Two Weeks After Upgrading Stocks, Goldman Downgrades Stocks
Just two short weeks ago, when Goldman's head strategist David Kostin announced that on one hand the market's "stellar return borrowed heavily from the future" and "is now 30%-45% overvalued compared with the average since 1928", which "logically" led to Kostin's conclusion that "we lift our year-end 2014 S&P 500 price target to 2050 (from 1900) and 12-month target to 2075, reflecting prospective returns of 4% and 6%, respectively" we said "one can almost feel Kostin's humiliation at having to pen such moronic drivel."
Yesterday, in what was probably a case of moronic drivel penner's remorse, the same firm which just upgraded its S&P price target by 150 points two weeks ago, decided to... downgrade stocks. But only kinda, sorta and only for the next 3 months: Kostin is unwilling to go so far as to tell the whole truth so while he did downgrade stocks to Neutral through October, he is still Overweight equities over the next 12 months. In other words, sell in July but don't go away, and keep on buying over the next 12 months, or something.
To wit: "We downgrade to neutral over 3 months as a sell-off in bonds could lead to a temporary sell-off in equities. This makes the near-term risk/ reward less attractive despite our strong conviction that equities are the best positioned asset class over 12 months, where we remain overweight."
Curiously, his reported release moments after our latest warning on High Yield debt was far more harsh on an asset class that has already been beaten down since the most recent round of Fed warnings that there is a corporate bond bubble brewing. As a result, Goldman also downgraded corporate credit "to underweight over both 3 and 12 months. We think spreads will narrow slightly, but given already tight levels, rising government bond yields are likely to dominate the returns, especially for US IG credit where spreads are the lowest."
Uh, rising government bond yields where? Oh yes, he must be referring to the plunge in the 10 Year from 3% on January 1 to just shy of 2014 lows at under 2.5% today.
Maybe instead of being wrong for all the wrong reasons again (Goldman expected a tiny increase in the S&P 500 to 1900 at the beginning of the year on 3% GDP growth in Q1 - it got the opposite) Goldman can just tell us what its prop trading group is doing. Because while it was clear that GS is selling if it is advising its clients to buy, now that Goldman is both bullish and bearish at the same time, nobody has any idea how to fade the 200 West firm.
Here are the punchlines from the Goldman report:
We downgrade corporate credit to underweight over both 3 and 12 months. We continue to have a benign outlook for spreads and expect a slight further tightening over the coming year as monetary policy remains very accommodative and inflation and macro risks remain relatively low leading to a strong search for yield. However, spreads are now so tight that carry and further spread compression offer a relatively low offset against the rise we expect in the underlying government bond yield, especially for US investment grade credits. This tension between total return and spread return expectations have existed for a while, but the latest developments have shifted the balance between these two forces far enough for us to prefer a credit underweight, given that our credit portfolio puts 60% weight on US investment grade.
We also downgrade equities to neutral over 3 months. We are concerned that a sell-off in government bonds will lead to a temporary sell-off in equities in line with what we saw last summer, though the magnitude is likely to be smaller as the need for bond yields to correct is lower than it was back then. At the same time, on our forecasts the acceleration of economic growth is now largely behind us, with any further expansion being very small compared to what we have seen. We see an environment where growth is sustained around current levels as being positive for equities over the longer term, but would expect the pace of returns to slow down relative to the strong performance we have seen over the last couple of years. This suggests that the forgone return by lowering the equity exposure temporarily if equities continue their grind higher is likely to be lower than it has been. This is particularly true in the US where earnings and valuations are at high levels, and where data surprises are already very positive. Our MAP index of data surprises here is close to its highest levels over the last couple of years (Exhibit 2). Over the longer term we still see equities as the best positioned asset class, and remain overweight over 12 months. We would see any sell-off over the next few months as an opportunity to increase exposure again also on a short-term basis.
Whereas absolute valuations are on the high side, relative valuations remain attractive. The gap between dividend yields and bond yields is still high and our estimates of equity risk premia ranges from 5.2% in the US to 8.5% in Asia ex-Japan. We expect continued compression of these high premia to offset the rise in bond yields over the longer term and therefore think valuations should be relatively steady even as bond yields rise. This leaves earnings as the key driver of returns in our view. Whereas earnings were revised down across all markets except Japan at the beginning of the year, they have now stabilised in all regions except Europe, where the downward revisions have continued. This stabilization is supportive of our forecasts for earnings growth which are roughly in line with consensus in all regions except for Japan where we are more optimistic. We are concerned about the continued downward revisions in Europe and see this as a key risk to our overweight here. But, we expect both a slight improvement in European economic growth for the rest of the year as well as the currency depreciation to lead to a stabilisation of earnings.
In short: yet another person who applies some logic and fundamentals to predict the future of a market that is so broken and centrally-planned that only the NY Fed trading desk at Liberty 33 has any idea what is going on any more. The same trading desk which on one hand sells VIX courtesy of Citadel and on the other accuses the market of complacency.
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