Recent market movements have priced in a significant negative growth shock, and even with some easing, the magnitude of concern over growth remains large compared to forecast adjustments, Goldman Sachs strategists said Tuesday.
Although the realization of their more benign central scenario could provide relief over time, two factors complicate the conclusion that the market has overreacted to macroeconomic conditions.
First, growth risks have increased. While Goldman’s baseline growth forecasts remain unchanged, their economists have raised the probability of a recession within the next 12 months from 15% to 25%.
“The main determinant of whether the market has ‘gone too far’ is the growth outlook—if recession does materialize, then there is room to fall,” strategists said in a note.
“Assets are not generally priced for recessionary outcomes, even if some markets were briefly in that zone last week,” they added.
Second, it’s possible that the market had already overestimated growth before the recent concerns emerged, the investment bank points out.
More concretely, the market might have become too optimistic about growth earlier in the year, outpacing the upgrades in consensus growth forecasts.
“We find some evidence that may have been the case, with the market seeming to have upgraded growth throughout the year by more than the accompanying upgrade in consensus growth forecasts,” strategists continued.
At the asset level, before the recent correction, equity implied volatility had been somewhat lower than what the macroeconomic backdrop might typically suggest. U.S. equities were overvalued, and both cyclical stocks and the Yen appeared disconnected from their usual relationships with fundamentals.
The current challenge, according to Goldman Sachs, is to find strategies that align with their more benign central scenario while also managing the downside risks posed by growth concerns and fragile market sentiment.
Strategists believe that the future path depends heavily on upcoming data, with the added uncertainty of the approaching presidential election in November. They expect that the focus will likely shift towards the potential for a recession, making markets more sensitive than usual to new information regarding growth and the labor market.