Goldman Turns "Tactically" Neutral On Stocks, Believes S&P Not Pricing In "Downshift In Macro Picture", Proposes "Zero Cost Cross-Asset" Hedge For SPX Drop

Tyler Durden's picture

In another key note out of Goldman, we now learn that it is not only Jim O'Neill who is the natural hedge to the firm's other diametrically opposing views (as discussed earlier). While it is no secret that the firm's chief strategist David Kostin continues to ignore warnings from Jan Hatzius et al warning that the economy is set for a period of slower than expected growth, we now find that Goldman's Roman Maranets is out with a note in which he says that "the downshift in the macro picture (excluding Friday’s payrolls print) has not been fully reflected in the level of SPX, prompting us to shift the tactical trading stance in equities to neutral." Hmm, it is somewhat odd that nobody else has noticed that Goldman is now, well, neutral (and we all know what that means in sellside lingo) on the market. Now, the question is whether this is an honest opinion, or merely a way for the firm's prop desk to accumulate ES at the expense of its clients. Judging by the market's sudden surge, asset managers seem to be convinced it is the latter. That said, the firm is now proposing a USD long as a "Zero Cost Cross-Asset Hedge for SPX"  due to the firm's motivation "to find application of our framework in construction of “cheap” cross-asset hedges for investors being long SPX." Of course, why not just buy the USD and the market. We are long past the point where anything makes logical sense any longer courtesy of central planning. We wonder how Thomas Stolper feels now that his thunder has been stolen by both Maranets and Fiotakis, who predicted the EURUSD toptick to within minutes of the near-800 pip plunge in the pair in less than a week.

From Goldman on using FX as an equity hedge:

In May 4th Global Markets Daily, Thomas Stolper highlighted that over the last two years the FX markets became attractive as a cross asset hedge for investors in other risky assets, and in particular that the number of currencies being used for this purpose widened out. As an example, the stability of historically low correlation in daily returns over a 3 month window between SPX and GS trade-weighted US Dollar index (average -60% over last two years) lent support to this argument. In today’s Daily, we revisit a methodology launched in 2007, which allowed us to contrast volatility against carry along a concept of risk/reward for FX portfolios and examine correlation of our optimized baskets versus global equity indices (proxies of systemic risk).

In a nutshell, our analytical framework maximizes carry per unit of volatility across a portfolio of 56 liquid crosses (28 short currency vs. USD and 28 short USD vs. currency). In our earlier empirical work we have demonstrated that higher expected returns are proportional to the level of carry we are receiving, and therefore we use current carry as a proxy of expected total return. Also for the purposes of this study, we use standard deviation of weekly FX returns over the last 52 weeks as a proxy for conditional volatility.

By introducing correlation with global equities as a third criterion in this problem, we showed that by reducing the amount of correlation with equities we would also typically reduce the net carry of our optimized basket. We linked this observation to the fact that higher carry currencies typically have higher correlations to equities and emphasized that carry traders have potential exposure not only to macro fundamentals of the cross, but also global shifts in risk appetite. A few other interesting results we extracted were: 1) Higher carry is generally associated with higher volatility (confirming the risk/reward concept), 2) In a portfolio, one could achieve a reduction in volatility for the same level of carry, by diversifying away the idiosyncratic risk. But most importantly, we have demonstrated that it is feasible to construct portfolios with non-negative carry gains that either have zero or negative correlation to the SPX (which is not straightforward to do in single cross space).

And here is how to hedge an overvalued (not our words, Goldman's):

In May 6th Global Markets Daily, Noah Weisberger had noted that the downshift in the macro picture (excluding Friday’s payrolls print) has not been fully reflected in the level of SPX, prompting us to shift the tactical trading stance in equities to neutral. With that said, on our part we would be motivated to find application of our framework in construction of “cheap” cross-asset hedges for investors being long SPX.

In our research we have often discussed that one of the best ways to reduce correlation to SPX through currencies is to increase USD exposure. However, by capping the volatility of our portfolio at 6% and diversifying away the idiosyncratic risk, our framework (in theory) allows us to create a carry-neutral FX portfolio with lower correlation to SPX than trading a basket of USD TWI would allow: -92% vs. -77%. This portfolio consists of 21 FX positions, which we break up into 10 net short and 12 net long currencies. We observe that this is a fairly diversified FX portfolio, where AUD, CAD and SEK are top three positions in net short portfolio (comprising 61%), while the net long portfolio is fairly distributed among six currencies: USD (21%), IDR (14%), CHF (13%), BRL (11%), JPY(10%) and GBP(9%).

