"How Much Worse Will It Get?" That's What Goldman's Clients Want To Know

Last weekend, just after the 666-point crash in the Dow which seemingly came out of nowhere after the market misinterpreted the average hourly wages print as strong (when in reality it was weaker than expected when factoring in the slide in hours worked), Goldman's clients had just one question: with the market suddenly tumbling after the best start to the year since 1987 (other parallels included a collapse in the dollar and a spike in yields), was this 1987 all over again?

Goldman's response, as delivered by the bank's chief equity strategist David Kostin, predictably was 'don't panic, things are very different than they were 31 years ago.'

In retrospect, and considering the immediate market plunge that followed, what happened next certainly certainly had the feel of 1987, Goldman's clients should have been asking Bank of America , which on payrolls Friday correctly predicted that a 12% plunge was imminent.

Meanwhile Goldman's David Kostin was out there defending his bullish thesis (even if he quietly suggested that "investors who are already long cash equities could instead consider purchasing puts as protection".)

Well, it's one week later, the biggest ever point crash in the Dow Jones is in the history books, as is the volocaust which sent the VIX up by the most on record and imploded the inverse VIX industry.

So yes, to all those clients who are wondering how the smartest FDIC-backed hedge fund investment bank could get it so wrong, we suggest you read "Goldman Does It Again: Crude Crashes 11% After "Most Bullish In A Decade" Call."

* * *

Fast forward one week later when the same David Kostin, whose infectious enthusiasm last Friday just cost his clients millions, tells us that the biggest question worrying Goldman (suddenly poorer) clients is no longer "is it really bad" - it is - but "how much worse will it get?"

It will probably not shock readers, to learn that once again Kostin - like JPM's Marko Kolanovic two weeks ago - has just one job: to prevent a liquidation panic, and to restore confidence that the 10% correction which just happened seemingly out of nowhere was a one off event, or - in the parlance of Wall Street - a "healthy correction."

Alas, after last week's forecast disaster, Kostin's promises that all is well have about as much value as an $100 XIV call. So instead of piling on his discredited opinion, here are the facts from the chief Goldman strategist, the bottom line being that once there is a correction, the market will likely keep selling for a while, with the peak to trough change for non-recession corrections 15%, and 27% for corrections that morph into outright recession, and a blended average drop of 18%, or roughly double the current drawdown.

Here are the details:

Most equity market corrections recover without developing into bear markets or presaging recessions. There have been 16 drawdowns of 10%+ since 1976. Of the 16 corrections, only five occurred around a recession. Of the remaining 11 non-recession episodes, 1987 was the only one that turned into a bear market (i.e., a decline of 20%). A bear market would mean the S&P 500 falls below 2300, which history suggests is unlikely to occur without a recession. Our economists believe the probability of a recession remains well below average, given strong global GDP growth and loose financial conditions. Earnings fundamentals also remain strong. Since the market peak, consensus 2018 EPS have been raised by 2%. Consensus EPS expectations rose by a median of 1% during corrections not associated with recessions compared with a decline of 3% in recession corrections.

In other words, the S&P 500 typically declined by 15% during the 11 non-recession corrections since 1976. Putting this in current context, a fall of this magnitude would carry the index to 2450, roughly 6% below the current level.

Some other facts: The typical correction took 70 trading days to trough and 88 days to recover. However, an investor who bought the S&P 500 10% below its peak without waiting for a bottom would have experienced median 3-, 6-, and 12-month returns of 6%, 12%, and 18%.

For those looking for a more granular breakdown, Kostin notes that market performance following past non-recession corrections suggests investors should prefer cyclical sectors to defensives (see Exhibit 3).

  • Materials has beat the S&P 500 by a median of 270 bp during the three months following past corrections. Industrials outpaced the index in 73% of periods by a median of 270 bp.
  • Telecom has been the worst post-correction performer, lagging the index in 64% of periods by a median of 410 bp.
  • Among factors, low valuation and small-cap stocks typically performed best following 10% declines. The Russell 2000 index has outpaced the S&P 500 by a median of 240 bp.
  • Low volatility stocks typically fare worst, lagging high volatility firms in 87% of post-correction periods by a median of 610 bp.

Finally, for those who simply hope to fade any advice Goldman brings to the table, just do the opposite of this:

We recommend investors focus on Cyclicals and Low Labor Cost stocks now that the long-awaited correction has occurred. Exhibit 4 identifies 25 Goldman Sachs Buy-rated stocks that have lagged most during the current correction relative to their respective beta-implied returns. The median stock has a beta of 1, but has lagged its beta-implied return by 5 pp since January 26.

For readers who believe the correction is only just starting, the choice is clear: just short Goldman's top 25 "laggard" stocks.

NYSE, October 19, 1987.


MK ULTRA Alpha Arrowflinger Sat, 02/10/2018 - 17:50 Permalink

I've had margin calls, it forces one to pay up, or sell off.

The buying interest Friday makes me hold off on the new crash theory, we need to understand market expectations and the reasons for buying. If the sell off continues, then the panic is causing a sell off at a loss, the earlier sell off was profit taking, it's harder to shake out holders with losses unless there is a margin call.

