In the midst of rampant uncertainty, Goldman’s cross-asset strategy team this week upgraded equities to Overweight on a three-month horizon, a somewhat bold decision considering the event risk captured by that timeframe.
Then again, stocks just staged one of the most ferocious rallies in history in the face of what, at least for a couple of months, was the closest thing to an outright depression the world had seen in a century.
Additionally, Goldman’s call contained quite a bit of nuance. It wasn’t a pedal-to-the-metal bull call, and besides, there is an argument to be made that if the US election manages to go some semblance of “smoothly” and a safe, effective vaccine comes to market, you’d have a setup for a pro-cyclical surge. (Those are some pretty big “ifs“, though.)
When it comes to US equities specifically, the bank’s David Kostin calls what happened over the past several sessions a “warp speed correction on the road to 3,600”.
The allusions are to The White House’s cartoonishly-named vaccine program and to the bank’s recently adopted year-end target for the S&P, respectively. The correction in the Nasdaq 100 was, in fact, of the “warp speed” variety, perhaps underscoring (again) the fragility of modern market structure.
“The S&P 500 reached a level of 3,450 for the first time in early August and then surged to within 20 points of our 3,600 year-end target before trading back down to 3,341 today”, Kostin wrote in a Friday note, adding that the bank “still expect[s] the market will rise to 3,600 at year-end 2020 (+8%) and 3,800 at mid-year 2021 (+14%) driven by improving earnings prospects and a declining risk premium”.
As for the vaccine push, the bank notes that despite this week’s setback (and the AstraZeneca trial has resumed, by the way) the near-term odds for a shot are still favorable. “According to the Superforecasters at the Good Judgment project, there is now a 68% probability of mass-distributed vaccine by 1Q 2021, up from 40% three weeks ago”, Goldman writes. Expectations for a vaccine are one principle reason behind the bank’s above-consensus 2021 GDP outlook.
Somewhat amusingly, Kostin says recent client conversations “have focused on our 2022 EPS estimate of $188”. Note that the bank’s 2021 EPS forecast is above consensus, but it still implies a somewhat stretched multiple. However, if you now look through 2021 as well as this year, it’s easier to wrap your head around current levels on SPX.
“One interpretation is that investors are seeking to rationalize or justify the summer surge in share prices”, Goldman writes, in the course of noting that “EPS revision sentiment has been extremely positive since June, rivaling other post-recession periods, but revisions to 2021 earnings have stalled in the past month”.
As you can imagine, the bank sees it as likely that the rollout of a safe, effective vaccine would prompt analysts to upgrade their profit forecasts.
Still, stocks are the most expensive in 20 years, and tech shares are even richer, trading near 25X. At least that’s below 37X (give or take) for the FAAMG cohort.
Kostin reiterates that positioning isn’t stretched on the whole, although hedge fund leverage is. The LS crowd was buying tech and software last Friday and also coming off the long Labor Day weekend on Tuesday, Goldman said this week. Data from Morgan Stanley’s prime desk showed similar buying, after large selling during previous sessions.
One issue going forward is hedge funds’ Overweight in tech, which could lead to performance bleed if the rout continues. “Should the market pull back further, the performance pain will likely be more significant on the long portfolio, but there could be further appetite to add to shorts”, Morgan Stanley remarked.
“Recent news reports of potential antitrust litigation represent a risk, as is record hedge fund crowding”, Goldman’s Kostin cautions, even as the bank still recommends an Overweight in the sector.
Goldman continues, noting that their Sentiment Indicator “reads only 0.4 standard deviations above average [as] net equity futures length is still low, and more than $1 trillion remains in US money market funds following inflows earlier this year”.
Kostin tosses out a possibly relevant factoid. Since the GFC, S&P pullbacks of at least 5% generally last about a month and typically stretch to 7% peak to trough. “Interestingly, there has been no difference in magnitude or duration between pullbacks driven by positioning unwinds defined by underperformance of the most popular hedge fund positions and other pullbacks”, he observes.
In case you were in any way unclear about this, Goldman’s US equity team also notes that, in the near-term, “the biggest source of uncertainty is Election Day”.