Goldman: Any Further Significant Weakness Is A Buying Opportunity

Markets were choppy again Wednesday as January’s epic swings continued unabated.

Needless to say, traders were looking to the Fed for answers after weeks of speculation about the likely scope of the forthcoming tightening cycle.

US equities have never suffered a worse start to a calendar year, a testament to the notion that the pain threshold vis-à-vis rising bond yields (and particularly real rates) is lower over time. Like everything else, that’s a self-fulfilling prophecy. The lower real yields go, the richer valuations get, which in turn makes equities even more sensitive.

Ultimately, though, some strategists now believe that headwinds aside, the three-week rout in US shares is “enough,” for now, and any additional weakness should be viewed as an opportunity.

The question is whether markets have already priced a slowdown in US growth and, relatedly, how persistent any slowdown that does materialize proves to be. Equities can rise with policy rates and bond yields as long as it’s all supported (or “funded“) by growth. If growth decelerates meaningfully, and durably, that’s a problem. Especially if the Fed is forced to keep hiking into the teeth of the slowdown by the necessity of waging war on inflation.

“To the extent that zero interest rate policies, negative real interest rates and QE have been supportive for risk assets, it is understandable that a perceived move away from these supports should cause a correction, particularly given high valuations,” Goldman’s Peter Oppenheimer wrote, in a new note that garnered a fair amount of media attention. He went on to suggest the upcoming policy “adjustment” is now “reflected” in markets and described potential downside risks as “much lower” assuming “economies can grow.”

That latter bit is important. I spent all day Tuesday discussing it. The figure on the right (below, from Goldman) makes the point.

The bank’s RAI has retreated significantly (figure on the left, above). Oppenheimer said we’re now “getting closer to levels that have typically been a good entry point for longer-term investors.”

I suppose this goes without saying, but “longer-term” is the operative adjective. This is a delicate juncture. Additional volatility is assured.

Oppenheimer asked what he called the “obvious question” — namely, “Whether this correction will deepen and turn into a bear market?” Goldman’s answer is that “it will not.” He referenced the extraordinarily elevated ratio of global market cap to GDP, calling it “in part… a function of QE.” Indeed, US tech (plus Tesla) alone is the third largest “country” in the world (figure below).

If you plot the evolution of major central bank balance sheets against the same chart of FAAMG market cap, it matches up even better than the infamous visual plotting the Fed’s balance sheet with the S&P.

For Goldman, though, a slow move away from an environment in which the lowest interest rates in 5,000 years effectively allowed investors to assign an infinity multiple to future cash flows isn’t necessarily an argument for a bear market. Instead, it’s “more likely” to entail “a cycle in which aggregate returns are much lower than in past ‘secular’ bull markets,” Oppenheimer said.

Again, it really all comes back to growth and whether the economy has enough gas left in the tank to finance the Fed’s efforts to fight inflation without going bankrupt, where “bankrupt” means a recession. “Given that economic activity in the fourth quarter of 2021 and the first quarter of this year have already been impacted by the effect of the Omicron variant, it’s probable that there will be a modest improvement in Q2 and Q3 even if rates are starting to rise,” Oppenheimer wrote, noting that cyclical assets have already priced slowing PMIs.

Further, it’s important to keep perspective. Even if terminal rates rise to meet Goldman’s above-consensus forecast, they’d still be “very low” in the historical context, and likely not high enough to trigger a recession, the bank said Tuesday.

Ultimately, Goldman’s view is that markets “are in a correction within a bull market cycle.” This is, Oppenheimer said, “the early part of the Growth phase” and although “returns will likely be low from here,” the bull market will trudge on, assuming respectable economic growth.

“Any further significant weakness at the index level should be seen as a buying opportunity,” Goldman said, summing up their view. The bank added a caveat: “Albeit with moderate upside through the year as a whole.”