Goldman Sachs' top traders respond to investors' most pressing question: Global stock markets, chase the rise or not?

Goldman Sachs' top trader and head of hedge fund research, Tony Pasquariello, stated in a recent report that after another fast-paced week, several major themes stand out:

• The world's largest central banks have suddenly taken a more dovish stance than the market expected. Following the Federal Reserve, the People's Bank of China also introduced its own easing policy.
• Last week, there was a very strong technical demand in the U.S. stock market, while this week saw a significant demand for bullish sentiment towards China and emerging markets, showing a certain "animal spirit" in the market.
• Recent risk assets have enjoyed two tailwinds: a significant drop in short-term U.S. interest rates and stable performance of the Japanese yen. However, I am starting to doubt whether the former is running out of steam, and the latter has reversed course after the LDP election.
• In terms of U.S. stocks, the S&P 500 index broke new highs on Thursday, with funds returning to tech stocks in an initial rotation, but small-cap stocks have performed poorly after the Fed rate cut.

Looking ahead, Pasquariello summarizes the current concerns of investors as: chase or not to chase?

Pasquariello said that his core contradiction is:

Still believing that the main trend is upward. And, definitely not planning to stand in front of the central bank "cannons". However, the market has already priced in a lot of these.

There are two additional factors to watch: earnings season and the U.S. election:

• On the earnings front, the core earnings season will arrive in two weeks, which will have a significant impact, including third-quarter performance, whether tech giants can continue to be strong, and fourth-quarter guidance. The market has an 11% upside expectation, which is quite high.
• Regarding the election, traders are not as focused on the potential impact of the U.S. election as I expected, which may reflect the market's belief that the most likely two outcomes are: Harris + a divided Congress, or a full Republican victory.

It can be said that there are many active variables in current trading, making risk/reward assessment complex. In order not to make the situation more complicated than it actually is, Pasquariello simplifies everything to:

The Fed is easing policy, and the U.S. economy is accelerating, so the path of least resistance is still upwards for the market.

Pasquariello also mentioned that if investors are hesitant to add significant additional positions at the current levels, it is understandable. With the S&P implied volatility dropping to levels before August, investors can easily adjust portfolio exposure through the options market. Against the backdrop of rising global stock markets, the cost of rising insurance has once again become quite cheap.

Pasquariello elaborated on some of the issues that investors are concerned about in the latest report.

U.S. Tech Stocks

Semiconductor stocks rose this week, with the Nasdaq 100 index only about 3% away from its historical high. Goldman Sachs' TMT expert Peter Callahan stated that overall, amidst the uncertainty, investors have reduced their exposure to tech stocks recently, becoming more diversified and defensiveThis is particularly evident during the rise of semiconductor stocks this week, as the market has developed a more "two-sided" narrative around the theme of generative AI. It is expected that there will be more discussions and tension around "chasing the rise".

The basket of U.S. stocks linked to the growth in electricity demand, although an extension of the AI frenzy, has experienced a turbulent summer. However, I believe there is a broader and deeper story to be told— from electric vehicles to cloud computing and more, we see a renewed interest in this theme.

Fund Flows/Positions

If there was one particularly noticeable area in fund flows last week, it was the demand for U.S. tech stocks and the Japanese market. This week, funds quickly flowed into the Chinese market.

U.S. households continue to buy, with another $28 billion flowing in this week.

Federal Reserve

While it is not yet clear whether the Federal Reserve's 50 basis point rate cut will become the new benchmark, it is evident that the threshold for stopping rate cuts is high, while the threshold for another 50 basis point cut is low.

Federal Reserve officials cited many reasons for the decision to cut rates by 50 basis points at the September meeting. This is noteworthy because it indicates that there are many paths that could lead to a more aggressive policy direction, which is not reflected in the dot plot. Fed Governor Waller's rationale based on the PCE tracking indicator from the CPI and PPI reports is the most aggressive, as it interprets the Fed's mission very narrowly.

This also indicates that strong U.S. GDP growth and a more moderate explanation for the rise in unemployment are not enough to prevent the Fed from accelerating rate cuts. In their view, the balance of risks has shifted, and their goal is to maximize employment, not strong GDP growth.

U.S. Consumers

In addition to the preference for tech stocks, Pasquariello remains positive on the U.S. non-essential consumer goods industry. Initial U.S. jobless claims data and oil prices are more important than consumer confidence data.

Our business sees demand from pure long investors, which contrasts sharply with the large-scale selling by hedge funds.

U.S. Stock Valuations

Pasquariello listed the issues that are being debated in the market: Do you expect an economic recession? Do you think market valuations are too high? Should an index dominated by large-cap tech stocks make us look at valuations differently?

The chart below shows the 8 easing cycles over the past 40 years, with the P/E ratio at the beginning of each cycle indicated. The blue bars represent cases where there was no economic recession within a year after the first rate cut by the Fed, and the S&P 500 performed very well, while the gray bars represent cases where there was an economic recession, and the S&P 500 performed very poorly.

It is worth noting that the current forward P/E ratio is 22 times, while the average P/E ratio in non-recession scenarios in the past was 11 times.

Chinese Market

The People's Bank of China took strong measures this week, introducing a comprehensive rate cut policy, and the September Political Bureau meeting highlighted the previously missing fiscal policy part. Pasquariello pointed out that the policy has shifted, marking the beginning of a new trading cycle.**

Pasquariello praised investors who foresaw this tactical rebound, according to data from Goldman Sachs, there have been eight consecutive days of buying, as well as a widespread demand for bullish protection in the Chinese market.

Pasquariello also mentioned that Chinese real estate stocks surged 20% this week, and it is necessary to monitor whether this rebound can be sustained.

Japan

Pasquariello stated that the impact of the Japanese election results seems somewhat complex, and he was surprised by the lack of attention before the election results were announced. The rise in short-term Japanese government bond yields and the strength of the yen are evidence of this.

More broadly, you need to decide whether you are willing to face the volatility of this market. As one client put it, the post-traumatic stress disorder from August will continue for some time, and it is clear that foreign investors sold off heavily in the first two weeks of September.

Pasquariello's view is that sometimes the Japanese market is straightforward, but this is not the case now. However, he still believes that there are abundant opportunities in market pullbacks, especially at the thematic level.

Europe

Pasquariello said that he is taking the risk of repeating the old tune and giving a very basic view: the current growth rate in the United States is around 3%, while the Eurozone has almost no growth.

At the same time, the Federal Reserve suddenly cut interest rates by 50 basis points, while the European Central Bank cut by 25 basis points. Finally, financial conditions in the United States have significantly eased over the past two years, while Europe has not seen such a change, which surprised him. Therefore, after experiencing weak PMI data in Europe, he does not intend to change his bias towards the U.S. market.

Pasquariello said that if he is wrong here, the guess might be that the European Central Bank has introduced some policies that have sparked market inspiration, which is a reaction to the market after the policies of the People's Bank of China.

Bitcoin

After the final data for the third quarter came out, Bitcoin had another healthy quarter. During this period, the price of Bitcoin following a 50 basis point rate cut aligned with Bitcoin's characteristic as a "liquidity sponge." In a broader context, Bitcoin has risen by 50% this year, with a Sharpe ratio of 1.0