Goldman Sachs' O'Neill gives optimistic report on conference call despite Standard & Poor's downgrade of US bonds

Brooke’s Note: High-level prognosticators have been tripping over each other to pronounce gloom of late. This Goldman Sachs briefing I listened to yesterday (Monday) was a breath of fresh air in that regard.

Jim O’Neill barely paused to catch his breath in yesterday’s monthly client briefing, which had local call-in numbers for 19 countries. It took 23 minutes – he wanted to leave time for questions. No doubt the stress level of the chairman of Goldman Sachs Asset Management was amped by the fact that markets were plummeting even as he delivered his optimistic message. The call also started an hour late, the product of faulty technical connections.

Deep breath

The overarching message from the former chief economist of Goldman Sachs was that the bull market is catching its breath, though the details he described – particularly about sovereign debt issues in Europe – were plenty grisly.

“I believe this is a correction and not the end of the bull market in equities,” O’Neill said.

The tumbling equity markets yesterday and last week are less a reaction to the U.S. debt downgrade than to slowing global growth. Still, current U.S. growth appears strong enough at about 2.5% and world growth, Europe aside, is quite impressive. China still appears to be growing at about 10% and – O’Neill added later – this is impressive when you consider the scale of that economy. For perspective, consider that 10% of China’s economy equals a South Korean economy or three of Greece’s.

“The next step in the bull market will be driven by China.”

There are other positive signs, including the fact that commodity prices are falling. “This is a very helpful development.”

Painted into a corner

As for the Standard & Poor’s downgrade, O’Neill believes that the big rating agency had painted itself into a corner. It had said that it would have to downgrade unless the U.S. government took certain actions that did not come to pass. And political circumstances might still not have triggered the downgrade was S&P not already feeling the pressure of other questionable calls. “It would have had more credibility issues” had it not followed through on its implied threats, he said.

O’Neill praised Moody’s commentary published Monday as more “thoughtful and rational.” Moody’s, one of the three big ratings agencies (Fitch is the third) said that it would look at the actions of the United States until 2013.

Moody’s Investors Service is sticking by its AAA rating on U.S. debt because it is not “necessarily impossible” that Congress come up with additional deficit-reduction measures next year, Reuters reported about the company’s stance.

Failure to effectively address the deficit by the end of 2013 would probably lead to a downgrade of U.S. ratings, Steven Hess, Moody’s top analyst for the United States, also told Reuters in an interview.

A downgrade could also occur before that if the current plan to reduce the budget deficit turns out not to be “credible,” he added.

Fed options

On balance, the S&P downgrade may actually be positive for markets, according to O’Neill, because it may encourage more fiscal restraint and may encourage the Fed to be more friendly.

To a question about whether the U.S. Federal Reserve has exhausted all its options, O’Neill was emphatic. “I don’t think the Fed’s hands are tied at all.” For example, he said, it could make greater purchases of bonds or buy up currencies around the world to drive down the value of the U.S. dollar (making US manufacturers more competitive).

One person asked a question about why O’Neill believes that the implementation of QE3 by the Fed could help when the first two programs, QE1 and QE2 (QE2 ended on June 30) were so ineffective. He questioned the questioners premise that the first two were ineffective with the reminder of just how deep the hole was in 2008 and where we stand economically right now. Without the easing, he says the U.S. might be closer to a Great Depression scenario today.

Losing sleep

Despite his generally upbeat outlook, O’Neill allowed himself a moment of out-loud reflection when a questioner asked whether he had become a “gloomster” – a term he apparently uses in his writings to describe people with a downbeat view on world economies and markets.

“I do frequently worry the markets are seeing something that I’m not,” he allowed.

O’Neill said he loses some sleep about that and spends every waking moment looking for “interconnectivity” between economic events that seemingly do not have any.

O’Neill said the one thing that could put a dent in his optimistic view is if Chinese growth slowed or if its inflation rate wasn’t brought under control. He spoke to Chinese officials Monday morning who convinced him for now that the inflation rate would be lower than 5% early in 2012.