Ok, well if what you needed to start your week on the “right” foot was Goldman telling you that “a correction of some kind seems a high probability in the coming months”, well then rejoice, because that’s exactly what the bank says in a brand new note.
Basically, the latest from the bank’s global equity strategy team amounts to an effort to rollup a bunch of recent notes into one sweeping assessment of the prevailing dynamics and you know what? That’s actually pretty damn useful, because it’s hard to keep up with all of this shit on a daily basis, so props to them for that.
Anyway, one theme that pervades the analysis is the idea that investors should be wary of rising bond yields. This is of course a hot topic right now, what with Treasurys posting some of their worst risk-adjusted returns on recored YTD while the S&P continues its inexorable rally.
“The ‘melt-up’ in equities has already happened despite sharp bond losses,” the bank writes, before showing you the rather stark contrast that seems to suggest the “everything bubble” may be at risk:
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Of course there are plenty of reasons why equity investors are feeling so goddamn optimistic and Goldman makes sure to list all of those reasons. Hint: it’s the usual suspects, so synchronous global growth, still low bond yields (even if they’re now rising), loose financial conditions, and low macro vol. That said, Goldman states the obvious which is that it’s better to buy at the bottom than the top:
Despite the strong macro outlook, it is worth remembering that it is typically better to buy a market when the news is poor and valuations are low than when all news is good and valuations are high. The risks associated with strong conditions are reflected in our bull/bear market indicator, which is currently high relative to history (Exhibit 8).
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The bank then goes on to list a number of risk factors including, but certainly not limited to, the fact that everyone is ignoring political risks, the high prices investors are now willing to fork over for upside exposure via calls (more on that here and here), the ongoing “valuation frustration” where equities, bonds, and credit are all the most simultaneously expensive in 100 years (more here), and the fact that equities are quickly becoming less attractive relative to bonds, something SocGen flagged last week (see here). Here’s Goldman on that latter point:
The sharp rise in equity prices has pushed market-cap-to-GDP ratios to record-high levels in the US (Exhibit 17). While the rise in equities partly reflects the lack of attractive alternatives, it has meant that the Equity Risk Premium (which has provided a strong cushion for the equity market over recent years) has recently fallen back towards more ‘normal’ levels, despite bond yields remaining very low. This suggests that there is now less room for bond yields to rise without causing damage to equities.
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Ultimately, Goldman does remind you that it’s entirely possible to have a short-lived “correction” that doesn’t morph into an outright bear market and that history shows it only takes the market four months to recover from ‘corrections’ (defined as 10%+ move lower) versus 22 months for bear markets. So I guess you shouldn’t panic unless stocks dive at least 10% and don’t recover all of that within 120 days.
Anyway, take that for what it’s worth which, in the minds of the deluded masses high on nine years of central bank heroin, probably isn’t much.
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