After ‘Goldilocks’ Rally, One Bank Ponders What’s Next

Enjoy it while it lasts?

Although the last two weeks have felt a bit monotonous as market participants grapple with conflicting narratives in the course of trying to discern whether the YTD surge in risk assets has legs, it’s worth noting that the Nasdaq 100 just logged its tenth consecutive weekly gain. That’s the longest streak of weekly advances since 2012.

That run has helped put the Q4 malaise squarely in the rearview mirror for investors who came into the year shell shocked by grievous losses for many of the market’s most beloved names. Big cap tech is up more than 20% since the Christmas Eve massacre.

Notably, market breadth has improved – or at least if you go by the relative performance of the equal-weighted Nasdaq 100, which came into March having outperformed the regular gauge for five consecutive months.

But it’s not just the Nasdaq. And it’s not just equities.

Indeed, as Goldman points out on Friday, you’d have a hard time finding something that hasn’t performed well in 2019.

“Cross-asset performance YTD has had a distinct ‘Goldilocks’ flavour, with equities and bonds rallying together”, the bank writes, adding that “with US 10-year real yields falling significantly, safe havens such as Gold and the Yen have not sold off [while] risk-adjusted returns for credit were particularly strong due to the repricing of recession risk but also a much more carry-friendly backdrop amid low yields and a sharp decline in volatility.”

The following visual from Goldman’s note underscores the notion that 2019 has been just about as indiscriminate on the upside as 2018 was on the downside (technically, the chart shows returns since the December 24 nadir, but you get the idea).

(Goldman)

The bank also notes that thanks to the simultaneously rally in stocks and bonds, both balanced portfolios and risk parity have performed well. Specifically, Goldman says a US 60/40 portfolio “had the strongest return YTD since 1991 [while] risk parity portfolios have had particularly strong relative risk-adjusted performance since Q4 last year due to a high weight in bonds (and low equity weight).”

You might recall that there were multiple instances in 2018 when the stock-bond return correlation flipped positive during bouts of market turmoil, leaving investors with “nowhere to hide.” That’s changed in the new year.

(Goldman)

So much for the “balanced bear”.

In credit, you already know the story – or at least you should if you frequent these pages. Spreads have tightened materially pretty much across the board after a harrowing Q4 dominated by a series of dour narratives tied to, among other things, the “BBB apocalypse” story in IG, slumping crude and generalized late-cycle jitters in HY, and concerns about a “bursting bubble” in leveraged loans. “Credit has been in a ‘sweet spot’ due to the bond rally and repricing of recession risk”, Goldman writes.

What comes next? Well, that’s always the question, now isn’t it? If you’re Goldman, you’re sticking with a “moderately pro-risk” asset allocation over the next 12 months, where that means overweight stocks, neutral credit and underweight bonds. The bank also prefers EM over DM, which isn’t surprising given their soggy dollar view.

Over a three-month horizon, however, things get a little more nuanced in light what’s unfolded since late December. Here’s what the bank’s Christian Mueller-Glissmann has to say:

Over a 3m horizon, we are turning more neutral on risky assets (N equities and credit, UW bonds) and retain our OW cash. A continuation of the ‘Goldilocks’ rally from here appears unlikely and, while we think bonds will eventually close the gap as global growth picks up, we also expect slowing returns for risky assets as a result of a sharp re-rating of valuations. We like selective equity option protection strategies post the rally and sharp vol reset.

If your question is “What does this mean for me?”, my answer is “Nothing, why?”

I’m just kidding. It means exactly what it sounds like it means – after a ridiculous surge in assets of all stripes, something presumably has to pull back, and if you’re Goldman, you think “a pick-up in US inflation could drive concerns over the Fed resuming its hiking cycle or drive a rebuild of term premia”, thereby pushing up yields.

As far as stocks go, we would just come full circle and say enjoy it while it lasts. While the Q4 rout was clearly overdone and was doubtlessly helped along by the perpetuation of a misguided “imminent recession” narrative (turbocharged by ceaseless media coverage of the flattening curve and exacerbated materially by worries about Fed balance sheet runoff and non-existent bottom-up liquidity) there were good arguments for why caution was warranted.

It’s not clear that all of those concerns have been addressed just because the Fed pivoted dovish. Indeed, when it comes to global growth, we still seem to be searching for a bottom, something we’ll likely need to “find” before anyone is willing to fall completely out of love with the bond story and completely embrace the equity rally as something that’s sustainable and not just “for rent”, as it were.