Goldilocks markets over?

“The ‘Goldilocks’ combination is unlikely to last; like Goldilocks herself, the market might get away with it for a while but it will eventually get caught by a bear” — Peter Oppenheimer analyst at Goldman Sachs.

Financial markets have benefited from what’s been called ‘Goldilocks’ scenario by analysts at Goldman Sachs for the past few years. A lack of volatility, falling bond yields and a desire by central banks around the world to do ‘whatever it takes’ to keep interest rates low has supported equity and bond yields. These Goldilocks conditions have almost reached a peak this summer as market volatility plunged to record lows, along with bond yields and trading volumes while markets pushed to record highs.

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The big question is, how much longer will these conditions last? Anyone who has been involved in the capital markets for more than ten years will know that calm does not last forever and sooner or later volatility will return, but what will be the catalyst that kills Goldilocks?

What will bring an end to the Goldilocks conditions supporting markets?

In a research report sent out to clients at the end of last week, Goldman Sachs’ Peter Oppenheimer laid out what he believes could be the four catalysts that influence market movements going forward. The four key scenarios are, a continuation of the Goldilocks theme, reflation, fat and flat or stagflation. Each theme will have a different outcome for equities as Oppenheimer explains:

“We see four main scenarios from here: (1) Goldilocks (the narrative behind the recent rally): Rising growth without higher bond yields – equity valuations go higher; high beta outperforms. (2) Reflation: Rising growth but with higher bond yields – equities go higher as earnings improve (but rising yields cap valuation expansion); cyclicals and financials outperform. (3) ‘Fat & Flat’: A continuation of the existing trend – moderate growth with yields staying low and valuations remaining unchanged; ‘stable growth’ and income outperform. (4) Stagflation: Higher inflation and yields but without stronger growth – equities de-rate, commodities outperform.”

More importantly however Oppenheimer goes on to explain that in his view, it is unlikely the Goldilocks scenario will continue as there are many different headwinds which could spark a sudden change in opinion by market participants:

“The ‘Goldilocks’ combination is unlikely to last; like Goldilocks herself, the market might get away with it for a while but it will eventually get caught by a bear. Either bond yields and interest rates stay at record lows and economic and profit growth disappoints once again (capping valuations), or growth and inflation surprise to the upside (perhaps on the back of more fiscal easing) but bond yields adjust higher (also capping valuations).”

All things considered, Oppenheimer believes fat and flat is the most likely outcome for equities going forward.

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