US investors still have room to increase their equity exposure if the economy has a soft landing: Goldman Sachs

By Isabel Wang

The recent drop in US equity positioning is short-lived, say strategists at Goldman Sachs

The S&P 500 index fell for the third straight week and is on track for its biggest monthly decline of 2023. Rising government bond yields and uncertainty about the trajectory of China’s economy are among concerns expressed by US stock market investors who are attending the recent uptrend may be coming to an end.

However, a team of Goldman Sachs strategists believe investors still have room to increase their equity exposure further if the economy stays on the path to a soft landing.

Goldman’s equity sentiment indicator, which summarizes nine different positioning metrics including hedge fund net exposure, net demand from foreign investors and flows into active and passive equity funds, fell to 0.8 in the week ended August 18, after last slipping at 1. 5 had recovered month from minus 1.8 in December.

The “rapid renewed risk-taking” by equity investors is driven by positive economic developments and optimism following the “widespread adoption” of artificial intelligence, said David Kostin, chief US equity strategist at Goldman Sachs, in a statement on Friday.

However, Kostin and his team believe the fall in stock positioning as measured by the sentiment indicator will be short-lived, as mutual funds and hedge funds will continue to increase their exposures “if the market environment continues to improve,” they said.

“Although hedge funds have increased net exposure this year, net leverage is currently below average levels over the past five years, suggesting there is scope for funds to increase their equity length if a soft landing continues,” they said .

Net exposure is the difference between a hedge fund’s long and short positions, while net leverage is defined as net debt divided by annualized adjusted earnings before interest, depreciation and amortization (Ebida).

“Similarly, mutual funds’ cash allocations remain 50 basis points above their all-time low of 1.5% in December 2021. If mutual funds were to reduce their cash holdings to the 2021 lows, it would equate to $49 billion in additional demand for equities,” so the analysts said.

Meanwhile, retail investors who have increased exposure to the stock market this year would also be increasing their bullish bets as data from Finra shows margin balances have risen in each of the first seven months of 2023 and are now at their highest levels since February 2022, scaled relative to US stock market cap.

Margin balance is the amount of money an investor owes its brokers for the funds they borrow to buy securities on margin.

However, retailers have an opportunity to “extend” their portfolios as this level of margin balance is close to the five-year average and is still well below the highs reached in March 2018 and October 2021, Kostin and his team said.

Additionally, the reopening of the buyback lockdown window will spur stock demand in the coming weeks, as nearly 85% of S&P 500 companies exited the lockdown window during the second-quarter earnings season, according to data from Goldman’s Buybacks.

A lock-up period occurs when certain officers or employees of a public company are prohibited from trading in the company’s stock before and after the release of quarterly or annual financial results.

Goldman Sachs strategists raised their S&P 500 target to 4,500 from 4,000 two months ago, up about 3% from where the large-cap index was today on Monday. The firm was among the first Wall Street investment banks, brokerages and research firms to raise its year-end targets as the large-cap benchmark entered the bull market in early June.

The S&P 500 SPX was little changed on Monday at 4,376, while the Dow Jones Industrial Average DJIA was down 0.4% and the Nasdaq Composite COMP was up 0.9%.

– Isabel Wang

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8/21/23 1337ET

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