By Colin Barr
July 20, 2010

Goldman Sachs traders fancy they can feast on any market. But even sharks get hungry when no one is swimming.

Goldman’s

 profit dropped 82% from a year ago in the second quarter. The firm was hit by more than $1 billion in one-time costs to pay a U.K. bonus tax and settle a Securities and Exchange Commission investigation, but the declines in its business were broad and deep.

Revenue fell 35% from a year ago in the bank’s biggest business, fixed income, currency and commodity trading. Revenue slid 36% in investment banking, 62% in equities trading and 11% asset management.

Admittedly, the comparisons are with the second quarter of 2009, which was the first of several rocket-fueled trading quarters for the firm. Even so, the pullback won’t reassure the growing crowd that frets that another economic downturn lies ahead.

“What we have here is not a lot of activity,” financial chief David Viniar said Tuesday on a conference call with reporters.

Even trades that materialized didn’t always go Goldman’s way. Viniar said the firm lost money in the second quarter when clients bet, presciently, that the market would grow more volatile.

Viniar attributed the slowdown in trading and banking activity to uncertainty surrounding regulatory reform and fear about the state of the economy. There is “a real lack of conviction” among customers, Viniar said, which has translated into less business for Goldman.

Goldman’s weak numbers come at a time when a number of high-profile market watchers have been predicting an economic slowdown or worse. Gluskin Sheff economist David Rosenberg, who rang an early alarm on the recession of 2008, has been calling for the better part of a year for stocks to pull back sharply. Fund manager John Hussman says U.S. stocks are perhaps 50% overvalued.

Even those who aren’t impatiently calling for a crash are sounding alarmed. Jeremy Grantham, the value investor who helped found fund manager GMO, said in a letter to investors this week that the current mix of slowing economic growth and hawkish fiscal policy proposals “looks downright frightening.”

Grantham says the problem starts with Fed chief Ben Bernanke’s commitment to prop up the financial markets by keeping short-term interest rates near zero. This, he says, keeps the Wall Street casino rolling without providing much meaningful support for the real economy, whose recovery has lagged far behind the rally in stocks since last year’s low point.

This sets up a clash between real world investors fretting about the next leg down and hedge fund managers reaching for the last scintilla of yield.

This market might well be called a fearful, speculative market. Low rates, although they tend to produce a feeding frenzy at the aggressive end of institutional investors, merely produce a feeling in ordinary individual investors somewhere between dejection and desperation. They hate to park money in cash at negative real returns, and yet they are still thoroughly nervous, so surveys reveal, about normal equity investing. These investors did not need the recent slowing in growth and sovereign debt problems to become nervous.

Yet it is far too early to say the market, and Wall Street’s roll, are done. Grantham concedes that what he fashions as speculative insanity could easily continue into next year — though he believes the chances of that happening are narrowing as the economy’s stimulus-fueled recovery peters out.

As an aside, a market bounce would at least temporarily restore big profits at Goldman and its peers Morgan Stanley

, JPMorgan Chase

, Bank of America

 and Citigroup

.

Despite growing nervousness and despite a slowing economy, I am so impressed by the power of low rates and Greenspanism (for lack of a better or shorter description) that I would still put odds of 45% (down from 50% last quarter) for the market to rise to over 1400 (down from 1500 to 1600 last quarter) by October of next year, accompanied by a speculative spin.

For those of you scoring at home, he’s talking about a 30% rise in the S&P 500 index from current levels. But obviously that’s far from a sure thing, and like many others Grantham believes the odds of a crash are rising. His estimate of S&P 500 fair value is 900, which is 16% below today’s level.

I also have to recognize that the 21% I put on a quick and rapid decline to fair value looks even more likely today, perhaps closer to 30%.

So it is in the age of volatility. In the meantime we’re left to chew on the nonjudgmental utterances of Viniar, who strives to give away nothing and frequently succeeds. “I can only tell you right now this environment is pretty slow,” he said Tuesday.

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