Goldman Sachs: Investors Still Have Room to Increase Exposure to Equities

The S&P 500 index has experienced a decline for the third consecutive week, signaling the potential for its largest monthly drop of 2023. U.S. stock-market investors are expressing concerns about rising Treasury yields and uncertainty surrounding China's economy, leading them to believe that the recent bullish run may be coming to an end.

However, Goldman Sachs strategists have a different perspective. They believe that investors still have room to further increase their exposure to equities as long as the economy continues on its path towards a soft landing.

Goldman's equity-sentiment indicator, which combines nine different positioning metrics, including the net exposure of hedge funds, the net demand of foreign investors, and flows into active and passive equity funds, declined to 0.8 in the week ending August 18. This decrease follows a rebound to 1.5 last month from negative 1.8 in December.

According to David Kostin, chief U.S. equity strategist at Goldman Sachs, this "swift re-risking" by equity investors was driven by positive economic developments and optimism stemming from the widespread adoption of artificial intelligence.

Despite the recent decline in equity positioning measured by the sentiment indicator, Kostin and his team expect it to be short-lived. They predict that mutual funds and hedge funds will increase their exposures further if the market environment continues to improve.

Hedge funds have raised net exposures this year; however, net leverage currently remains below the average level of the past five years. This suggests that there is still room for funds to increase their equity length if a soft landing scenario continues to unfold.

Mutual fund cash allocations also remain 50 basis points above their all-time low of 1.5% in December 2021. If mutual funds decrease their cash exposures to the 2021 low, this would result in an additional $49 billion of equity demand, according to the analysts at Goldman Sachs.

In conclusion, despite the recent concerns raised by U.S. stock-market investors, Goldman Sachs remains optimistic about the potential for investors to increase their exposure to equities. The overall sentiment is that as long as the economy remains on track for a soft landing, there is still room for growth in the equity market.

Retail Investors Increase Bullish Bets

Retail investors have been actively engaged in the stock market this year, with their bullish bets on the rise. Data from Finra reveals that margin balances have consistently increased for the first seven months of 2023. As a result, margin balances have reached their highest level since February 2022 when scaled relative to the market capitalization of the U.S. equity market.

Margin Balance Explained

Margin balance refers to the amount of money that investors owe their brokers for funds borrowed to purchase securities on margin.

However, retail traders still have room to expand their portfolios further. Despite the current margin balance being close to the five-year average, it remains below the peaks reached in March 2018 and October 2021, according to Kostin and his team.

Reopening of the Buyback-Blackout Window

Furthermore, the reopening of the buyback-blackout window is anticipated to bolster equity demand in the upcoming weeks. Recently, approximately 85% of S&P 500 companies have emerged from the blackout window during the second-quarter earnings reporting season, as reported by Goldman's Buybacks desk.

Earnings blackout period refers to the time when certain executives or employees of a public company are prohibited from trading company stocks before and after the release of quarterly or annual financial results.

Goldman Sachs Raises S&P 500 Target

Two months ago, Goldman Sachs strategists raised their S&P 500 target to 4,500 from 4,000. This upward revision implies roughly a 3% upside from the current level of the large-cap index on Monday. In fact, Goldman Sachs was one of the first Wall Street investment banks, brokers, and research firms to revise their year-end targets as the large-cap benchmark entered the bull market in early June.

On Monday, the S&P 500 SPX remained almost flat at 4,376, while the Dow Jones Industrial Average DJIA experienced a 0.4% decline and the Nasdaq Composite COMP gained 0.9%.