This week I’ll detail Goldman Sachs’ client guide to market volatility, why global asset allocations might cause more selling in equities, some context to the ominous yen carry trade and suggest a book that objectively changed how I think my way through the world.
Investor guide for volatility plus stock opportunities from Goldman Sachs
Goldman Sachs chief U.S. equity strategist David Kostin provided compelling evidence of a change in focus for equity markets and offered both an investor roadmap for the weeks ahead and a list of stocks to consider during future periods of volatility.
Mr. Kostin identified weak labour market data as the catalyst for last week’s sell-off as initial jobless claims, manufacturing employment and non-farm payroll numbers all came in below expectations. A seasonal lack of volatility, hedge fund profit taking in the Japanese equity market, the partial unwinding of the vaunted yen carry trade (more on that below) and deleveraging by high-speed algorithm-based Commodity Trading Advisor (CTA) funds served to exacerbate the volatility.
The severe underperformance of cyclical market sectors relative to defensives, technology stocks, and the Russell 2000 indicate a change in market leadership towards recession fears according to Goldman Sachs. Previously, investors had been rewarding individual stocks with strong profit outlooks by a larger margin than the historical average, a microeconomic emphasis, but last week performance was largely determined by sensitivity to economic growth – a macroeconomic perspective.
Jan Hatzius, Goldman’s chief economist and head of global investment research, is arguably the most respected and prominent forecaster on Wall Street. He raised his probability of U.S. recession marginally from 15 per cent to 25 per cent but is emphasizing that expansion is a far more likely scenario than recession.
Using the precedents of similar sell-offs, Mr. Kostin made two important predictions. One, that market volatility will only slowly return to normal. The second is that declines of this magnitude have historically been lucrative buying opportunities.
The stocks most likely to benefit as focus returns to individual stock performance are those that have been unfairly sold off. Mr. Kostin screened for companies that are down most since July 31st but where earnings estimates are healthy and rising.
The result of the screen was a 45-member list of opportunities ranked by worst return since the end of July. Stocks down most that are most likely to interest Canadian investors include Norwegian Cruise Line Holdings Ltd. (down 16 per cent when 2025 profit estimates are up 23 per cent), Carnival Corp. (13 per cent, 32 per cent), Amazon.com Inc., (11 per cent, 25 per cent), McKesson Corpu. (11 per cent, 12, per cent), Stanley Black and Decker (11 per cent, 35 per cent), Flowserve Corp., (10 per cent, 15 per cent) and Ingersol Rand (10 per cent, 9.0 per cent).
Global asset allocations suggests more selling to come
J.P. Morgan global market strategist Nikolaos Panigirtzoglou described a disquieting element of asset allocation as part of his analysis of last week’s Monday sell-off. Mr. Panigirtzoglou noted that even after the almost-correction, the allocation of equities relative to bonds and cash globally is well above the post-2015 average at 46.5 per cent.
The strategist uses the post-2015 average as a benchmark to account for what he calls the “new equity culture” - higher household allocations to stocks incentivized by zero commission trading and access to leverage.
What’s the disquieting part? Mr. Panigirtzoglou estimates that global equities would need to fall another eight per cent to return global allocations to average levels.
As an addendum to last week’s comments about the yen carry trade, J.P. Morgan offered more context and an estimated total value of US$4-trillion. Mr. Panigirtzoglou listed three types of yen carry trades. One is foreign investment in Japanese assets with currency hedges. Two is the conventional type – hedge funds borrowing yen to buy non-Japanese assets. The third, Japanese investors buying foreign stocks and bonds, is by far the biggest in size
This book legitimately changed my life
I went through most of my life believing that my conscious brain was acting as a kind of quarterback or orchestra conductor for the thinking that was happening. Then I read a book that changed my life – Incognito: The Secret Lives of the Brain by neurobiologist David Eagleman.
The premise of the book is that our conscious brains do not have security clearance for the majority of the activity going on. Mr. Eagleman provides countless examples of how the subconscious determines behaviour and decision making, often without informing the conscious mind of the process behind it.
I will mention one incredible fact from the book. There is a potentially fatal form of epilepsy that requires the removal of an entire hemisphere, half of the brain. If the removal happens before a child is seven or eight years old, there is zero long-term loss of intelligence of function.
The essentials
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What’s up next
The domestic economic calendar is light next week with only existing home sales and housing starts worth significant focus. In the U.S., the release of CPI data on Wednesday will suck up a lot of finance media oxygen (core CPI consensus estimate is 0.2 per cent month over month) and retail sales is the day after (Ex-autos expected at 0.1 per cent month over month).
For the technically inclined, Nvidia went through its 100-day moving average last week and the trend line appears to be acting as resistance now.
See our full economic and earnings calendar here (You can bookmark the page - it gets updated weekly)