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Investors should take advantage of the recent rally in stocks and prepare for losses by buying insurance, according to Goldman Sachs.
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The bank said the narrow leadership of mega-cap tech stocks means downside risk is high.
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These are the five reasons Goldman Sachs says now is the time to hedge your portfolio.
Stocks have been in freefall since the S&P 500 hit a low in mid-October, jumping more than 25%, but Goldman Sachs believes now is the time for investors to protect their portfolios against future losses.
The bank advised investors to prepare for a stock market sell-off of up to 20% over the next few months due to a possible recession.
“Some portfolio managers expect a recession to begin within the next year, a view that matches most economic forecasters. In this scenario…the index could fall 23% to 3,400” , said David Kostin of Goldman Sachs in a June. 20 grades.
Given the strong stock market rally, combined with a potential recession over the next year, Kostin outlined five reasons why investors should buy portfolio insurance now.
1. “Downside protection comes at an attractive price.”
“While investors were well hedged from March to May, investors started paying higher prices for single stock calls in late May and buyers of index calls joined in from May 2. June performance, and they clearly show that investors have been buying the upside asymmetry in stocks and indices.With investors already positioned to the upside, it may be more difficult for the market to rally further from here.
2. The narrow rally in the market suggests that downside risk is high.
“Historically, large declines in market breadth have generally been associated with large declines in subsequent months. One of our market breadth indicators compares the distance from the 52-week high for the aggregate index and the median stock. Market breadth has recently shrunk the most since the tech bubble on this metric.”
3. Valuations are high in absolute and relative terms.
“The S&P 500 is trading at a NTM P/E of 19x, which represents the 88th percentile since 1976. Historically, when the index has traded at or above this level, the S&P 500 has seen a median decline by 14% over the next 12 months compared to a drawdown of 5% over a typical 12 month period.”
4. Stocks already value a bullish outlook.
“Our economists expect U.S. GDP growth to average 1.0% during 2H 2023. However, as measured by the performance of cyclical stocks relative to defensive stocks, the equity market involves an economic growth rate of around 2%.
5. Positioning is no longer a tailwind for equities.
“As 2023 progressed, investors increased their exposure to equities. Hedge funds increased their net leverage, mutual funds reduced their cash balances and foreign investors were net buyers. In recent readings, the IS recorded a 1.2 week high of +114, suggesting that light positioning should no longer be a tailwind for the equity market.There are many reasonable alternatives to stock markets today. equities, indicating that the flow of funds is unlikely to be a tailwind for equities this year.
Kostin’s view on investor sentiment and positioning was reinforced on Wednesday by market veteran Ed Yardeni, who pointed out in a note that there may be “too many bulls.”
“The bull/bear ratio compiled by Investors Intelligence rose to 3.00 during the week of July 4 from 2.69 the previous week. This is the highest reading since the March 23 bull run. 2020 to January 3, 2022,” he said. “High bullish sentiment can be a signal for caution.”
Read the original article on Business Insider