Goldman Urges Bet Against Euro Junk Debt

Goldman Sachs Group Inc., after this year’s losing endorsement of U.S. bank stocks, recommends as its top trade for 2012 a bet against European high-yield corporate debt and forecasts a “deeper recession” for the region.

The fifth-biggest U.S. bank in terms of assets recommended in a research note that investors speculate on the rising cost of insuring against the default of European junk bonds by using the Markit iTraxx Crossover Index of 50 companies with mostly high-yield credit ratings. The gauge of derivatives will climb to 950 basis points, or 9.5 percentage points, from 770 basis points, according to Goldman Sachs, which urges investors to exit the trade if the index falls to 680 basis points.

“The ongoing shocks from the region’s sovereign crisis -- and policy responses to them -- are likely to be the biggest determinant of the outlook over the next few months,” Dominic Wilson and Jan Hatzius, economists at Goldman Sachs, wrote in the research note, published today.

Goldman Sachs said a year ago that the U.S. economy would expand 2.7 percent in 2011, and U.S. bank stocks, junk bonds, commodities, Japanese equities and China’s currency were its top recommendations. America’s gross domestic product is forecast to grow 1.8 percent in 2011, according to the median forecast of 63 economists in a Bloomberg News survey.
Drop in Financials

The Standard & Poor’s 500 Financials Index has lost 18 percent this year in the worst performance among 10 industry groups. U.S. banks, measured by the 24-company KBW Bank Index, have fallen 26 percent on a total return basis.

America’s high-yield corporate debt has returned 1.4 percent as of yesterday, according to Bank of America Merrill Lynch index data. The Standard & Poor’s GSCI Total Return Index of commodities has gained 1 percent. Japan’s Nikkei 225 Stock Average has dropped 16 percent, while China’s yuan has appreciated 3.6 percent against the dollar this year, according to the China Foreign Exchange Trade System.

The U.S. economy will expand 1.5 percent next year, while Europe’s will contract 0.8 percent, according to Goldman Sachs. The bank lowered its worldwide economic growth estimate to 3.2 percent from 3.4 percent.

The financial crisis in the euro zone will weigh on the U.S. economy through early 2012, according to Hatzius.
Hatzius on Crisis

“There will be an intensification over the next few months,” Hatzius said today in a conference call with clients. A “tightening of financial conditions” will limit the “willingness of banks to lend,” he said.
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