(also, the profit taking sell off must pay capital gain, increased tax revenues from winning, but if the market declines to a certain point, then the loss is a tax write off, this would neutralize the profit taking sell off capital gain, tax revenue.)

Friday's buying was evidence there is still robust demand. Now the demand could have come from the Fed's plunge protection team. If one believes the Fed intervenes in markets to prevent a crash.

But things are happening, and it's early, we really can't make run away inflation predictions based upon a small up tick in velocity of money and greater employment and wage growth.

The hyper inflation of the early 80's and before that the price controls of the 70's, would have had to be lived to realize, the US is a long way from hyper inflation and price controls.

Economist often use 18 months as the length of time to see results from an economic input. It will be interesting to see the tax reforms results in 18 months. That's an expectation. The continued equity buying in the face of doom and gloom hype could be driven by the expectation of greater economic growth over the next two years. This is the trend driving the market, could there still be robust demand from this trend?


In reply to by Arrowflinger

Brazen Heist MK ULTRA Alpha Sat, 02/10/2018 - 18:11 Permalink

First ones out the door win. The plunge protection team will be there to cushion the 1% as they unwind positions, leaving the bagholders to take the loss. Its either the 1% or the 99% and every single time its the 99% that gets shafted. Calling tops is hard, but this one is looking very precarious especially in light of interest rate normalisation. The chart alone looks like a monstrosity.

In reply to by MK ULTRA Alpha

Debt-Is-Not-Money Brazen Heist Sat, 02/10/2018 - 20:03 Permalink

You are absolutely right.

All the way up from about $8,000 (DOW) "they" have been playing with borrowed 'money' that some assholes called "free money". They may not have to pay interest on it but they sure as hell need to repay the basis. This has been laddered (especially on margin as you mentioned) all the way up so the last ones in will be the first out. All the middle class "followers" and their financial 'advisors' don't have a clue, and have been programmed to 'buy-the-Fuckin' dip'.

Look out below!

This has the potential for a massive waterfall decline down to the $6,000-$7,000 level.



In reply to by Brazen Heist

adolphz Sat, 02/10/2018 - 17:00 Permalink

Only  Goldman's wealthiest clients will get any thing of value from them.   if nothing else it is proven that Goldman comes out at the last minute with any accurate market information.  Usually months after the SHEPWAVE traders have been in position. 

buzzsaw99 Sat, 02/10/2018 - 17:10 Permalink

Kostin's promises that all is well have about as much value as an $100 XIV call...   LULZ

a lot of people wanted to top tick this bitch.  even the snb can't stand the thought of a mere 5% decline in nav.  those who got in late are shitting bricks right now.

El Hosel Sat, 02/10/2018 - 18:11 Permalink

When was the last "drawdown" after 10 years of "Engineering" a Recovery with the main emphasis on asset inflation? I guess they can rig the correction as well but there really has never been anything like this shit show Bull Market.

CRM114 Sat, 02/10/2018 - 19:06 Permalink

"which seemingly came out of nowhere after the market misinterpreted the average hourly wages print as strong (when in reality it was weaker"


Is this the best reason available? The first signs of the crash started because of the misinterpretation of one stat that everyone knows is manipulated anyway?

I think not.

Either give us the real reason or admit you have no clue.

Not that any other financial journalist has been any better for the last 15 years. At least.


2008 started because mortgages were being handed out to anyone with a pulse, and the mortgage companies were lying about doing due diligence, when they were doing the exact opposite. I worked this out because I spoke to several people with a pulse who'd been given said mortgages, and who told me how the companies said they wouldn't check their income data. So when the crash happened, I was nowhere near "the markets"

There is no substitute for 1st hand experience. There is no excuse for pretending you have it when you don't.


Yen Cross Sat, 02/10/2018 - 19:10 Permalink

  I want to know why people even do business with the Squid in the first place?

 How many tarders lost their asses on that long oil reco from the Squid last month?

loveyajimbo Sat, 02/10/2018 - 19:46 Permalink

Interest rate derivatives will be the spark... and maybe the fire is already burning... heard a rumor that two major banks will not open for business Monday... one in Europe, one in the USA. If that happens, BOOOOOM!

Wonder why Trump's SEC head has done nothing about HFT or derivatives... or anything else?

InnVestuhrr Sat, 02/10/2018 - 20:02 Permalink

Question for anyone who has owned an equity ETF that does NOT include derivatives, just equities, eg SPY, DGT, IVV, VTI, etc:

On your IRS Form 1099 for the equity ETF(s), are the dividends from the ETF regarded as qualified dividends or just ordinary dividends ?

Yen Cross InnVestuhrr Sat, 02/10/2018 - 21:00 Permalink

 short term capital gains=qualified [ if you don't reinvest]

  Normally mutual funds will send quarterly/monthly statements and have you rolling gains back into the fund.

  ETF's are very similar, but the funds are held in a giant LLC-Trust.

 I wouldn't worry too much though. The IRS is too busy selling your S.S. to Russian hackers.


   Lois Lerner

In reply to by InnVestuhrr

francis scott … Sun, 02/11/2018 - 00:48 Permalink

"How Much Worse Will It Get?"

But.. but.. but ... all the famous Wall Street analysts are saying

that things are great.  Are they just saying that to keep the top