The economy faces a headwind, not a hurricane

- Plus: China may reach energy self-sufficiency by 2060. --------------------------------------------------------------- In today's edition: - Our economists don't think the current banking system stress will [tip the U.S. economy into a recession.]( - What does the [turmoil mean for the bond market?]( - Competition between global powers is giving way to [geopolitical “swing states.”]( (Was this newsletter forwarded to you? [Sign up now.]( --------------------------------------------------------------- Why banking turmoil is a headwind, not a hurricane The full effect of the turmoil that started with the collapse of Silicon Valley Bank is still unclear, but our economists don't expect the stress on the banking system to tip the U.S. into a recession: They raised their forecast for a U.S. recession in the next 12 months to a probability of 35% (up from 25%), but their projections are still well below the consensus view among economic forecasters (60%). The tumult has caused Goldman Sachs Research to reduce its Q4/Q4 growth forecast to 1.1% (down from 1.5%), our chief economist Jan Hatzius [writes in the team's report.]( There are several key reasons our economists expect the impact of tighter credit to be smaller than some might have anticipated: - Banks have been tightening their lending standards since mid-2022, so the incremental impact of the recent turmoil on credit availability and growth should be much smaller than in 2008, when the prior economic expansion had been built on easy credit. In fact, the private sector runs a small financial surplus today, compared with a sizable deficit on the eve of the 2008 crisis. - Goldman Sachs Research doesn't expect larger banks — which have higher capital and liquidity standards than smaller banks and are subject to more stringent stress tests — to reduce their loan supply. - Unrealized losses on hold-to-maturity government bond portfolios have diminished in the recent rates market rally — another major difference with 2008 when the problem assets lost value during the crisis. - Demand for credit in commercial real estate — where 80% of outstanding bank loans are from banks with less than $250 billion in assets — was already under pressure because of post-Covid changes in the real economy, so the impact of reduced credit supply may end up being quite muted in that sector. Of course, the turmoil could still be made worse by another deposit run, Hatzius says. But U.S. Treasury Secretary Janet Yellen signalled that the Federal Deposit Insurance Corporation will continue to use the “systemic risk exception” aggressively to protect all depositors (insured and uninsured) in the event of additional bank failures. At least for now, this message seems to have helped, judging from data indicators and statements from officials. --------------------------------------------------------------- The stock alternative: bonds are back The flow of money in the U.S. into bond and money-market funds accelerated over the last two weeks amid jitters about the banking sector. The surge added to the shift in flows this year from stocks to lower-risk assets that offer more yield, [according to Goldman Sachs Research.]( The rise in yields shows that the era of “there is no alternative” (TINA) to stocks is over, as now “there are reasonable alternatives” (TARA), Goldman Sachs strategists Cormac Conners and David Kostin wrote in [the team's report](. U.S. Treasuries that mature in two years yield about 4%, up from around 2.4% a year ago. Our strategists expect households to sell $750 billion of stocks this year as they rotate into bond and money market funds. In a separate interview, Ashish Shah, chief investment officer of public investing at Goldman Sachs Asset Management, says bonds are again proving themselves to investors. The banking turmoil has refocused attention to diversified investments like the [classic 60/40 portfolio]( between stocks (60%) and bonds (40%). While that strategy struggled in 2022 as inflation concerns grew, bonds have rallied this year amid financial sector stress. [Read the rest of the Q&A with Ashish Shah.]( --------------------------------------------------------------- The rise of geopolitical swing states (L to R): Goldman Sachs' Jared Cohen, George Lee and Allison Nathan The rise of geopolitical uncertainty is creating a new world order that's become a key focus in corporate boardrooms and among investors. In the [latest episode of Exchanges at Goldman Sachs]( Jared Cohen and George Lee, the co-heads of Goldman Sachs' newly created Office of Applied Innovation, explore these issues and how they intersect with the rapid shifts in technological innovation. - “If you look at this next chapter of globalization, the competition between great powers is going to continue to play out, but competing is going to require them to court and thwart other countries that are highly relevant in this competition,” says Jared Cohen, who also serves as