Goldman Sachs: Bear Stock Market isn't Over

Many investors grew optimistic about stocks as the S&P 500 climbed 17% from June 16 through Aug. 16.

But since then, the index has slid 9%, as Federal Reserve officials have made it clear they won’t pivot away from interest-rate hikes any time soon. That decline has left the S&P 500 down 18% year to date.

So the question arises: was the ascent of June to August just a bear market rally, or was it the sign of a bigger rise ahead?

Goldman Sachs strategists have some interesting views on the topic. “As investors process new information and adjust expectations accordingly, it would be unusual if there were never rallies within bear markets,” they wrote in a commentary.

“But there are usually two reasons for bear market rallies:

1. “Longer-term expectations of growth improve, even if in the short term they are still pretty negative; and

2. “Investors become increasingly confident that they are approaching the peak in the interest rate cycle.”

Both of Goldman’s conditions seem to have been met this time around.

Small Change, Big Effect

“Often, given light positioning in bear markets, marginal changes in these variables can have amplified effects on markets,” the strategists said. The strategist note that bear market rallies are quite common.

“Taking the experience of the bear markets since the 1980s, including the collapse of the technology bubble in 2000-2002 and the Great Financial Crisis in 2008, we see a repeated pattern of rebounds before the market reaches a trough,” they said.

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“In this context, the recent rally since June 22 is, in our view, a bear market rally. Its duration and magnitude were not unusual relative to the experience of previous decades.”

So where does that leave stocks going forward? “We expect further weakness and bumpy markets before a decisive trough is established,” the strategists said.

Selling Time

Goldman isn’t the only major financial institution that is skeptical about stocks. Amundi, Europe’s biggest money manager, is another.

“It’s time to reduce equity exposure and become more defensive,” Vincent Mortier, Amundi’s chief investment officer, wrote in a commentary cited by Bloomberg.

“While a global recession may be avoided, after the recent rally there are no elements supporting a positive stance in equity markets, while risks are increasing.”

Meanwhile, Bank of America customers are voting with their feet. Last week, they sold a net $1.9 billion of U.S. stocks, representing the third straight week of outflows, BofA said. The clients unloaded both exchange-traded funds and individual stocks.

Given the Fed’s determination to keep increasing interest rates, stocks may well fall further.

Activity in the interest-rate futures market shows traders see an 81% probability of at least another 150 basis points of tightening this year. The Fed has done 225 basis points already since March.

As for valuation, the S&P 500 forward price-earnings ratio stood at 16.7 as of Sept. 2, according to FactSet. That’s marginally below the 10-year average of 17.

But a strong bull market has prevailed over the last decade, with a 13% annualized return, according to Morningstar. So the market may still be overvalued.

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