These results are not entirely surprising. First of all, carry funding currencies such as JPY, CHF and USD have historically had negative correlations with equities, while currencies with commodity exposure, such as AUD, CAD and SEK, have had positive. Since the correlations between equity and FX returns have typically been very unstable and tended to change over time, there is no systematic way to pin down why these correlations kick in and for how long they will persist. Nevertheless, by making some reasonable assumptions about what these correlations reflect, carry trades tend to be driven by the same cross-asset sentiment for risk taking that also helps strong equity performance. Therefore, it is not unreasonable to expect that funding currencies like JPY, CHF and USD are negatively correlated with global equities, while high-beta currencies such as AUD, CAD and SEK are positively correlated.

So how would the proposed carry-correlation trade off look like?

As mentioned above, in the past we demonstrated that a reduction in correlation with SPX comes with a sacrifice of carry gains. We analyze the carry/correlation trade-off by looking in detail at optimized FX portfolios with positive and neutral correlations to SPX.

In our attempt to construct FX portfolios with positive and neutral correlations to SPX, we target investors with two motivations: 1) receiving the maximum carry for a specific level of risk (in our case 6% annualized vol), and 2) the same as 1) but also diversifying away systemic risk at the same time.

First, the positively correlated portfolio (+52% correlation) consists of five FX positions, which we break up into 3 net short and 3 net long currencies. The weights analysis suggests that this is a fairly concentrated portfolio in two currencies: TWD (61%) on the short side and INR (79%) on the long side. These results intuitively make sense given that long INR/TWD cross has demonstrated solid total return (including carry) among EM’s over time (70% since 1998). Our uncorrelated portfolio with SPX is slightly more diversified with USD (46%) and TWD (42%) as the two largest positions on the short side, and INR (43%), CHF (33%) and JPY (13%) as three largest on the long side.

From carry perspective, we highlight that we gave up 2.1% of carry to diversify away the systemic risk and arrive from positively correlated portfolio (4.8% carry) to uncorrelated (2.7% carry). To scratch the surface of this finding, we statistically analyze a sample of correlation and carry data from a full set of our optimized baskets. These results are quite striking as they imply that the relationship between carry and correlation is fairly linear and has a solid fit given the 98% R-squared. A coefficient of 0.03 suggests that a 1% decrease in correlation to SPX would typically correspond to a 3bp reduction in net carry of our portfolio.

As usual the stated message is secondary. The key theme is that Goldman is likely about to turn full blown bearish on stocks with an official stamp of (dis)approval coming imminently from David Kostin. As to whether Goldman prop is positioned appropriately already, we think that, as always, this is a rhetorical question.

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The Count's picture

Can't wait for the day that GS implodes.

rocker's picture

+10  These bastards belong in Jail.  It would be the ultimate Golden Swan.  When they put Lord Blankfein and or Neel Kashkari in Jail I buy my first bank stock.  Until then, I short on every rip. TBTF is a crime, they made them bigger.

Ratscam's picture

Anyone have the latest insider trading figures? 

Urban Redneck's picture

Ratscam, Any problems with the JBSICA execution? Thanks

Ratscam's picture

still no execution, tremendous paper BS according to UBS PB!

No time line given so far. So far 7 business days for physical redemption, this during "normal" times!!!



Urban Redneck's picture

Thanks for the update, is this going through UBS in the USSA or Schweiz - if Swiss they should just be able to give you the paper and let you pick it up.  Regardless, I now need to brush up on my German and reread the legally binding prospectus.

By the way the last time I pried silver out of the Crimex's cold dead hands (2+ yrs ago), it took well over a month.  I had to go through a broker because I didn't have enough cash then for a full contract, but he was prompt and only added 3 business days to the headache.

Ratscam's picture

unfortunately not that easy, order from UBS Zurich, just across the road from JB.

To give them credit it is the first exercise to them, me beeing such a nut case in finding out if it would work in reality.

Termsheet is available in English as well and contractually liable.

Enough funds to sort out any differences in price, especially since JBSICA is USD/CHF hedged. Just on the quanto hedge gain of 15% in the last 24 months.

