Sharmin Mossavar-Rahmani, chief investment officer of wealth management at Goldman Sachs, has been bullish on the U.S. for more than two decades, and bearish on China since 2013. Those calls look even better today, given the diminishing likelihood of a U.S. recession even as China’s growth sags and its financial troubles grow.
Mossavar-Rahmani, an economist who has spent more than 30 years at Goldman, has long warned about China’s rising debt load and the challenges it poses for the world’s second-largest economy. As cheap valuations abroad enticed investors, Mossavar-Rahmani urged clients to keep their portfolios tilted toward U.S. stocks. Last year, as inflation concerns in the U.S. grew and pessimism about the stock market set in, she rightly encouraged investors to stay put in U.S. stocks.
The
S&P 500 index
fell 18% last year; this year, it is up 18%, so far.
Mossavar-Rahmani talked with Barron’s by phone in late August about the recession outlook in the U.S., why U.S. stocks aren’t as pricey as they seem, and what’s behind China’s deepening economic challenges. An edited version of the conversation follows.
Barron’s: What is your economic and market outlook for the next 12 months?
Sharmin Mossavar-Rahmani: For now, we have lowered the probability of a U.S. recession to 30% to 40% [from 45% to 55%] for the next 12 months. We are at the lower end of that range. For context, looking at the frequency of recession since World War II, it is an 18% probability. Since 1980, it has been 12%.
We aren’t at extremes—in leverage or valuation in the markets—so the ability of the U.S. economy to absorb shocks is greater, reducing the likelihood of recession. But we have given ourselves a 10% range for recession probabilities since the beginning of 2023.
The inflation outlook is driving uncertainty about the economic outlook. Where is inflation headed?
We see inflation headed lower, with headline inflation at the end of the fourth quarter a little above 3% and core inflation just under 4% because of the impact of [higher] energy [prices]. The stickiness of wages is going to trend down slowly. Look at job openings versus unemployment. The gap has narrowed and continues to do so.
Another 25-basis-point tightening in interest rates would surprise the markets. [A basis point is a hundredth of a percentage point.] Would the Federal Reserve lift rates another one or two times because of stronger growth or stickier inflation? That would increase the odds of a recession later in 2024. There is more likelihood that the Fed will cut rates toward the latter half of [next] year. We expect a cut of around three quarters of a percentage point, compared with the market’s expectation of a one-percentage-point cut.
China’s economic recovery has sputtered. What is the likely fallout here?
We have had a generally bearish outlook for China since 2013. Ten years prior to Covid, China’s annual growth was 7.7%. The target now is going to be, at best, 3.5% on average, and 2.5% by the end of 2032. It isn’t an implosion but a steady decline that they can’t do anything about.
Major exporters to China will be most severely impacted by this decline. The U.S. isn’t a major exporter. It is less than 1% of China’s GDP. But a country like Australia, with its iron-ore exports, or Chile, or Saudi Arabia with oil, needs to factor in slower growth.
Why are the Chinese authorities so hamstrung in reversing the decline?
They didn’t institute reforms during the “Goldilocks” period when emerging markets benefited from China’s joining the World Trade Organization. They didn’t do anything when foreign direct investment and portfolio flows were still interested in China. Now, the headwinds are insurmountable.
There is nothing the government can do about demographics, which are unfavorable. There is nothing good they can do to have an immediate impact on low levels of productivity and education. There is nothing they can do about the geopolitical headwinds. China isn’t going to backtrack on its support for Russia. In some ways, it is doubling down and acting aggressively in the Indo-Pacific region. The backlash from other countries isn’t going to abate.
When you think about the three pillars [of growth], exports will be a big focus. Property is steadily declining, and the country has too much infrastructure. China is repeating the mistakes of Japan in terms of roads to nowhere, and those of the former Soviet Union by trying to win allies that are generally much weaker. Also, China is increasing its military expenditures.
What does that mean for investors?
People have changed their view of China’s long-term intentions and woken up to the reality of the economy and the geopolitical atmosphere. We have had a significant underweight to emerging markets that started in 2013 and a theme of U.S. pre-eminence since the inception of the group in 2001—and those two themes continue.
Which companies are most at risk from China’s slowing growth?
