The perils of predicting: Goldman Sachs gone mad

I  came across a very smart observation yesterday which went something along the line of markets currently having to trade from one economic release to the next as they have no consensus view as to what lies any further ahead. At the same time, Fed officials and their peers are all over the wires reaffirming the validity of the 2 per cent inflation target. The latest on this came from Mary Daly, president of the San Francisco Fed, when speaking at a Brookings Institution event at the Hutchins Center on Fiscal and Monetary Policy.

There are no less than two more rate increases to be expected, maybe more, if the US central bank is to hit its 2 per cent target. At the same time, however, forward markets are pricing US CPI to fall no lower than 3.95 per cent a year ahead and 2.95 per cent three years from now. Either the Fed or the market will have got it wrong although based on the skittish way in which markets are trading, who knows?  Whether it is one or both and whether it is to the upside or the downside is anybody’s guess.
 
It’s not yet supposed to be the silly season, something which the once mighty Vampire Squid, Goldman Sachs, seems to have missed. Goldman’s economists have come out with one of the most ridiculous pieces of “research” that I can remember. According to the firm’s brainboxes, India is “poised” to displace the United States as the world’s second-largest economy. And when, according to these geniuses, is it “poised” to undertake the overtake? This year? Next year? No, by 2075. Yes, the wizards of 200 West Street are making a prediction 52 years into the future. I don’t know how many of them went to the latest rave DJ’d by their chairman, CEO and Muppet-in-Chief David “DJ D-Sol” Solomon and what they snorted or popped whilst there but I have rarely in my 45 years in the industry read such a meaningless piece of irrelevant economic conjecture. How the mighty fall.   
 
Currently, US per capita GDP is estimated by the IMF to be wrapped around US$ 80,000 but that of China to be under US$ 24,000. China’s population, however, is around 1.4 billion as opposed to the USA with 336 million. Which country is inherently richer? The weight of numbers does make straight comparisons a little meaningless. On the other hand, if I were to go back 52 years to 1971, China was in the midst of Mao Zedong’s ruthlessly destructive Cultural Revolution and anybody, Goldman economist included, who would have forecast that in 2023 or thereabouts China’s economy would be overtaking that of the USA would have been taken off the desk to wait for the men in white to come and pick them up, once confined in a straitjacket. Not so much for the forecast per se but for being so crazy as to expect anyone to read an economic projection over a half-century ahead and expect to be taken seriously. In 1971, the Vietnam War was in full swing, as was civil unrest in the streets of America. The 6 Day War of 1967 had made Israel the wunderkind of the world and the Yom Kippur War was still two years away. So, of course, was the oil shock. The Cold War was also at its coldest although just two years earlier the Americans had hit the jackpot by beating the USSR and putting a man on the moon with a few computers and a lot of long-hand arithmetic. Oil was trading between US$ 2.55 and US$ 3.15 per barrel. The Dow was at 6,500 pts and the S&P500 in the mid-700s. In June ’82, by the way, the S&P was back down at a low of 334 pts, having peaked in December 1968 at just a whisker under 900 pts. In the 14 years from ’68 to ’82, the main US stock index had lost knocking on two-thirds of its value.
 
I would never say that history repeats itself. It doesn’t. But it might also be wise not to assume that stocks always can only go one way. As John Maynard Keynes said, in the long run we’re all dead. Current Indian per capita GDP is under US$ 9,000 and in 2023 the entire country is calculated to generate US$3.7 trn in GDP whereas the USA is expected to throw off US$ 26 trn.
 
Sure, the growth of China over the past 30 years has been epic but can we expect the same growth rates in India? From an environmental perspective, that sort of growth rate would be catastrophic. We know the damage that the rise of China has brought with it. Any fundamental energy transition, the kind of which both India and China currently seem to insist on refusing to adopt, will surely kill off the sort of growth rate which would be needed for India to emerge in the way in which Goldman is forecasting. One can barely expect Wall Street’s finest to assume that the overtake will be generated by a decline of God’s own country. Yikes!
 
So, instead of worrying about where India will be in 2075, how about looking at the quality of Goldman’s forecasting for tomorrow’s monthly US CPI figures. There is enough debate going on about the meaning of headline CPI as opposed to the core. Great! To the less well-off and to the elderly, food and energy consumes by far the largest part of their daily, weekly or monthly household budgets. To them the cost of 90 per cent of the items measured in the core inflation number mean little. Apart from that, even if inflation falls, the price of goods doesn’t. A decline in the velocity of price increases is disinflation. A decline in prices is deflation. Energy prices have fallen precipitously since the mad times of Spring and Summer 2022 but there is no deflation in sight either which means that the overall cost of living might be rising at a slower pace but it clearly will not be coming back down. And so we will continue to get hot under the collar over the decimals on a guess.
 
