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What Does Goldman Sachs (NYSE: GS) Really Think About the Stock Market?

By Jim Fink on April 11, 2012

“Life is deeply, terrifyingly uncertain. Humans can’t consistently pick the right stocks or call markets, foretell political or geopolitical events or successfully predict changes in interest rates or commodity prices. Life is far too complex and baffling for the minds of mortals to understand it as it happens, let alone to predict it accurately.”

Ben Stein, economist and comedian

“If you’re going to predict, predict often.”

— Milton Friedman, Nobel Prize-winning economist

Everybody wants to know “what happens next?,” and are willing to pay money to an “expert” who claims to know – especially if that expert confirms the future that a person hopes will occur. Case in point: investment bank Goldman Sachs (NYSE: GS). If you’re bullish on the U.S. stock market and want some confirmation of your bias, Goldman Sachs has you covered. However, if your bearish on stocks, Goldman Sachs . . . also has you covered.   

Goldman is such a large financial organization that it doesn’t need one of its experts to predict often in order to be “right” some of the time. Rather, it just requires that its multitude of experts disagree on stock-market direction so that every possible future outcome is predicted in advance by one Goldman strategist. Then, when the future stock-market outcome comes to pass, Goldman can trot out whichever of its experts turned out to be right and forget about the predictions made by the rest – until the next round of predictions provides another opportunity for a different expert to be right.

Below is a list of five of Goldman’s top stock experts of managing director rank or higher:

  • David Kostin – Chief U.S. Equity Strategist (partner)
  • Peter Oppenheimer – Chief Global Equity Strategist (managing director)
  • Jim O’Neill – Chairman of Asset Management (partner)
  • Jan Hatzius – Chief Economist (partner)
  • Abby Joseph Cohen – President of Global Markets Institute (public policy lobbying, er, research) (partner)
  • Dominic Wilson – Director of Global Macro and Markets Research (economist working under Hatzius) (managing director)

O’Neill, Oppenheimer, and Cohen are bullish while Kostin, Hatzius, and Wilson are bearish. Two have recently written large reports providing the rationale for their respective directional views: Oppenheimer for the bulls and Kostin for the bears. Since Kostin is a Goldman partner and Oppenheimer is just a mere managing director, I guess Kostin’s view should be considered closer to Goldman’s “official” position. After all, the Wall Street Journal, calls Kostin Goldman’s “top equities strategist.”

Kostin bases his bearish view on the following points:

  • “The [S&P 500] index trades at 13.2X forward earnings estimates vs. 12.8X on average since the mid-1970s. On a cyclically-adjusted basis using operating earnings we estimate the S&P 500 trades at 18.5X relative to an average of 16.7X since 1929 and 22.9X since 1990.”
  • “The expected 12-month EPS growth rate has dropped by 25% to 9.4% from 13% in October 2007 and the reduced EPS growth rate should translate into a lower P/E multiple.”
  • “Our expectation the US economy registers its fifth consecutive year of below-trend GDP growth in 2012 underpins our equity market forecast.”
  • “We find it hard to make a credible argument that investors should buy stocks at an above-average multiple of earnings when those earnings stem in part from record [profit] margins that have already started to decline.”
  • Abnormally high S&P 500 earnings yield relative to the 10-Year U.S. Treasury yield does not necessarily mean that stocks are undervalued and will go up. Rather, it may mean that bonds are overvalued and will go down.

Chief economist Jan Hatzius agrees with Kostin that U.S. growth should slow because of a fast-approaching “fiscal cliff” caused by stimulus programs ending. Hatzius predicts that the Federal Reserve will need to engage in another round of quantitative easing (QE3).

All of this bearishness sounds very convincing, but wait! You haven’t heard yet from Goldman’s chief global equities strategist Peter Oppenheimer who isn’t just bullish, but super-bullish. In a March paper entitled The Long Good Buy; the Case for Equities, Oppenheimer baldly states that the outlook for stocks is the best “in a generation.” His conclusion is based almost entirely on “reversion to the mean” and the fact that stocks have performed so poorly relative to bonds:

  • Annualized 10- and 20-year stock returns relative to bond returns have been at their most negative for over a century.
  • Equity prices are implying unrealistically large declines in growth and returns into the future.
  • While future growth may be lower than experienced over the past decade in many parts of the world, we believe this is more than reflected in current valuations. If growth rates are low, but the market has assumed that the outcome will be even worse, then the returns can be high.
  • While profit margins may struggle to rise much from current levels, other factors (technology and compensation control) are likely to prevent margins falling.
  • Emerging-market economic growth will lift all stock boats, including stocks in slow-growth developed markets. The decade of 2010-2019 will be the decade of “peak” global growth, averaging 4.3% per year, well above the average of the last decade or the previous one.

All well and good, and I really like Oppenheimer’s emphasis on valuation (p. 12) and investor expectations because stocks can go up even in a weak economic environment if prices are too low. But I don’t like his method for demonstrating “low” valuation – he focuses on stock valuation “relative” to bonds rather than stock valuation based on “absolute” measures of normalized earnings and profit margins. Out of his entire 37-page report, he devotes one page (p. 15) to absolute valuation, stating that the stock market’s current P/E ratio has “tended to be pretty good for markets.”  His evidence is a study of P/E ratios and subsequent returns in Asian markets (ex-Japan), which may not be transferable to the U.S. Furthermore, unlike Kostin, Oppenheimer fails to discuss cyclically-adjusted normalized earnings and his insistence that peak U.S. profit margins will not fall is conclusory and not substantiated by any facts.

Bottom line: if you’re confused about Goldman’s true stock-market view, join the club. I don’t blame Goldman for the confusion because it’s just a fact of life that different people have different views and Goldman is a large organization. Rather than complain, I recommend reading all of the disparate Goldman views and choosing the one that makes the most sense. For me, Kostin makes more sense than Oppenheimer.

Kostin recently tried to smooth over his disagreement with Oppenheimer by writing that his bearish view takes into account short-term tactical risks and applies only to the next 12 months, whereas Oppenheimer’s view is more long-term in nature. Maybe so, but something tells me that Kostin’s bearish view is longer than only 12 months and most investors are more interested in the next 12 months anyway.

It also is helpful to pay attention to what Goldman is buying for its own account rather than simply what it is saying to the muppets, er, clients.  According to the Zerohedge website, Goldman was buying bonds at the same time Oppenheimer was telling clients to sell bonds and buy stocks.  Zerohedge didn’t provide any evidence for its assertion of Goldman bond buying, but bonds have significantly outperformed stocks since Oppenheimer’s March 21st report was released which is suspicious. Now that Goldman has closed its March 15th Russell 2000 buy recommendation, it’s probably time to buy stocks again.

Forgive my Goldman cynicism. Blame it on Greg Smith. Unfortunately, the facts continually justify the cynicism rather than disprove it.

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