Who’s in the mood for some generic “don’t panic, the fundamentals are sound” analysis on Saturday?
I’m just kidding. I don’t want to be derisive because really, the fundamentals are pretty sound, although I fully acknowledge that “the fundamentals are sound” is one of the worst, most nebulous clichés in the history of markets.
But before we get deep into the weeds this weekend (and I’ll drag you there kicking and screaming before it’s over), I wanted to kick things off with something straightforward.
First of all, it’s not hard to understand why some folks are nervous. The S&P has now logged five weeks of >3% declines in 2018 – that hasn’t happened since 2011.
This is still on pace to be the worst month for U.S. equities since 2009 and if lines are your thing, the S&P closed on Friday below its 50-week moving average.
All of that said, there are plenty of reasons to think this isn’t systemic and on Friday evening, Goldman suggested stocks will rebound based on the old stalwarts – earnings and ongoing optimism about the U.S. economy.
“The S&P fell by 4% this week as the market sharply lowered its growth expectations, but gradually decelerating economic and earnings growth has been our and most investors’ baseline forecast for much of the year”, the bank reminds you, adding that in their view, “the market has moved past fair value.”
In case the implication there isn’t clear enough, Goldman isn’t prepared to budge on their year-end S&P 2,850 target.
I’m sure this will elicit some jeers from the peanut gallery (i.e., from the “blackouts are a myth” crowd), but Goldman also notes that “48% of S&P 500 firms are now out of their blackout windows and will be able to resume discretionary share repurchases.”
Again, Goldman basically argues that from a fundamental perspective, everyone appears to be suddenly pricing in what the market has known all year and in that respect, may have overshot.
“Our US economists’ forecast is for US GDP growth to gradually slow from 3.5% in 3Q 2018 to 1.6% in 4Q 2019, [but] the move in equity prices reflects a sharp adjustment in growth expectations”, the bank says, adding that “based on historical relationships, current prices would correspond with a near-term drop in the ISM to roughly 52 or a deceleration in US economic growth of roughly 1-2 pp”.
Obviously, a quick look under the hood (so to speak) reveals concerns about the cycle. That’s documented extensively in “Slow Bleeding The Aging Bull”.
But while homebuilders, autos, semis, etc. are under siege, Goldman notes that “railroads have outperformed the S&P 500 by 11 pp YTD (+12% vs. +1%) and underperformed by only 3 pp this month, while corporate credit spreads have widened by a much smaller amount than implied by their historical beta to S&P 500 moves.”
That latter point is interesting and potentially telling. If it’s systemic risk you’re looking for, well then you should note that IG and HY haven’t widened out commensurate with the stock selloff. Particularly interesting is the extent to which CCCs have outperformed their beta to the S&P this month even as Cyclicals have been crushed amid late-cycle concerns.
“Within the HY rating spectrum, the under-reaction has been stronger for the growth-sensitive CCC-rated bonds, which is somewhat surprising given the sharp underperformance of cyclicals vs. defensives in the equity market”, Goldman’s U.S. credit team wrote this week, in a separate note.
If you’re in the camp that thinks credit is usually “right” while equities are mostly “wrong” (or if you want to substitute “early” and “late” there, that works too), well then you need to explain credit’s relative resiliency if you’re going to contend that what we’ve seen in October from stocks signals something systemic unfolding behind the scenes.
All of that said, Goldman’s credit team does acknowledge the obvious, which is that sour sentiment can become self-fulfilling, and on the equities side, the bank observes that “market breadth has sharply narrowed during the recent price volatility [and] rapid declines in market breadth typically precede larger-than-average drawdowns.”
Draw your own conclusions.