Goldman refuses to turn optimistic, and once again chief equity strategist David Kostin follows in the footsteps of Jan Hatzius, this time telling clients to shift to a defensive mix of stocks after recently downgrading his 2010 S&P target to 1,200. "We shift to a more defensive sector allocation in anticipation of slowing economic growth indicators and downward revisions to consensus earnings and real GDP forecasts." Just as all Wall Street economists followed Hatzius in lockstep, so all equity strategists will now begin dropping their S&P targets, especially since from this point on corporate margins can only go down.
From A. Joseph Cohen's successor:
This report describes the macro and micro factors influencing our sector recommendations. We highlight the “perception gaps” between our weightings and current mutual fund positioning; note where our preferences differ from the direct application of historical sector performance; and where our top-down earnings projections differ most from bottom-up consensus forecasts. We also identify stocks in each sector that fit with our key macro investment themes; stocks our industry analysts highlight on a micro basis; and stocks mutual fund managers are both overweight and underweight vs. S&P 500.
Below-trend GDP growth, a return to 10% unemployment, and expectations that headline US ISM may fall below 50 by year-end 2010 prompt another defensive shift in our sector recommendations. Goldman Sachs US Economics recently reduced its 2011 real GDP forecast to 1.8% from 2.5% and we expect a long normalization period before the economy returns to trend growth levels. The economic forecast is consistent with US ISM falling to 50 by year end with risk to the downside. Goldman Sachs Economics currently does not expect the US to experience a “double-dip” and shift back into recession, however, subdued ISM prospects place us firmly in the late expansion stage of the business cycle.
The late expansion stage of the ISM cycle favors a mixed portfolio allocation. In June we raised Consumer Staples to Overweight (from Neutral), lowered Materials to Neutral (from Overweight) and reduced the size of our Energy Overweight (see 2H 2010: Strategies for a complicated world). Since then our recommended sector weights have generated -16 bp of alpha, driven by our Technology Overweight and Telecom Services Underweight.
Now we further adjust our sector allocations for the weak economic backdrop by focusing on those sectors with (1) a defensive performance history; (2) expected earnings growth greater than the S&P 500; (3) lower risk of negative EPS revisions; and (4) attractive dividend yield. Our new recommendations take cues from history but also respect the unique characteristics of the current cycle.
We make the following changes: (1) Raise Consumer Staples Overweight to 200 bp from 100 bp; (2) Raise Telecom Services to 100 bp Overweight from 100 bp Underweight; (3) Lower Industrials to Neutral from + 200 bp Overweight; and (4) Lower Energy allocation by 100 bp to Neutral from Overweight.