Goldman Sounds The Alarm On Stocks: When Euphoria Is This High, "It's A Good Time To Reduce Risk"

The past few months can best be characterized as a period of unprecedented market optimism and sheer euphoria. But whereas in the recent past, the euphoria was always bounded by the upper limit reached during the insatiable buying spree of the dot com bubble, the first week of 2021 is when we went off the chart. Literally. As we showed last week, Citi's (C) latest Panic/Euphoria model hit a record reading of 1.83 versus an upwardly revised 1.69 in the prior week. 

What does this mean? It's simple: as Citi chief economist Tobias Levkovich wrote last Friday when looking at market returns following previous euphoria extremes, there is now a "100% historical probability of down markets in the next 12 months at current levels."

Judging by the market action in the subsequent week which saw the S&P slide 1.5%, the Citi economist may be right, and the selloff is only just starting. Then again, the market has a tendency to do the opposite of what consensus expects it to do - and right now consensus among even the most bullish banks is that the next move in stocks will be lower - which is why the fact that Citi's call for a selloff becoming consensus, make us wonder if the next move in stocks won't be much higher instead.

Case in point, in the latest Goldman Portfolio Research Strategy report, Christian Mueller-Glissman writes that Goldman's Risk Appetite Indicator (RAI) reached a reading of 1 this week - the highest in 4 years and just shy of an all time high - after a large increase in risk appetite since Q4 last year.

How did we get to such a high reading?

As Goldman explains, this was largely on the back of growth optimism in 2021, and while the bank expects monetary policy to remain supportive, "we see less potential for much more positive impulses from here. Following the news of a successful COVID-19 vaccine in November, growth optimism has broken out and shifted further into positive territory since Q4 as markets have become more optimistic on the prospects for reflation." These various dynamics are shown below:

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