Goldman Sachs doesn't see a bear market for US stocks anytime soon

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If Goldman Sachs’ Bear Market Risk Indicator is right, the risk of a significant slide in US stocks within the next year is growing.

The indicator, using valuations, the shape of the US yield curve along with economic indicators such as inflation, unemployment and PMI surveys, currently sits at 67%, a level that has acted as a lead indicator for bear markets in US stocks in the past.

A bear market is deemed to be a decline of 20% or more.

This chart shows where the risk indicator currently sits.

Source: Goldman Sachs

It’s clearly at elevated levels, a somewhat ominous warning given the onset of quantitative tightening from the US Federal Reserve that will begin next month.

However, while the risk indicator is starting to flash red, Goldman isn’t overly concerned that an imminent stock market rout is on the way.

“First, inflation has played an important part in rising bear market risks in past cycles,” it says.

“Structural factors may be keeping inflation lower than in the past, and central bank forward guidance is reducing interest rate volatility and the term premium.

“Without monetary policy tightening much, concerns about a looming recession — and therefore risks of a ‘cyclical’ bear market — are lower.”

It also says that the US financial system is on a sounder footing compared to the period leading up to the global financial crisis, the last major bear market seen in US stocks.

“Financial imbalances and leverage in the banking system have been reduced post the financial crisis. This makes a structural bear market less likely than in the past,” it says.

Goldman also notes that of all the variables that make up the risk indicator, market valuation is currently the most stretched, something it says is largely a function of very loose monetary policy and bond yields.

“If we exclude valuation from the index, the level falls into the low 60% category. On historical relationships this would imply a 50/50 probability of a bear market in the next 12 months,” it says.

At this point, Goldman says the combination of higher valuations but lower prospects for interest rates and inflation volatility leads them to expect lower future returns as a central case rather than an imminent bear market.

However, that call is premised around the view that inflationary pressures will remain weak.

“Should inflation expectations rise, necessitating higher interest rates, then the probability would rise that the next bear market would be sharp and, with fewer options to ease monetary policy, it would likely be long,” Goldman says.

The US S&P 500 has risen 275% from the bear market low of 666 points struck in March 2009. It currently sits just 0.33% off its record high.

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