Research Watch

Goldman's gigantic equities call. What's behind US profits? The new Middle East. On video: Bernanke kills the gold standard.

PORTFOLIO POINT: This is a sampling of the week's best research notes. In a world of too much information, we hope our selection helps you spot the market's key signals.

After making news for all the wrong reasons, Goldman Sachs produced another headline-grabber this week with an outrageously bullish call on stocks. In a strategy paper titled 'The Long Good Buy; the Case for Equities', the bank said investors had a once-in-a-lifetime opportunity to buy stocks, after 20 years' relative underperformance against bonds. Peter Oppenheimer, Goldman’s chief global equities strategist, neatly summed up the 40-page report when he wrote: "The prospects for future returns in equities relative to bonds are as good as they have been in a generation." Elsewhere, GMO’s James Montier cast a bit of a dampener on recent US profit results, detailing exactly what’s behind the record numbers and why they can’t last. In a more upbeat report, Citigroup reveals why US energy production could lead not only to an economic turnaround, but a new Industrial Revolution. Learn how to hug like a Goldmanite and trade like a billionaire, plus why equities are less important in Australia than in other major economies. And on video, Ben Bernanke takes the shine off the gold standard in a pointed university lecture – complete with his own class reading list.

Goldman's 'once-in-a-generation' call'¦ “Stocks will probably begin a 'steady upward trajectory’ over the next few years because any declines in economic growth are already reflected in share prices, Goldman Sachs said. 'Given current valuations, we think it’s time to say a 'long goodbye’ to bonds, and embrace the 'long good buy’ for equities as we expect them to embark on an upward trend over the next few years,’ Peter Oppenheimer, chief global equity strategist at Goldman Sachs in London, wrote in a report. 'Periods of sustained falls in the market are typically better times to buy for the long run. '¦ Partly, of course, this is also a function of valuations typically improving after a period of sustained losses in the market. Nonetheless, the key point is that in particularly bad economic periods, once the news is fully priced, investment outcomes tend to improve.’ Gains in bond yields can also support equities, according to Goldman. Ten-year yields have climbed from a record low of 1.67% set on September 23 '¦ [to] 2.37%, near their highest in almost five months. 'We would expect the early rises in bond yields to be positive for equity prices as they both become a reflection of rising growth and inflationary expectations, and could expect some equity re-rating in the initial stages of rising yields,’ Oppenheimer wrote. Equities offer an opportunity now, the strategist wrote, saying some risks to future growth are exaggerated, and emerging markets may offset fiscal policy tightening in some developed markets.” (Bloomberg, March 21)

What goes up must come down'¦ “GMO’s James Montier takes the Kalecki profit equation and breaks down the recent drivers of record corporate profit margins into segments (Profits = Investment – Household Savings – Government Savings – Foreign Savings Dividends). He shows that the budget deficit has been the primary driver of corporate profits in recent years:

“Exhibit 6 shows the breakdown of profits during 2011. The massive impact that the fiscal deficit has had becomes immediately clear. Government savings have a negative effect on profits; a fiscal deficit is just negative government savings, hence the double minus sign in the table. '¦ The government deficit may stay high this year, due largely to it being an election year. However, it is almost unthinkable that it will remain at current levels over the course of the next few years. As such, unless households start to re-leverage or the current account improves significantly, and assuming that the government moves toward some form of deficit reduction plan, corporate profits are likely to struggle. From this perspective, a structural break in profit margins looks to be difficult to support. So, for the time being we will continue to base our forecasts on the mean reversion of profit margins.” (James Montier of GMO, March 20)

Welcome to 'the new Middle East’'¦ “Citi economists expect total [US energy] production to as much as double '¦ in the next decade, and predict that the US could overtake both Russia and Saudi Arabia in oil production by 2020. That's because there is incredible potential to extract and refine energy products on domestic soil. This energy boom would have a transformative effect on the domestic economy:

- Citi analysts expect real GDP to increase by 2.0% to 3.3% – $370 to $624 billion – as a consequence of new production, a decline in energy consumption, and the economic activity generated along with this.
- 3.6 million new jobs could be created by 2020 as a consequence of increased energy production. '¦ National unemployment could subsequently decline by up to 1.1%.
- The current account deficit could shrink by 80% to 90% due to energy exports '¦ [and] Citi analysts predict that the current account balance could move from -3.0% of GDP to -0.6% of GDP by 2020.
- The value of the US dollar could jump by 1.6% to 5.4%, primarily based on changes in the current account balance. '¦
- Finally, Citi analysts note that this could lead to a considerable decline in oil prices.

