‘Disharmony’ And What’s ‘Frustrating’ Goldman’s Clients

US equities may have had their best day in more than a month on Friday, but for the week, it was largely a wash.

Friday’s post-jobs surge helped erase losses logged on Wednesday and Thursday, when investors struggled to make sense of a dovish Fed statement followed immediately by a hawkish presser.

Notably, Thursday saw concurrent selloffs in stocks and bonds amid repositioning as Powell appeared intent on dialing back expectations for the much ballyhooed “insurance cut”.

In general, this week’s data and good cop/bad cop messaging from the Fed underscore what Goldman on Friday evening called a “disharmony”. On the data side, that manifested itself in the worst ISM manufacturing read since late 2016 and (another) robust jobs report.

“This week the Reiwa era of ‘beautiful harmony’ began in Japan [but] in the US… a disharmony of mixed economic data and Fed messaging pulled stocks off the record highs reached earlier in the week”, Goldman writes, adding that “this week’s mixed data stand in contrast to the general strength of economic releases thus far in 2019, which have contributed to a 17% S&P 500 YTD return and supported the sharp outperformance of cyclical equities.”

What’s particularly notable is the extent to which strength in cyclicals hasn’t triggered a rotation into value stocks. That, Goldman says, has led to “frustration” among clients, who are curious to know why “‘catch up’ trades are not working with the S&P 500 back at record highs.”

(Goldman)

The reason, the bank muses, is that although generally robust economic data and a dovish Fed have helped alleviate fears of an imminent recession, folks are still concerned about the late-cycle environment. “Economic data have improved, but the unemployment rate is 3.6% and the current economic cycle will match the longest on record next month”, Goldman notes, before running through the following set of indicators which together underscore anxiety about the cycle:

The futures market shows a 50% likelihood of Fed rate cut by year-end. The CEO Business Confidence survey improved modestly in 1Q 2019 relative to 4Q 2018, but otherwise registers the lowest reading since 2012. And the Philly Fed’s Anxious Index shows that professional forecasters assign a 22% probability of recession within the next four quarters, the highest reading this cycle outside of the 23% print in 4Q 2018.

So, where to from here (the ubiquitous quandary)?

Well, according to Goldman, you fall into one of three “camps”. Either you i) think the US economy is going to slow and thereby doubt whether cyclicals can continue to perform, ii) believe the outlook is going to brighten, leading to a widespread belief that the cycle can drag on, which may eventually catalyze a rotation into value and/or low-quality names, or iii) you’re like Goldman, and expect “the combination of healthy but unspectacular economic growth and a patient Fed” to continue, leading investors to “reward firms with superior idiosyncratic growth profiles despite premium valuations.”

Of course, indiscriminately chasing growth has the potential to leave one piling into expensive names. Indeed, the bank cautions that “dispersion today is close to the widest level this cycle and according to some measures the widest since the Tech Bubble.” That, in turn, means you might want to steer clear of anything with an “extreme valuation.”

On that note, we’ll leave you with one last chart…