Weekly Chartology; Goldman Introduces Its Own Version Of Rosenberg's SIRP For A Low GDP Growth Environment

In a surprising act of lucidity, David Kostin recently reduced his 2010 S&P target from 1,250 to 1,200. Now, the Goldman strategist has penned his own version of David Rosenberg's SIRP (Safety and Income at A Reasonable Price), by introducing two strategies for a low GDP environment: Low Operating Leverage And Dividend Growth (LOL-DG - yes, we prefer Rosenberg's acronym).Hopefully, this means that the GARP abortion is finally dead and buried.

Kostin clarifies this new recommendation, after various client meetings:

Clients were most interested in discussing our recommendation to buy stocks with low operating leverage and sell firms with high operating leverage. The weak US GDP growth forecast and specter of deflation means top-line sales increases will be hard to achieve. Firms with low operating leverage should benefit from stable margins and less risk of negative EPS revisions and should outperform companies with high operating leverage. We suggest buying a basket of 25 stocks with low operating leverage (Bloomberg ticker: <GSTHOPLO>) and selling a sector neutral basket of 25 companies with high operating leverage (Bloomberg: <GSTHOPHI>). The long/short trade has returned 1.6% since initiation at the start of the week.

The intuition behind our low vs. high operating leverage trade has two components: First, Goldman Sachs Economics forecasts US GDP will post average annual growth of 1.9% in 2011, near the low of the 51 economists surveyed by the Blue Chip Economic Forecast. Consensus growth forecast averages 2.8%. The earnings models that equity analysts use to forecast EPS estimates incorporate a GDP growth rate assumption. If consensus 2011 GDP growth (2.8%) falls towards the Goldman Sachs estimate (1.9%), then consensus sales projections will have to be slashed because GDP and sales are correlated. As a result, earnings estimates will also have to be reduced. Negative EPS revisions should be more modest for firms with low operating leverage compared with companies with high operating leverage. EPS revision differential should drive relative share price performance.

Second, profit margins have already returned to near-record levels for the overall market (2Q reached 96% of prior peak). The prospect that profit margins will continue to rise meaningfully from already elevated levels is becoming more difficult to embrace given a weak US economy will retard top-line revenue growth. Significant cost savings have been realized during the past year but incremental margin improvement will be more challenging.

Buy High Dividend Growth: Lower potential upside to the US equity market favors buying stocks offering a combination of both high initial dividend yield and strong dividend growth. Our basket of 40 S&P 500 stocks have an estimated cash-return-on-cashinvested of 3.9%, more than 200 bp higher than the equal weighted S&P 500. The stocks have a larger market cap, higher current annualized dividend yield, and faster expected dividend growth than the equal-weighted S&P 500.

Essential beach reading: Our 2Q 2010 S&P 500 Beige Book

We included verbatim excerpts from 56 company conference call transcripts in our quarterly S&P 500 Beige Book. We highlighted 5 key themes:

Theme 1: Uncertain economic outlook but Europe better-than-feared. Managements were positive on 2H outlook but tempered it with caution around the consumer. Views differ across sectors, with Industrials and Materials generally more positive and Health Care more conservative. Examples: F, MCD, NKE, KMB, JPM, MS, UNH, JNJ, ETN, FDX, GE, BA, V, XRX, FCX, OI.

Theme 2: Focus on margin improvement. Corporate margins continue to benefit from 2009 cost cuts and lean hiring. Many firms guided to flat or slightly higher sequential margins in 2H and seem to be placing a higher priority on margin levels than other performance metrics. Managements indicated that much of the previous cost cuts will remain “permanent”. sExamples: NKE, CL, COP, MHS, CMI, GE, LMT, WM, XRX.

Theme 3: Disciplined hiring practices. Corporations remained tentative in their hiring practices, waiting for stronger signs of stabilization. Many firms cited high unemployment and weak sentiment as reasons for caution. Lean payrolls may help companies protect their margins in a slowing economy. Examples: AMZN, KMB, MMM, UPS, PAYX, AKS, ETN.

Theme 4: Use of large cash balances. Corporate cash balances remain high and companies continued to pay down debt, raise dividends, and buyback stock in 2Q. The desire to expand margins and capture limited growth opportunities has curtailed investment spending. Examples: F, CAT, GE, UPS, AMZN, PEP, MMM, X.

Theme 5: Mitigated impact from currency moves. Many firms hedge their near-term FX exposure. Managers noted that a persistently strong USD could be a headwind. If the USD weakens against the Euro it could be a mild positive for profits as hedges roll off. Examples: KO, FDX, UPS, MCD, NKE.

Comments

[bugs_]

Lets see GST-hope-LO or GST-hope-HI?  Which is best for the IRA?

