Goldman Sachs Recommends Staying Long Equities & Buying the Dips ~ market folly

Thursday, April 19, 2012

Goldman Sachs Recommends Staying Long Equities & Buying the Dips

Goldman Sachs' Investment Strategy Group recently reviewed four areas they're watching in regards to the markets and economy. In a research note, they address:

1. The current US trajectory: While they do not project growth above the natural trend, they do believe the country is on a sustainable, slow & steady trajectory.

2. Equity valuations: Goldman uses numerous metrics to measure valuation such as 10-year cash flow, price to book, and price to trend earnings. Using a combination of those, they believe equities are fairly valued. They outline two key questions: are margins at risk of declining? And do earnings have to follow suit and decline as well? They feel that margins will be sustained.

3. Geopolitical and other risks: They highlight Middle East tension, renewed pressures in the European periphery, as well as a hard landing in China as key risks. On the last issue, we've posted up Dan Arbess versus Jim Chanos on whether China is a bubble or bonanza. Goldman outlines a combination of these risks accounting for a 25% downside probability in US markets.

4. The merits - or lack thereof - of the old adage, "Sell in May, and go away": Goldman's team identified statistically significant weakness in the month of September. But historically, they point to positive returns in May through August. The main takeaway here is that if the market is down in September, it has typically gone down a lot. That said, they found no evidence to support a consistent "sell in May and go away" investment strategy.

Goldman's Investment Conclusion

Their Investment Strategy Group writes,

"While the economic backdrop, neutral valuations, and moderate geopolitical and economic risks favor equities in our opinion, we also recognize that investing in equities entails volatility. As an asset class with 15% annual volatility, it is typical for equities to decline by 5% or more about 3 times a year and 10% or more about once a year, on average. So to capture the upward trend in equities, an investor has to tolerate the frequent downdrafts. The latest non-farm payroll and heightened concerns about peripheral Europe might well result in one of these downdrafts; in fact, our very short-term momentum signals have turned negative. But as investors - rather than traders - we recommend staying long equities. For those who are underinvested, we recommend using downdrafts as opportunities to build equity positions."

For additional market commentary, head to strategist Jeff Saut's latest note on being conservative, not conventional.

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