They conclude: 'The coming generation of Americans and its leaders may be privileged to witness a remarkable resurgence of the American economy and industry, led by its energy sector, but spreading to the rest of the manufacturing sector and beyond, a potential minor Industrial Revolution.’” (Citigroup via Business Insider, March 21)

Stocks may have a long way to fall'¦

“We believe that a sustainable period of equity market multiple expansion is unlikely until the Fed begins normalising policy, despite the seemingly inevitable correction that will accompany the early stages of exit strategies. So, if the growth outlook deteriorates, a correction is probable; both of which will likely restart the QE3 debate. Conversely, if the Fed ends Operation Twist without any additional accommodation, we suspect index implied volatility will increase, the term structure will flatten, correlation will rise and downside put skew will remain expensive on a relative basis. ... Simply put, stocks will pull back '¦ To be clear though, if we make it through 2012 without another round of unconventional monetary policy easing we would view that as an important step out of the post-crisis financial repression deleveraging period, thereby increasing the likelihood of a sustainable period of rising PE multiples. A pullback associated with investor concerns about monetary policy tightening would be a buying opportunity, but it’s a bit premature to consider your options in reaction to a correction that hasn’t occurred yet.” (Barry Knapp and Eric Slover of Barclays, March 19)

Time to buy crisis insurance?'¦

“The VIX is near historical lows. At 15.8 (as of Wednesday afternoon) it is a point above its low of 14.6 going back to the beginning of 2008. The VIX fell to these levels 3 times since the beginning of 2008: in August (before the crisis of September 2008), in April 2010 (before the first euro sovereign crisis), and in May 2011 (before the US debt limit crisis and second euro crisis; see chart). We do not mean to imply that the VIX is signalling a crisis, but we do mean to point out that options are cheap. And history tells us that if one is interested in hedging tail risks, the best time to buy is not in the midst of a crisis or a strong recovery, but at times like now when the market is lulled into a belief that the future holds neither large upside nor large downside shocks.” (Ralph Axel of Bank of America, March 17)

Hug like a Goldmanite'¦ “In December of 2000 '¦ Goldman broke a rather unusual international record: the world’s largest hug. The company hug was initiated by Maynard Holt, a Goldman vice-president in the energy and power group, who '¦ expressed an interest in breaking the record at the firm’s annual investment-banking conference, which typically draws about three thousand Goldman employees from around the globe. '¦ As the second day of the Goldman conference drew to a close '¦ the investment bankers went to work. Four young ones, who had been ordered to put on Teletubby costumes, emerged from the wings and began roaming the tables, to put their colleagues in a huggable mood. '¦ Partner or peon, it didn’t matter. The big hug was for everyone. Those who signed up were given yellow stickers, which read 'One Team, One Hug,’ and were told to line up along the wall. '¦ [Guinness spokeswoman Jerramy] Fine announced, 'I can now certify that this will be the world’s largest hug, if you execute correctly. '¦ At a given signal, each participant should squeeze the person on either side of them, holding the hug for a minimum of ten seconds.’ Holt gave the signal. The huggers squeezed. The countdown began. At zero, the song 'Lean on Me’ came over the sound system, and the ring of eight hundred and ninety-nine bankers swayed and broke.” (New Yorker, March 20)

Trade like a billionaire'¦

“The Billionaire Hedge Fund Index '¦ tracks nearly 400 hedge fund managers and prominent investors. Around 10% of these people are billionaires. We created this Billionaire Hedge Fund Index to track the top 30 holdings of these 39 billionaire fund managers. Warren Buffett, George Soros, John Paulson, Jim Simons, David Einhorn, Ray Dalio, and T. Boone Pickens are some of these fund managers. Each stock’s weight was in proportion to the number of billionaires who had at least $10 million invested in the stock. Billionaire Hedge Fund Index returned 16.7% since the end of 2011, vs. 12.3% for S&P 500 ETF (SPY). Click here for a list of the 30 most popular stocks among billionaires.” (Insider Monkey, March 19)

Australia’s investment foundations'¦

“The Australian housing market is the country’s largest and arguably, most important asset class. The total value of homes across the country as at December 2011 was $4.54 trillion. In comparison, Australian equities had a total market capitalisation at the same time of $1.17 trillion. The result highlights that the Australian housing market is worth more than three and half times that of the equities market and the total value of superannuation funds at around $1.3 trillion.” (RP Data Property Capital Markets Report 2012)

Central bank homework'¦ (Click image for the full reading list)

Video of the Week: All that glitters'¦ Watch Ben Bernanke kill the gold standard.

(Ben Bernanke, March 20)

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