[Turd Ferguson]

"Essential beach reading: Our 2Q 2010 S&P 500 Beige Book". 

Uhh.....no. I don't think so.

This is much better:

http://www.europac.net/commentaries/no_exit_–_stage_left_or_right

Read this, too:

http://www.marketoracle.co.uk/Article21676.html

And this is a fun one:

http://www.bullionbullscanada.com/index.php?option=com_content&view=arti...

Lastly, an oldie but a goodie:

http://www.sprott.com/Docs/InvestorsDigest/2010/06_23_2010%20Gold%27s%20...

[lettuce]

I like this quote from the "market oracle" article:

The numbers were pretty much bottom-bouncing during the second half of 2009. The auto deals and the homebuyer deals added a little spike to the growth pattern, but that growth was stolen from the future. It didn't create new demand.

I never thought about the bounce 'growth' as being stolen from the future. I like that notion (well I don't LIKE it but I think it's an interesting idea).

[ZackLo]

It's all stealing from the future man! thats how this system was set up by england in 1913. we need to just go back to the days of gold and silver, where banks were just a place to store your "real money" but it would probably work alot different somewhere along the lines of you go to the bank deposit your gold and silver and the banker asks you whether you want to collect interest while assuming some level of risk or just pay a small fee for holding it. and a bank have a designated account for loans of pooled risk money (not just stealing it and saying sorry FDIC pay up) also with gold and silver debt would have a finite limit. bankruptcy bitchez...Because you can't pursue life and liberty with a 10,000 pound debt collector on your back, But also if you wanted a loan you would have to have assets (no free lunch)..Because thats where the wealth is, not in the money but, in the objects and things we produce of value that other people need and what should be to a lesser extent want.

Some say paper money that the government prints interest free and would print based on population growth would keep prices stablized but, I trust no man with a printer.

yes gold and silver would be a diffrent world completly there is only so much..you add more people you just get more purchasing power...I guess net result deflation (who doesn't like cheap goods of real quality made here because, taxes would actually go to services not funding some interest payments), but It would definitly put a leesh on some of these corporations that are gobbling up all the credit....oh and the government too, sorry congress, no overbloughted pension, sorry public sector workers no more double pension double chair schemes..and how about cut the beauracracy and pay the teachers and police..we don't need any unproductive paper pushers.oh and we could actually remove the income tax and replace it with just sales tax on corporations.

and of course since it would be gold and silver anyone who takes a risk, if it works out good, if not, creditors take a haircut. no bank runs, no "SYSTEMIC RISK" all capital "RISKED" would be "RISK CAPITAL" can't have capitalism without capital.....and as long as the presses are running there will NEVER be a stable pricing mechanism.....oh yeah and and all assets marked to market...and I saw the article the other day of the coinage act of 1775 that said the US mint would mint coins for free, bring that back, also the little part about being put to death for devaluing the dollar. sounds great. But, the u.s. economy would have to step up and drop the populist parenting our politicians do and promise. also alot less credit would be available to chase stocks and bonds....but what you would get out of it would be alot more yeild in real buying terms.

I hardly ever say very much, just my 2c, there's some people that hate markets...I think markets are find accounting fraud isn't and the only accountability we will ever see is the day we can as local communities go to the bank pull every coin of physical out and the system still be fine (no apacolyptic crash)...till then, street lights go out, schools close up, and all those politicians smicker behind closed doors, but I really don't think they understand what happens when you play with the fires of populism, sigmund freud understood, bernays apperently didn't , but, history shows it doesn't end well I doubt this time will be any diffrent.

bless you guys and good luck in the times that are upon us, we will all need it

[99er]

Chart: DJX

Bearish.

http://www.screencast.com/t/ZWY4NTkw

[hound dog vigilante]

All of these asshats continue to operate in a debt-growth, low-risk paradigm... thus the 'always higher' prognostications for risk assets. Fundamentals were worshipped for decades, but now that fundamentals run contrary to the infallible debt paradigm, fundamentals are thrown out the window and rplaced by pure propaganda.

It's been >5 years since we've heard a credible case for growth/returns in risk assets based on fundamentals.

Who's 2010 call is more credible/likely... S&P 1200?  or S&P 900?

[icm63]

WD GANN would short stocks now !

 http://chart.ly/6avs9c

[sawyer]

We are a few months a way from market collapse as everyone and their mother piles into the Blue Chip and dividend yield play forgetting about "the reasonably priced". Once everyone realises it is not working out, watch the sprint to the exit...

[Grand Supercycle]

Updated DOW and SP500 charts:

http://stockmarket618.wordpress.com

[Herry12]

Resources like the one you mentioned here will be very useful for me! I like to share it with all my friends and hope they will definitely like it.
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