Just 2 months ago, the illustrious muppet catchers at Goldman Sachs stated that both stocks were 30-45% overvalued but lifted its year-end target in what we subjectively described as 'moronic drivel'. Then, 2 short weeks after that 'upgrade', the same thought-provoking sell-side strategist downgraded stocks on the basis that a 'sell-off in bonds could lead to short-term weakness in stocks'. Now, with the S&P 500 closing at new record highs on the worst employment data of the year, Goldman is at it again - upgrading equities to overweight for the next 3 months, rolling index targets forward, and piling investors into high-yield credit. Welcome to muppetville...
First - BUY!
Then - SELL!
Now - BUY AGAIN!!
September 5th 2014: Upgrading Equities
We upgrade equities to overweight over 3 months, in line with our 12-month view. We have rolled our index targets forward to higher levels for all regions except Japan and, following the dovish ECB decisions yesterday, we now see the risk to equities from higher bond yields as less imminent. We maintain a high conviction that yields will rise from here, but since our last GOAL, risks have clearly shifted in the direction of a slower path. Today we re-iterated our yield forecast for the US, UK and Japan and lowered our year-end Bund forecast from 1.60% to 1.30%
Our recommended asset allocation
Equities: We are overweight over both 3 and 12 months. We expect earnings growth, dividends, and high risk premia to support returns.
Commodities: We are neutral over both 3 and 12 months but expect significant dispersion below the index level. We like nickel, palladium, zinc and aluminium, but see downside for copper and gold. Roll carry is likely to contribute significantly to returns, especially for oil, copper and aluminium.
Corporate credit: We remain underweight over both 3 and 12 months. We expect spreads to narrow, but given already tight levels, rising government bond yields are likely to dominate the returns, especially for US IG credit. The exception is US HY, and within credit we would recommend an overweight in HY relative to IG.
Government bonds: We remain underweight. We expect yields to rise due to sustained high US growth and accelerating inflation, a decline in deflation concerns in Europe, and support to inflation expectations from ECB policy action.
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This week, we have rolled forward our equity targets for the US, Europe and Asia ex-Japan to higher levels. We have also lowered our forecast for German Bunds from 1.60% to 1.30% by year-end. We upgrade equities to overweight over 3 months and, within corporate credit, we emphasize an overweight in high yield relative to investment grade from a total return perspective. We balance the upgrade of equities with a downgrade of cash to neutral over 3 months.
Yesterday’s ECB decisions were more dovish than expected. On the back of this new information, our bond strategists have today lowered their year-end forecast for German bunds to 1.30% while re-iterating their existing year-end forecasts for the US, the UK and Japan. We maintain a high conviction that yields will rise from here, but since our last GOAL, risks have clearly shifted in the direction of a slower path.
Still Underweight credit, but...
In our last GOAL, we downgraded equities to neutral over 3 months and corporate credit to underweight over both 3 and 12 months. In the case of equities, we were concerned about the risk from a rise in bond yields and, to a lesser extent, geopolitical risks that had to be held up against our longer-term very constructive outlook. In corporate credit, we were still constructive on spreads, but this constructive view had to be held up against the losses we expect on the government bond component of the total return. Even with bond risks somewhat lower they still dominate the spread return for IG credit, and we remain underweight corporate credit. For high yield on the other hand, the spread return has the potential to offset any loss on the bond component of the total return. Therefore, on a total return basis, we have a clear preference for HY over IG.
For equities, our longer-term view is very positive. We expect solid returns for all the major regions, driven mainly by earnings growth and dividends. Reflecting this longer-term view and the passage of time, this week we rolled our equity targets to higher numbers in both the US, Europe and Asia ex-Japan. Given this and the somewhat lower risk we see from bonds, we upgrade equities to overweight over 3 months, in line with our 12-month allocation. The ECB policy action reflects a weaker growth and inflation outlook for the Euro area, which is also a drag on equities. However, we think much of this is already reflected in the data and, on balance, we think the net effect of the policy action from here will be positive for equity markets.
Over 12 months, we maintain our current regional allocations within equities: overweight Europe and Japan; neutral Asia ex-Japan; and underweight the US. We have less conviction in our regional allocations over 3 months but, on balance, we downgrade Japan to underweight after a strong run in recent months and given current macro headwinds. Longer term, for Japan, we still believe in the ability of reforms to drive profit and performance and that, together with an attractive valuation, is reflected in our overweight stance over 12 months. We upgrade Asia ex-Japan to overweight over 3 months and expect support from the Shanghai-Hong Kong stock connect theme as well as our generally more positive view on EM assets. We upgrade the US to neutral reflecting the current robust US growth environment. Finally, we maintain our overweight in Europe.
And remember - as we noted here - the preferred method for getting long...
So how does one trade an idiotic market in which Fear Of Missing Out (on one's Christmas bonus) is the only "catalyst"?
For stock-pickers, we highlight three strategies with historical precedent that should outperform into year-end:
- Stocks with high beta should outperform as the S&P 500 rises modestly in 4Q. In particular, our Dual Beta basket (Bloomberg: GSTHBETA) consists of 50 stocks on a sectorneutral basis with the highest combined sensitivity to the S&P 500 and US economy.
- High price momentum stocks that have posted the strongest returns YTD will likely continue to outperform laggards as investors reallocate positioning in an attempt to ride "what's working" into year-end.
- The most popular stocks should benefit as funds add incremental length to existing positions they already own and which are already outperforming in 2014. Our Hedge Fund VIP list (GSTHHVIP) and Mutual Fund Overweight list (GSTHMFOW) each identify the 50 stocks most popular among fund managers
The punchline: "investors should buy the following 15 S&P 500 stocks, rated "Buy" by Goldman Sachs Equity Research analysts, which should benefit from a combination of beta, momentum, and popularity as funds attempt to remedy their weak YTD performance heading into late 2014."
Translation: come inside the Hedge Fund hotel Kalifornia: it's nice and warm inside, and superb returns are virtually assured.
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The Bottom Line: Goldman Sachs - who recently explained how the market's "stellar return borrowed heavily from the future" and "is now 30%-45% overvalued compared with the average since 1928" would now once again like you - dear client - to buy these stocks from them because - shockingly - the ECB was dovish... Trade accordingly.