Even Goldman Sachs Gets it Wrong Sometimes…

What a relief.

It’s not just me who gets things wrong and then has to fess up about it…sometimes sheepishly. Remember my prediction of a 40% house price crash in 2008 anyone?!

As Bloomberg reported this week:

Goldman Sachs to clients: whoops. Just six weeks into 2016, the New York-based bank has abandoned five of six recommended top trades for the year.

The dollar versus a basket of euro and yen; yields on Italian bonds versus their German counterparts; U.S. inflation expectations: Goldman Sachs Group Inc. was wrong on all that and more.

This is a reasonably big deal. Goldman Sachs is the ‘kingmaker’ on Wall Street. Once you’re in, you’re in for life. And being a Goldman Sachs alumnus can open doors and create opportunities like no other.

Look at the number of Goldman execs and representatives who are or have been in senior political and financial roles around the world…

Mark Carney — Governor of the Bank of England (formerly Governor of the Bank of Canada).

Mario Draghi — President of the European Central Bank.

Ian Macfarlane — former Governor of the Reserve Bank of Australia.

Robert Zoellick — former World Bank president.

Lawrence Summers — former Secretary of the US Treasury.

Hank Paulson — former Secretary of the US Treasury.

Mario Monti — former Italian prime minister.

And of course, Malcolm Turnbull, Australia’s current prime minister.

So for Goldman Sachs to get something wrong, it’s a big deal. Remember, it’s not so long ago, in May 2013, that Bloomberg reported this news:

Goldman Sachs Group Inc., which generated about half its revenue from trading last quarter, posted losses from that business on two days in the first three months of 2013, compared with one day a year earlier.

The bank’s traders made more than $100 million on 17 days in the quarter ended March 31, compared with 24 days in the year-earlier period…

If you can make money every…single…day (almost), you’re doing a pretty good job.

Of course, it’s easier for Goldman to make money from trading almost every day. As a market maker (price maker) it can simultaneously buy low and sell high without taking on board any risk.

It can simply use its position of market maker to beneficially trade the spread between buy and sell prices.

And there’s a big difference between trading the spread and making outright calls on market direction.

But who would have thought that the direction of the US dollar against the euro and Japanese yen would be the undoing of Goldman.

Here’s a chart from Bloomberg showing Goldman’s prediction, and the reality:

Source: BloombergClick to enlarge

That’s a big difference, especially in the foreign exchange markets, where a one-thousandth of a cent difference in the currency rates can mean the difference between millions in profits or millions in losses.

But at least they owned up to their mistake. Perhaps the folks at Goldman Sachs are human after all. Who’d have thunk it?

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Overnight, the US Dow Jones Industrial Average fell 99 points or 0.6%.

The S&P 500 index fell 0.02%.

Both indices were up, until turning south late in the day.

Earlier, European stocks bounced from the previous day’s slump. The Euro Stoxx 50 index closed up 1.9%.

The FTSE 100 index gained 0.7%, and Germany’s DAX index gained 1.6%.

On Asian markets, things just aren’t getting better. Today, the Hang Seng index is down 762 points, or 3.9%.

Japan’s Nikkei 225 index is down 372 points, or 2.3%. The Nikkei is down 7.9% since Monday. It has also given back all the gains and more from when the Bank of Japan announced a few weeks ago that it would impose negative interest rates on funds held at the central bank.

In the days following that announcement, the Nikkei soared. In the days since, it has slumped. The arrow on the chart below denotes when the Bank of Japan went negative:

Source: BloombergClick to enlarge

As we’ve said before, money printing and low interest rates just don’t have the impact that they once did.

Even the Fed can’t save stocks from falling

But wait!

When we say that money printing and low interest rates no longer have the same impact, we are of course only talking about the second tier of central banks — the Bank of Japan and European Central Bank.

What we really want to know is whether the markets will react the same way if the US Federal Reserve launches a new round of stimulus?

Wednesday night’s market gave us a small clue. And it may not be the kind of clue investors had hoped for. The arrow on the chart below highlights reports of Federal Reserve chairman, Dr Janet Yellen’s testimony to the US Congress:

Source: BloombergClick to enlarge

As Bloomberg reported of Dr Yellen’s testimony:

U.S stocks rose in choppy trading, while Treasuries and the dollar were little changed as Janet Yellen indicated the Federal Reserve won’t be in a rush to tighten monetary policy amid heightened financial-market turmoil.

In other words, unless the markets calm down, don’t expect the Fed to raise rates again anytime soon.

As usually happens with these things, the knee-jerk reaction is for the market to rise. Hooray, no more interest rate increases.

But as is so often the case in recent times (as with Japan and Europe), the market soon becomes bored. The promises of low interest rates and money printing just aren’t enough to convince investors that it’s worth buying stocks at relatively high prices.

And as the chart below shows, even though the price to earnings (PE) ratio for the US S&P 500 index is moving back to the 10 year average, you know that nothing ever stays at the average for long.

Source: BloombergClick to enlarge

A trend will always overshoot one way and then the other. That’s what creates an average. After spending three years above the average, it’s about time for the index to spend some time below the average.

And as we’ve shown before, Wall Street is still forecasting earnings way above what US companies can reasonably expect to deliver.

So we’d expect to see PE ratios fall significantly from here as company earnings disappoint investors, and share prices fall to reflect that disappointment.

The Aussie market may have bounced today, but we’re not yet ready to see that as the end of the current bearish trend.

Gold’s rise

That terrible and useless metal (sarcasm, folks), gold continues to bounce higher, in US and Aussie dollar terms.

As I write (Thursday afternoon), it’s trading at US$1,210 per ounce. In Aussie dollar terms, it’s AU$1,705 per ounce.

In Aussie dollars, it’s at the highest level since 2012, and only $100 from breaking the all-time high from 2011.

I’ve long advised investors to own gold. I’ve seen it as a hedge against a falling Aussie dollar, and a potential hedge against falling stock prices.

It’s why, even though my personal share portfolio has taken a beating in recent months, I haven’t sold a single share. That’s because as a long term investor, and an investor with a significant amount of gold in my portfolio (about 30–40% of the total value of the portfolio), as stocks have fallen, the value of my gold position has risen.

I guess that even if stock investors didn’t like what Janet Yellen had to say, it seems that gold investors certainly did.


Kris Sayce,

Publisher, Money Morning

Ed Note: This is an edited extract from an article first published in Port Phillip Insider.

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