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The foreign brokerage said the duration and magnitude of the recent rally have not been unusual relative to the experience of previous decades.
Low valuations is a necessary, although not sufficient, condition for market recovery, it said, adding that getting close to the worst point in the economic cycle, reaching a peak in inflation and interest rates, and negative positioning is also important.
The recent rally, Goldman Sachs said, was largely a reflection of growing confidence that inflation is reaching a peak and that the peak in the interest rate cycle (or the Fed pivot) is closer at hand than previously feared.
"This renewed optimism resulted in a 'bad news is good news' regime that has been a feature of a large part of the past cycle when central banks regularly had large dovish pivots during growth slowdowns. As a result, during this rally, equities had been negatively correlated with macro surprises," the brokerage said.
Goldman Sachs said it saw the current rally as temporary and not the inflection point marking the start of the real ‘Hope’ phase and added that it expects further weakness and bumpy markets before a decisive trough is established.
Hope is a phase where markets start with a decisive and powerful initial recovery, irrespective of whether they have been cyclical, structural or event-driven.
Goldman Sachs gave an example of 18 global bear market rallies since the early 1980s. On average, they last 44 days and the MSCI AC World return stood at 10-15 per cent. Cyclicals outperform defensives 83 per cent of the time and by four per cent on an average, it said.
"We find a similar result at the regional level; emerging market outperforms developed market 67 per cent of the time. During these periods there is no clear pattern in the performance of value vs growth or small vs large caps," it said.
In that context, Goldman Sach said the recent rally since June is a bear market rally. The brokerage has given three reasons why a genuine bear market trough has not yet been reached:
1) Inflation
It said inflation may be close to a peak but the levels of inflation may stay elevated for some time, putting upward pressure on rates relative to current market pricing.
"At the same time, our economists argue that there is a narrow path to a soft landing that requires policymakers to (i) slow GDP growth to a below-potential pace in order to (ii) re-balance supply and demand in the labour market enough to (iii) bring down wage growth and, ultimately, inflation."
Related to this point, the most recent central bank commentary and the Jackson Hole statement have been hawkish again. Similar comments have emerged in Europe.
2) Economic growth
Economic growth is likely to weaken, GS said. Strong private-sector balances may help to moderate any economic downturn but many of the problems that economies are currently facing stem from profound supply-driven issues, not demand. It is not clear that a peak in interest rates alone will provide a lasting solution, Goldman Sachs said.
Constraints in labour and commodities may contribute to weaker growth and lower profit margins, it said. The brokerage said even as recessions could be relatively shallow compared with many in the past, there is still a greater than even chance that investors will price more recessionary risk as interest rates continue to rise.
3) Valuation not at extremes
Goldman Sachs said valuations and positioning are not at extremes. Optimism over the path for monetary policy and inflation is just one of the factors that typically triggers a recovery into the next bull market. Valuation and positioning are also important.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)
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