Goldman Has 7 Reasons Why Stocks Didn’t Crash

Although the S&P just logged its first losing quarter since the onset of the pandemic, US equities have nevertheless been remarkably resilient in 2022, all things considered.

Yes, big-cap US tech fell into a technical bear market at the lows, but considering the backdrop, it could’ve been far worse. Bonds are experiencing the biggest drawdown in modern history and developed market central banks are determined to reestablish their inflation-fighting credentials with what counts as aggressive tightening.

Soaring yields and higher rates should be a death sentence for overvalued, long-duration equities. Instead, they’ve persevered. Indeed, the positioning-driven rally off recent lows was accompanied by outperformance in some rate-sensitive shares, including speculative corners of the market, like profitless tech.

There’s no question that the S&P’s two- (going on three-) week rally was driven primarily by a mechanical, flows-driven squeeze, but a lack of ambiguity around the “cause” of stocks’ snapback into quarter-end hasn’t quenched market participants’ thirst for an explanation that makes sense to the layperson.

In a new note, Goldman’s Peter Oppenheimer and Sharon Bell set about enumerating “seven reasons why equities are holding up well.” There’s not much that’s novel about the list (that’s not a criticism, by the way, it’s just to say Oppenheimer and Bell weren’t trying to reinvent the wheel on Thursday), but it’s worth highlighting because, again, investors want answers they can easily wrap their minds around, and too many market participants cringe at the first mention of the Greeks.

Needless to say, Goldman’s full exposition is lengthy (more than a dozen pages), but the bullet points are straightforward enough. Here are seven explanations for stocks’ recent buoyancy, heavily abridged and truncated from Oppenheimer and Bell:

1. Real interest rates remain deeply negative and equities provide a real yield.
2. Equities are a real asset as they make a claim on nominal GDP. So long as economies grow, revenues and dividends should also grow.
3. Private sector balance sheets are strong. Pandemic-led savings have left household savings rates high. Notwithstanding the risks of a squeeze in real disposable income (given higher inflation), households are in a reasonably strong position.
4. Credit markets have been relatively stable, reducing systemic risks. Cash to asset ratios remain high. Debt servicing capacity is as strong as it has been in 30 years. This is why we believe investors can expect dividends to be sustained, even in a weaker economic environment.
5. Spending on capex and infrastructure is likely to rise, at least in areas like China and Europe [where] the Russian invasion of Ukraine has dramatically changed attitudes… towards fiscal spending, the opposite of the post-financial crisis era.
6. Valuations have fallen to below long-run averages. While equities are only moderately below their highs, aggregate valuations have come down over the past year as markets have fallen behind the progression of earnings.
7. Positioning had been heavily reduced, raising the asymmetry on risk assets.

To be sure, Goldman’s outlook for US equities isn’t ebullient. Far from it. David Kostin sees (very) limited upside for the balance of the year. He cut the bank’s S&P target earlier this month.

“There’s going to be a significant number of negative earnings surprises. In fact, you’ll probably get a large number of pre-announcements in the coming weeks, just before earnings season,” he told Bloomberg this week, in an interview.

Oppenheimer and Bell adopted a similarly cautious cadence. “While equities should provide a hedge against inflation over the medium term, and should outperform bonds, there remain risks to the downside and more volatility, particularly related to growth risks,” they said, in the same Thursday noted cited above.

For Oppenheimer and Bell, wider trading ranges and lower returns are likely to be defining features of the market environment going forward. “There are risks to equities on the downside, mainly around recessionary risks,” they said, noting that Goldman sees a 25-30% risk of recession over the next year, higher than the 15% unconditional average.

In the bank’s recession scenario, the S&P could fall more than 20% to 3,600, Oppenheimer reiterated, adding that clients currently exhibit a “notable lack of conviction or enthusiasm at current valuation levels, given the slowing economy and rising rate environment.”