It is not just the nature of inflation which has one wondering. The UK government commissioned a review of equity research by the lawyer Rachel Kent. Time has come to free London up from Brussels and from MiFID 2, possibly one of the most misguided pieces of market legislation ever written. With over 30,000 pages and 1.4 million individual rules, it is surely the craziest attempt at catching the wind. If anybody ever wanted to know what the sort of overreach was that motivated many City traders to vote for Brexit, look no further. I have in the past written about my modest involvement around the fringes of its emergence although the attitude of the authorities to suggestions and recommendations from the coalface was such that as far as I was concerned MiFID 2 was doomed to turn into a book that would be no good for anything other than lighting the fire.
 
That might be a bit harsh but the fact is that the markets are not a level playing field, never have been and never will be. The rule that research should no longer be free and should have to be paid for was driven by the assumption that supplying it free of cost would encourage deals to be directed towards the providers. I can assure you that in the 30 years I spent at the sharp end of the market, I never once had a conversation with a client which mentioned our research output and an implicit obligation to pass me some business. Bond trading is and always has been about price and nothing else. It’s head to head competition to the death and anybody who believes that a good piece of economic or credit research has ever made the difference must have been hanging out with Goldman’s India desk. I long ago discovered that all that wonderful research went straight into a drawer. When the client made money, it was his or her skill. When money was lost, a piece was pulled back out of the drawer and shown to the boss with the words “But so and so wrote this and that; it made sense at the time. But guess they must have been wrong. Not my fault. Sorry.”  
 
I have been writing my little missives for longer than I care to remember although when MiFID 2 came into force in 2014, I did have some recipients call me in order to ask me to take them off as it had been deemed by some compliance animal to be unpaid for research. Doh!
 
Equity markets work in a different way and there was a culture of exchanging research for execution orders. We bond sales people looked down on our counterparts in equities. We needed to know our stuff and tell good enough a story to get asked a price, albeit in blind competition and for best execution against at least two other houses. To us it seemed as though all the equity sales folks had to do was to arrange loads of meetings between their clients and their research analysts and then to sit back and ring the till when the order came in. The idea of paid-for research appealed in as much as it separated it from trading. Older readers will remember “softing”, when everything from Bloomberg terminals to all expenses paid research trips were offered to investors in exchange for a measurable flow of business.
 
But people don’t want to pay for research and most certainly not in the breadth and depth that free research provided. The output by brokers and therefore the diversity of opinions has declined so that the overall landscape facing investors is significantly less transparent. Please don’t get me wrong; I’m not suggesting that averaging 20 earnings forecasts will get much closer to the reality than that of 10 or even 3 but every little helps and it is in some of the marginal observations that the thought provoking value added is to be found.
 
MiFID 2 was supposed to level the playing field between large institutional investors and private punters. No one was supposed to be privileged. It’s not whether my order for 20 shares gets executed before Met Life’s for 20,000. It’s about who’s phone line gets picked up first. I once had a client, now retired, whom had I pursued for many years before we wrote our first trade. He tried to direct his business to just three firms. Today that would be questioned. At the time it was admired. His opinion was that as he had only a limited amount of business to do, he wanted to be a top client with three firms rather than an average one with more. He wanted to be on the list of the first investors to be called when there was news to be told. “Premium clients get premium service” was his mantra. Although I was at BNP where we prided ourselves for our prowess in German, French and Italian bonds, it was as dealers in Danish ones that we finally broke in. He is, by the way, still a dear friend. I digress.
 
Rachel Kent’s brief has been to see how MiFID rules can be rolled back and how the City can emerge as less regulated that the centres of Paris, Frankfurt and above all Amsterdam. Part of her “solution” includes what appears to be a kind of government-sponsored research hub. Perish the thought.
 
Fact is that markets are dog eat dog and as far as I am concerned that is what they should remain. Just like football. Or will some government-sponsored investigation conclude that the top teams should have to sell their best players at a discount to the bottom teams so that everybody has an equal chance? I liked the City when it was a jungle. It wasn’t fair but it had rules which it had developed itself, not ones that had been imposed by a bunch of civil servants who have never carried risk. When at BNP, we had a high profile, albeit rather dodgy Irish head of derivatives trading. When one of the ubiquitous French functionaries would show up and try to instruct him what to do, his stock answer was “…and how much did you make for the bank today?”  He got fired when they found his books to be a bit on the side of creative. He went on to become the CEO of one of the City’s biggest and most powerful brokers. On my conscience I carry only two memorable trades which I maybe should not have done. Life just isn’t fair. 

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