‘Choppy In Coming Months’

The S&P hit Goldman’s year-end target this week. And then it kept on going.

Eventually, if US equities continue to run, sell-side strategists whose targets are antiquated will likely “mark to market,” as it were. But for their part (and for now), Goldman is sticking to 4,300 for year-end.

In his latest, the bank’s David Kostin outlined “strategies for H2 when the S&P 500 will be flat.” I found that language somewhat amusing — “will be,” as though “flat” is a foregone conclusion.

The irony is that if we can say anything with near certainty about US equities (as proxied by the S&P), it’s that the benchmark will almost surely not be at 4,300 on December 31. That’s not a prediction about whether stocks will be higher or lower, it’s just to say that the odds of the S&P “settling” somewhere in a narrow band around 4,300 six months from now are surely lower than the odds of some series of unforeseen events conspiring to leave the benchmark materially lower or higher than where it sits today.

In any case, Kostin reiterated that the bank’s expectations of higher interest rates and higher corporate tax rates by year-end “are the primary reasons” for the forecasted sideways grind from here through year-end. The S&P trades at 22x on a forward multiple (figure below). That’s in the 94th percentile.

Given that, Kostin’s contention that “equities during the next six months are more likely to experience multiple contraction than expansion” is easy to agree with.

After calling additional absolute multiple expansion “unlikely,” he delivered the obligatory nod to just how relative it all is. US equities are not particularly stretched compared to bonds.

Speaking of that, Goldman reminded folks that “every investor needs to have a view regarding the forward trajectory of bond yields.” Again, I can’t help but chuckle. If you go by how wrong most professional forecasters have been dating back decades, you’d come away with the notion that forecasting benchmark US bond yields is one of the most difficult tasks known to mankind.

So, while Kostin is undoubtedly correct to say that “every investor needs to have a view” when it comes to the likely evolution of US rates, formulating such a view is notoriously difficult.

“Aside from a late January disruption when a few meme stocks rocketed higher and sparked an epic short squeeze, the dominant macro driver of equity returns during H1 was interest rates,” he went on to say, noting that during the height of mini-tantrum, 10-year yields were nearly 100bps higher than they were at the beginning of 2021.

Where rates go from here is the multi-trillion-dollar question, and the answer will determine whether the reflation trade, in all its various manifestations, is just getting started, or already past its sell-by date.

Long/short duration should be “a major theme” during the second half of the year, Kostin said, noting that when it peaked on May 12, “the pair trade had posted a YTD return of +40%.”

Who remembers what happened on May 12? That was the day markets were compelled to digest April’s CPI “shocker,” which set in motion a “pull-forward” dynamic in rates, as market participants began to anticipate an accelerated timeline for policy tightening and thereby the possible ramifications for growth of the Fed tapping the proverbial brakes. That culminated in the post-June FOMC power-flattening in the curve. (For a complete recap, see here.)

Recently, the long/short duration trade has reversed alongside the drop in yields. That coincided with the worst month for value shares relative to growth shares in two decades (figure below).

Although Goldman sees potential for the long/short duration trade to reverse again (i.e., short duration shares outperforming) assuming the the bank’s economic forecasts pan out, Kostin said Friday that “strategically… decelerating economic growth [may] support the outperformance of Growth versus Value in late H2 and into 2022,” even as Goldman said the trade “will remain volatile in the near-term.”

That latter bit (and Kostin’s subsequent remarks) underscored just how difficult it is to get a handle on things right now, with the narrative prone to shifts every other day.

“Economic growth deceleration generally supports owning Growth, but both rising interest rates and the passage of a fiscal package including infrastructure and tax reform would benefit Value and therefore suggests a choppy outlook for the trade in coming months,” he said.

“Choppy in coming months” would probably work as a title for any strategy piece published between now and the September FOMC.