Have to go to the gym now to train my muscles for the date of delivery.



JW n FL's picture

Stretched SEC delays filing deadline for Hedge Fund Registration by another “YEAR!”…


Categories: Hedge Funds

Topics: Dodd-Frank Act, Schulte Roth & Zabel, Regulation, Dodd-Frank Wall Street Reform and Consumer Protection Act, Securities & Exchange Commission (SEC), United States, US Congress, Mary Shapiro, Schulte Roth & Zabel, Kinetic Partners


Republican-controlled committee voted for a 18-month delay of regulations intended to reduce risk in OTC Derivatives.


Senate trying to hide Campaign Contribution Monies from Government (Military) Contractors with the Argument “Free Speech” LMFAO!!


Why Wall Street Ignores Real Risk And Why History Will Repeat Itself  Banker LOVE! Free Tax Dollars! Gov. Loves Lobby $'s!


****** "Who has an incentive to increase debt relative to equity in really big ways? Again, it’s the largest banks. The executives in these companies are paid based on their return on equity -- and the easiest way to increase that is to add leverage. Of course, this increases returns only when times are good. It also increases the potential losses when markets tumble. In other words, greater leverage increases risk." ******



Canucklehead's picture

Based on Martin Armstrong's comments, I suspect the time to BTFD is June 13th.

Chasecran's picture

Goldman:  You need a hedge for SPX longs?   Buy a life insurance policy on Ben Bernanke.

Chasecran's picture

And then short the insurer of course...

Papasmurf's picture

The insurer is backed by the US gov't.  So the insurerer will remain solvent longer than anyone else.

max2205's picture

Zero Hedge....they said it in code...."Zero Cost Cross-Asset Hedge for SPX"

firstdivision's picture

Anyone else watching the carry/es arb?

SheepDog-One's picture

Something hasnt been priced in X1,000 times yet? WHAT???

RobotTrader's picture

If we close over the 11-day and 22-day.

Thousands of macro theme hedge funds that are short stocks will have to cover and go long.

SheepDog-One's picture

Wow another empty dried husk of a post from MomoFader!

JW n FL's picture

he is describing a forced hand, which would lead to a slaughter.. give him a chance Bro.. he is not here becuase he hates people.. now if he gets pissed on enough, he gets to trolling for fun.. but robo is good people, trust me on that.

bugs_'s picture

goldman telegraphing bearish code

... --- ...

QE over


GFORCE's picture

Typical flip flop from an IB. They're one of the major reasons that the S&P is not pricing in downshift, due to their BS predatory analysis.

slewie the pi-rat's picture

i've been tactically neutral on paper since 1986!

JW n FL's picture

In interviews with more than two dozen fund managers, bankers and traders, no clear cause emerged for the plunge in price. Market players were unable to identify any single bank or fund orchestrating a massive sale to liquidate positions, not even an errant trade that triggered panic selling, as seen in the equities flash crash last May.

Rather, the picture pieced together from interviews on Thursday and Friday is one of a richly priced commodities market -- raw goods have been on a five-month winning tear over all other major investment classes -- hit by a flurry of negative factors that individually could be absorbed but cumulatively triggered a maelstrom.

Computerized trading kicked in when key price levels were reached, accelerating the fall.

"It was a domino effect," said Dominic Cagliotti, a New York-based oil options broker.


"Yesterday was organized chaos down on the floor, it was right back to the old days," said Chris Kenny, crude oil options trader at Lloyd Group. "The size of the move was almost unprecedented and you could see it all there. Greed and fear, that's what this job is all about."

Action in the options pit was still lively, they said, reminding them of the jostling and jousting of days gone by.

Miles away from the emotional rollercoaster that marked Thursday's puzzling rout, the new breed of computer traders counted their profits in anonymous offices across the country.

High-frequency and algorithmic traders, comprising half the oil market, seem to have weathered Thursday's mayhem without breaking a sweat, unlike many of the new breed who took a beating in the stock market "flash crash" exactly a year ago.

"We continued to trade normally and be involved in the market the whole time, no differently than the day before. We didn't change our risk parameters or our model parameters," an oil futures trader at an proprietary algorithmic trading firm told Reuters.

Unlike with the stock market's "flash crash," few old-school traders blamed the algos for the fall, although some did blame them for the end of a way of life that aided both transparency and liquidity in an often opaque market.