Goldman Strategist Sees High Chance of 10% Market Drop
Here is the opening for this topical article from Bloomberg:
Goldman Sachs Group Inc.’s David Kostin has some good news, and some bad news.
First, the bad news. There’s a good chance the U.S. stock market will see a 10 percent drop sometime during the next 12 months. Well, as far as precision goes, “good chance” is not good enough for a quant like Kostin, so he gives an exact probability: 67 percent odds of a 10 percent retreat from a peak in the next 12 months.
Though quant work can be complicated, his rationale is actually quite simple -- the market has gone way too long without a so-called correction, or a drop of at least 10 percent from a peak. The biggest declines from highs this year and last year were about 6 percent, and it’s been 22 months since the Standard & Poor’s 500 Index (SPX) saw a 10 percent drop. Mix in a little fancy math, and Kostin ends up with 67 percent odds we’ll see a correction in the next 12 months.
Now for the good news, if you can call it that: He still expects the market to end the year higher, though not by much. Kostin is sticking with his year-end S&P 500 forecast of 1,900, according to a note to clients dated yesterday. That implies a gain of less than 2.8 percent for the year and less than 3 percent from yesterday’s close. In other words, a relatively flat market given the ferocity of the gains seen in this bull run.
Next year will be better in Kostin’s view, with a gain of 11 percent to 2,100 from his 2014 forecast. The S&P 500 will add another 4.8 percent on top of that to 2,200 in 2016, he predicts.
2014 is a year for Wall Street’s indices to tread water at best. The reasons are not complicated. The US stock market rose for five consecutive years and the biggest gain occurred in 2013, with the S&P 500 Index (weekly & daily) surging 30%. That is typical of late-in-the-cycle moves when previously cautious investors are emboldened to pile in.
Corporate profits, on average, did not appreciate at the same rate so valuations became high relative to other stock markets, particularly for the Nasdaq Composite Index (weekly & daily) which led the bull market. Typically slow GDP growth following a severe credit crisis recession is a restraint on earnings, which are mainly benefiting from technological efficiencies and share buyback programmes.
For these reasons I have previously said that we will most likely see a 10%+ correction for the S&P 500 between Q2 & Q3 this year. The risks would be higher were it not for extremely accommodative monetary conditions which will keep short-term interest rates very low, at least until employment or more likely inflationary pressures increase.
However, there are also wildcard risks. Usually the concern is crude oil prices (Brent weekly & daily). These can certainly contribute to bear markets as we last saw in 2008. However, fracking and solar-led renewables are reducing the energy risk, although no other country enjoys this advantage to the extent of the USA.
Today, the main risk is Vladimir Putin, the old KGB Colonel who wants to create a vast Eurasian Customs Union. He is motivated far more by Russia’s current economic slide and declining power, which weakens his own position in Russia, rather than ‘an aggressive NATO and USA’, as Western apologists claim.
Note the quotes in this penultimate paragraph from an excellent article for The Guardian: A brief primer on Vladimir Putin’s Eurasian dream:
"The Eurasian project is a mirage of a post-Soviet archipelago, in which authoritarian leaders use each other to preserve their power," Lilia Shevtsova, author of Putin's Russia, wrote recently. Economist Anders Aslund went further, describing Putin's grand plan as "a neo-imperialist hole" into which Russia was digging itself "ever deeper".
The 10%+ correction that I expect on Wall Street would create another buying opportunity, during which my preference would be for Autonomies which have lower estimated P/Es than the S&P 500 and also provide decent yields. The bigger the correction, the more spoiled we will be for choice. Meanwhile, China remains a recovery candidate; Vietnam is still in form; Europe is cheap relative to the USA but perhaps more susceptible to concerns over Russia, and leading miners are also recovery candidates.Back to top