Rio Tinto
[ticker: RIO] and European luxury-goods companies such as
Swatch
(SWGAY),
LVMH Moët Hennessy Louis Vuitton
[MC.France], and
Hermès International
[RMS.France] will be affected by the slower growth rate and the change [in sentiment] in showing off high-end luxury goods. When we speak to our clients, [they say] they are not going to want to attend lavish galas or have lavish goods on public display in that environment.
U.S. companies have earnings [exposure] to China, but nothing like European companies such as
BMW
[BMW.Germany],
Adidas
[ADS.Germany], or
BASF
[BASFY]. There are some technology companies in the U.S. that would be affected, but some of those exports are then re-exported, so slower growth in China might not have as much impact. But
Tesla
[TSLA] would be affected.
What type of stimulus is China likely to unleash?
We can’t see something that would change anything in a meaningful way, unless there is a huge transfer of assets to the consumer—local governments, for instance, giving land in rural areas to consumers, or [authorities] providing a lot of support to the average depositor.
Do you see more meaningful interest-rate cuts?
China’s central bank won’t do that because it doesn’t want to hurt the state-owned banks. Interest margins would shrink in an already deteriorating economic environment.
If China lowers lending rates to stimulate the economy, it will also lower deposit rates that savers earn. Such a policy only hinders the much-required rebalancing of the economy toward consumption and away from property, infrastructure, and exports. China’s measures will all be temporary Band-Aids.
Does this bolster your view of U.S. pre-eminence, even though U.S. stocks have done well this year?
Yes. Earnings growth in the U.S. has far outpaced other regions. The earnings of companies in the
MSCI China index
have declined 20% going back almost a decade, while U.S. corporate earnings are up 65%. [Equity] valuations reflect much faster earnings growth in the U.S. with a lot more stability.
Looking at the markets and adjusting for sector weights, the U.S. is still more expensive than China and other markets, but not as expensive. The forward price/earnings multiple for the
MSCI Emerging Markets Index,
adjusted for sector weight, is 15.8 versus more than 18 for the U.S. India is trading at a huge premium to the U.S.—a 34% premium after adjusting for sector weights.
Investors are excited about India as they seek a China alternative. Is the bullish view warranted?
People are too optimistic about earnings growth and about India absorbing the de-risking from China in a meaningful way. For companies to either move to India or incrementally replace efforts in China is very difficult. There are issues of infrastructure, education of the labor force, tariffs, and bureaucracy. All of that must change.
What is the outlook for U.S. profits, given inflationary pressures and the reshuffling of supply chains?
Quarter-on-quarter margins have improved, providing good support for our view of earnings growth. Investors and analysts downgraded earnings [expectations], and both first- and second-quarter results surprised to the upside. Earnings will grow around mid-single digits, by 4% to 5% this year. Also, we aren’t so worried about inflation getting out of hand. That supports the equity market. Long-term earnings-per-share growth since World War II is about 6%, so 4% to 5% isn’t that small.
If the U.S. is the place to be, what should investors buy?
We have a small allocation to MLPs [master limited partnerships], given our view that energy prices will hover between $70 and $100. But we don’t have a conviction right now to be overweight any one sector. We have looked at past episodes in which growth outperformed value by a wide margin to see whether there is a pattern of growth continuing to outperform. In all the cases, the S&P 500 is higher, so our view is just to stick with the S&P 500 in this environment.
What pushback do you get on your bullish U.S. stance, especially with another presidential election ahead?
The U.S. pre-eminence view isn’t driven by any one factor. It is driven by U.S. labor productivity, the quality of human capital, and the incredible innovation here. S&P 500 companies’ corporate management has the highest ranking among corporate managements globally, based on a Stanford University study [of management practices and traits]. The view is also driven by the country’s natural resources, and its demographics, which are relatively better than other countries’. Short term, there could be volatility and dislocation. But long term, what drives the pre-eminence isn’t going to change, as the U.S. is ahead on many of the metrics that underpin economic growth.
What does the U.S. debt situation mean for bond portfolios?
We suggest high-quality securities to dampen portfolio volatility and hedge against a deflationary environment or geopolitical shock. In spite of the high level of federal debt relative to gross domestic product, or Fitch’s downgrade of the U.S. credit rating, U.S. Treasuries are still the safest and best asset class to own.
Thanks, Sharmin.
Write to Reshma Kapadia at [email protected]
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