. in terms of these issues. So it would be obviously U.S., it's Canada, it's Australia, it's Japan, it's all of Europe, et cetera. And then we take Russia and China. And we say, look at the aggregate GDP of those countries relative to Russia and China together. And it's about a third. Then you look at GDP per capita and it's about a quarter. Then you look at top universities.

You look at Nobel laureates and it's substantially less. on the forward when you're talking about productivity, when you're talking about innovation, et cetera. And so when you look at that combination, you would say, why would actually these two countries choose to divide the world and become so hostile towards the West in some ways? And why is that economically reasonable?

And from our perspective, it is not a economically rational decision. And we try to emphasize that, because at the end of the day, if ideology is dominating the economy, then it's not relevant. There's actually a great exhibit. We think it really conveys the image so well.

The sort of the announcement of the B-21 bomber. They had that incredible launch in December with this beautiful imagery and this incredible piece of machinery. And then also in December, the wide-bodied airplanes, the C-919 and China also did its first flight. And what's interesting is the vast majority of the components, the parts of the parts of, of the C-919 come from the U.S. and Western Europe. And so when people talk about technology and where each country stands, we have that as an image that the vast majority,

and together we're talking about over 80%. We're not taking 60, 65, 70. It's well over 80% comes from the U.S. and Europe. It's fascinating. We're coming to the end here, but I'm going to make you play the game. So this is based on your report, great table, and you kind of mentioned it already.

Here's the number, 407. 47. Yeah, it's your number. It's your number. It's a 95-page report. I'm a careful consumer. I told you. Yeah.

You looked at, no, no, you're cheating because you looked at the summary deck I sent you. You didn't read the whole report. It's true. It's true. It's true. Although it's the number of U.S. Nobel laureates, 407. Yeah. Yeah. And of course, China, actually, I was a little surprised Europe had more. I can't remember how many total Nobel laureates.

It might have been close to a thousand. Yeah, that's about what the number was. Yeah. About a thousand. Yeah. And of course, China had very few. But anyway, that one thing, Charming, though, that I, you know, because I'm right with you with your perspective on China, I always guard against them. I have a hard time kind of correcting for it. And you mentioned there are predisposition to be either half full or half empty. The other is, home bias. You know, I, I, I feel like, you know, I'm an American. You know, I have a team and I'm, I'm always worried that, you know, I'm, in fact, here's a, here's a interesting observation, really to me interesting, because from my travels around the world, I'm curious what you think. Everyone tends to be more optimistic about their own country than every other country, all else being equal, except there's, one country where that's not true. And that's apropos to the kind of the ethnic heritage of this panel. And that's Italians. The Italians to think things are worse than they actually are. Everywhere else, certainly in America in the United States, we overestimate, we're overly optimistic about things. Does that, is that entered into your thinking at all? That there might be a home bias in the way we're thinking about the rest of the world, particularly like a China? Are you self-aware and you try to correct for that?

The group is very, very international. So if you look at the list of people who actually are involved in writing the report with me, our team, we have Brazilian, we have Chinese, Chinese, meaning people's Republic of China, Chinese, not American Chinese, who are based either in the U.S., in Europe or actually in Hong Kong. We have Mexicans on the team. We have Indians, people born and raised in those countries. So it's actually the team that gets involved in the report has a lot of people from emerging markets. And so when you look at it, I don't think there's any home bias.

Even though people have asked us, are you U.S. centric just because we emphasize U.S. preeminence. But again, look at the market returns, right? Look at the role of the dollar. I mean, just you look at all these factors. It's hard to argue against it, even though there are people? people who do that. Yeah, yeah, makes sense. Well, I want to thank you, Charmaine, for spending the time with us. I know your time is a great value and really do appreciate it. And I'm going to keep plugging you. You're my cousin. I'm going to hug you hard. We love that. We love that.

We love that. Thank you. It really was great fun. This was great fun. Thank you. Thank you. And dear listener, we will be back to you next week. Take care now.