[Outlook 2009] Goldman seeks big rally

Posted by Neil Hume on Dec 05 08:56.

Goldman has published its Outlook for 2009 and it’s quite upbeat. Not as upbeat as the piece published by UBS on Tuesday obviously, but…

Strategist Peter Oppenheimer is looking for a big rally in the second half of next year (30-50%), but says markets could fall further (20-30%) before then.

In our view, fears of debt deflation are probably overdone — the mistakes of the 1930s, and Japan in the 1990s, are unlikely to be repeated as government action becomes ever more aggressive, coordinated and unorthodox. But we live in an age where the unexpected happens — regularly. Investors are prone to assume the worst before they are proved wrong. Governments are seen as guilty until proven innocent, and so deflation, while unlikely in our view, is likely to be priced as a growing probability in the near term.

In any case, we remain too early in the process of growth deterioration for investors to start pricing in the next recovery. We believe markets are vulnerable to a 20%-30% fall from current levels before they recover, based on a deflation scenario being priced in.

Nonetheless, many markets have experienced record falls (the US is likely to have had its worst ever year based on data since 1900) and on many measures, value abounds across risky assets. When markets do eventually turn, they are likely to do so very rapidly. Our best guess of when they might rally is around the middle of the year, based on estimates of growth momentum. A rally of 30%-50% off the low is quite likely, in our view.

And so Mr Oppenheimer’s main conclusions are:
We believe equities are cheap and already pricing a sustained recession.

• However, we believe equities are still vulnerable on the downside in the near term as economic activity, default rates and working capital constraints reduce risk willingness further and investors price in an increased probability of deflation. We see a further 20% downside risk on the DJ Stoxx to 160, based on a short-lived deflation scenario.

• While most risky assets look inexpensive relative to history, on a risk-adjusted basis, investment grade credit appears cheapest. We believe the credit market needs to normalize for the equity market to enter a new bull phase.

• We believe that the market will transition into a sustained upturn from around Q2 or the middle of 2009, staging a rally of at least 30%-50% from the trough over the following 6-12 months.