While many look for a specific event (PSI or NFP) to be the catalyst for the next leg up (or down), Goldman sees several factors at play that could create a 'sell-off by a thousand cuts', rather than one big flush, as macro- and micro- news impacts stocks. First, after habitually delivering better-than-expected news for much of the last several months, recent data points have not been able to best expectations. Second, cyclical weakness has coincided with oil price rises, and third, Bernanke's recent testimony was a little less unconditionally accomodative than the hoards would have liked. Decomposing US equity performance into risk-appetite, growth-expectations, and European-event-risk concerns shows two of the three rolling over and dragging on stocks since March began. With market growth views under pressure and signs of frayed data on the edges, following last week’s marginally disappointing Manufacturing ISM print, last Thursday Goldman went market neutral as in their words, they are taking 'market signals seriously'.
- Cyclical assets continue their slide, as the macro data turns murky
- After a disappointing ISM, we closed our long Russell recommendation and are now neutral
- Alongside cyclical underperformance, other disquieting shifts include …
- …headwinds from oil prices, perceptions of a less-accommodative Fed, and softer data
- Over the past month, index leadership was predominantly among defensive equities …
- … and, as a result, the gap between macro drivers and the index level has significantly widened
- Payrolls on Friday, and early March data next week may provide an opportunity to reengage
Our typical decomposition of S&P 500 performance relative to its macro drivers is another way to view this dynamic (Exhibit 7 above). From October 2011 lows through the end of February, we estimate that improving growth views accounted for 12 percentage points of the market’s nearly 18% rally. The risk contribution while sizeable, had declined sharply earlier in the year.
Since February, growth views have retreated sharply, and the market continued to be buoyed by sentiment, and not macro fundamentals. Although the market has sold off the first few days in March, the cyclical sell off continues to be much sharper. Taken literally, the ongoing rerating lower of market growth views would imply an S&P level in the 1100 range.
The gap between market growth views and the index itself reached “wides” reminiscent of 2011. Last year, we first noted the growing gap between the market’s growth view and the market in the spring. Although the Wavefront Growth basket continued to trend lower, the index itself remained range bound until August, when the two reconnected for a time.
It certainly has been worthwhile to heed the warnings beneath the index. Indeed, our recent choice to cut risk was informed by the growing disconnect. But we would be hesitant to lean too heavily on last year as a template just yet. Two important differences remain: first and foremost, the GLI, ISM and other important indicators began to weaken last spring, and we have yet to see clear evidence this time around. And, although oil prices were a constraint then and now, financial conditions remain quite loose. But we do take the market signals seriously, and will continue to weigh the evolving data against these signals.