the firm's president of global affairs. “So there's this new category that I would describe as geopolitical swing states. They're going to have a unique amount of agency over the next 10 years.” - “The emergence of geopolitical swing states will cause companies and boards to have to think in a more tactical way,” George Lee tells host Allison Nathan. “New countries will emerge as kingmakers. And so knowing where to place your chips, where to make your bets, how to align yourself has just become far more complicated.” - “All of a sudden, understanding where the geopolitics [are] going — the second- and third-order effects of these geopolitical tensions — is absolutely essential to forecasting how to run a business,” Cohen adds. “So we're seeing companies wanting to understand the new centers of economic gravity.” --------------------------------------------------------------- China may reach energy self-sufficiency by 2060 China is on track to [produce almost three times more power from wind turbines and solar panels]( government targets predict by the end of the decade — and it could become energy self-sufficient by 2060. Goldman Sachs Research forecasts China's combined capacity of solar and wind energy to reach 3.3 terawatts by 2030, far exceeding the government's current target of 1.2 terawatts, analysts Nikhil Bhandari, Amber Cai, Chao Ji and Chelsea Zhai write in a report. They credit China's massive investments in clean energy technologies over the past decade. China now controls about 90% of the market for upstream solar products, and about 30% of wind turbine manufacturing. In batteries, China is the top-producing country for midstream materials and cell assemblies, and its access to lithium and other battery raw materials has improved due to investments the country has made around the world. Solar and wind energy production in Yancheng City, China. Combined with advances in clean hydrogen, China's progress on renewables should help cut its energy imports by 10% by 2030, GS researchers estimate. They believe a 50% cut in energy imports is possible by the early 2040s if renewable energy installations accelerate in line with their forecasts. Along with lower coal prices, our analysts expect renewable energy cost innovations will ultimately lead to lower costs for consumers. But a lot more spending will be needed — the projected increase in renewables and grid storage will require investment of $2.26 trillion by 2040, according to the report. “As China focuses on the challenges to reduce imported fossil fuels, we view an affordable renewable energy system, equipped with sufficient energy storage and smart grid transmission, as China's long-term solution to achieving energy self-sufficiency,” the report authors write. --------------------------------------------------------------- Defined benefit plans shrank in 2022. That's not necessarily bad news As interest rates rose, assets and liabilities of defined benefit pension plans shrank roughly in tandem in 2022, according to [Goldman Sachs Asset Management's Pension Review “First Take.”]( Fortunately for the companies running those pensions, declines in plan assets due to the fall in equity and fixed income values were offset by reductions in plan liabilities as rising interest rates allowed plan sponsors to use their highest discount rates (an actuarial accounting measure used to figure out the present value of future pension payments) in more than a decade. The 21st annual review of U.S. corporate pensions, which analyzes the 50 companies in the S&P 500 with the largest defined benefit plans based on asset values, shows that, in aggregate, the system ended the year at a fully funded level for the first time since 2007. --------------------------------------------------------------- Briefings brainteaser: The best performing asset so far this year is … Amid growing U.S. recession concerns and persisting worries about inflation, 2023 is proving to be a turbulent year for investors. Which of these assets has had the highest year-to-date total return (through March 29)? A) Bitcoin B) Gold C) High-yield credit D) Emerging market equities [Check your answer here.]( --------------------------------------------------------------- ICYMI: In the media [CNBC]( March 30 [It's ‘premature' to talk about interest rate cuts, says Goldman Sachs]( (1:48) [CNBC]( March 27 [Odds of uninsured depositors losing funds are pretty low, says Goldman Sachs' Alec Phillips]( [Bloomberg]( March 27 [Goldman says AI will spur U.S. productivity jump, global growth]( --------------------------------------------------------------- --------------------------------------------------------------- Some of the images used in this newsletter are sourced via Getty Images. The data provided in this newsletter is for information purposes only and should not be construed as investment or tax advice nor as a recommendation to buy, sell, or hold any particular security. 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