Time To Look At The Fat-Tails On Both Sides: Goldman Warns Market Is 'Not Fully Pricing In Any Scenario'

The market is not pricing fully any scenario, according to top Goldman Sachs trader, Edoardo Lorenzo Greco.

LNG supply flows through the Strait of Hormuz, typically averaging 80 mtpa, have dropped to zero

This means it’s now time to look at the fat tails on both sides...

The bullish view

Given the tone of the headlines, the reduction in net leverage from our PB clients, the hawkishness been priced in rates…it doesn’t take much for a squeeze the minute there’s a vague perspective of a ceasefire. 

While you have 3 agents directly sitting at the table, you might need another one to move things forward…but anything that breaks the standstill might give a breather.

I’d personally play this by being long duration in government bonds (UK/EU/US front-end in order of preference).

In equities it’s frankly harder to play via equity indices as the pullback has been fairly minimal so far…you need to go thematically via either GBM Peace Deal (GSPEACED) or HY Debt (GSXEDEBT) baskets or alternatively spice things up via hybrids by calling central banks going back onto normalizing rates (lower), and assuming that any ceasefire triggers the journey into a stable off-ramp.

The muddle-through view

This is where we are, especially as no real panic has been seen in equities.

I don’t know how long this can last for you to make money in equities on an absolute level, but if offers you the set-up we’ll have even if we fall into the bearish view. 

Investors should initially price a stagflation but the overarching narrative is one of moving from an inflation scare into growth worries.

Personally this would have been the end game for the market anyway as comparables for the economic cycle in H2 were getting tougher: more doubts on German fiscal spend delivery; US fiscal boost mostly front-loaded + midterms uncertainty; labour markets increasingly fragile; increasingly tighter financial conditions on private credit reducing overall appetite for loan growth.

In here you see fixed income investors shifting from credit to government bonds (surely the appetite to own the former is going down), and equity PMs running towards quality / defensives. Up to you how the structural AI trend and the Mag-7 fits in this camp, surely here valuation is no longer the hurdle to add.

The bearish view

It’s easy to argue that commodity markets price definitely more risk than equities one. VIX at 22 is one of the cheapest vol out there (ok, maybe you get lower one in FX) or at least it’s a fraction of what oil and LNG markets are experiencing. 

What equity investors refuse to acknowledge if that commodities depend also on the physical world and we are probably overlooking too much the importance of Qatar in global LNG markets.

Think like this: oil can go higher for quite some time before we see demand destruction and it’s just (simplified) an exercise of moving money from consumers to producers…as 70% is used for transportation (either of goods or people).

This is why you even see in the short-term upward revisions for GDP and EPS at the aggregate level in certain regions.

Gas or specifically LNG is a different story for 3 reasons:

(1) there are no reserves and even Russia’s ability to step in as a buffer is limited vs the total amount of LNG being blocked;

(2) Qatar is 20% of LNG’s globally, 30% of Helium (used for semis manufacturing cooling) and likely an even higher proportion for the World-ex-the US. This is much bigger than Russia-Ukraine;

(3) time is against us but also the seasons. It takes 4 weeks to ramp-up again Qatar production and in May/June is when seasonally you see a pick-up to re-fill gas storage levels in Europe…this time around the process will be more competitive as LNG cargoes are already re-routing towards Asia.

Here you need to start pricing 3rd derivative effects on two levels;

(1) South Korea and to a lesser extent Taiwan are major importers / rely on LNG. At the very least they’ll bid up on LNG;

(2) parts of South East Asia are already rationing production, quite often those are the factories of the world: is there another risk of a scarcity in goods / larger supply chain disruptions?

In this scenario, it’s no longer about reducing net-leverage but probably de-grossing as not even your winners save you if we need to rewrite (for a short amount of time until things resolve) global power markets. 

Left-tail hedges across crowed positions in KOSPI or in general equities might be a good idea.

In terms of relative winners, energy independence for Europe should definitely become a secular winner you want to own: Utilities, Electricals, Grids, Infrastructure; call spreads on European Gas (TTF).

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