GOLDMAN: Here Are Our Top 6 Trades For 2014

LoonUSFWS PacificThe ‘loonie’ is key to one of Goldman’s top trades.

Goldman Sachs has unveiled its top six trade recommendations for the year ahead in a series of notes to clients.

The trades aren’t for everyone and some of them are pretty technical.

Many of the recommendations are pair trades (buy one thing, sell another) driven by what is perhaps the most important and widely-expected macro development in the year ahead: a winding down of the Federal Reserve’s quantitative easing program.

“The purpose of the Top Trade Recommendation list is, as always, to connect specific and actionable trade ideas to the set of key market themes that are likely to play out over the course of the year and that we expect to form the backbone of our strategic approach to markets for the year to come,” says Goldman Sachs managing director Noah Weisberger. “While our initial list will be comprehensive, and connect back to the economic and market forces as we see them currently, we are likely to add to the list of Top Trade Recommendations (along with our usual slate of tactical trade recommendations) as the year progresses, as our views evolve, and as market risks and opportunities shift.”

Go Long Euro Area 5-Year Rates, Short US 5-Year Rates

Originally introduced: November 26

Target: Yield differential of -130 basis points

The trade: Open long EUR swap (EONIA) 5-year rate and sell 5-year Treasuries.

The logic: Goldman forecasts U.S. growth will outpace euro area growth in 2014. 'The choice of Treasuries over OIS or LIBOR on the short leg is motivated by the fact that yields on the former could underperform more than they have already in relative space as the Fed scales down its asset purchase program,' says Goldman. 'In the Euro area, we are of the view that German bonds may 'cheapen' further relative to EONIA as fixed income portfolios are rebalanced in favour of higher-yielding securities, particularly if the ECB eases further.'

Go Long Chinese Stocks, Short Copper

Originally introduced: December 2

Target return: 25%

The trade: Buy the HSCEI Index and sell Copper Dec 14 LME futures.

The logic: 'This long equity/short commodity trade is a way of isolating exposure to China equity risk via a long HSCEI position, which we think is underpriced by the market given our views of stable growth and ongoing rebalancing there, while the copper short hedges out exposure to China's economic growth, which we think will be stable but not stellar,' says Goldman. 'Short copper, which is typically highly correlated to China growth outcomes and China equities too, has the added advantage of being an asset that we think will likely be facing headwinds of its own over the course of the year, with the short position potentially adding to the positions' expected returns, and not just a hedge against unanticipated outcomes.'

Go Long Risk on Investment Grade Credit Default Swaps

Originally introduced: December 3

Target: Spread of 395 basis points

The trade: Sell protection on the 7-year CDX IG Series 21 junior mezzanine tranche.

The logic: Shorting credit default swaps is analogous to investing in the underlying assets that the swaps reference because the default protection the swap provides becomes less valuable as the company's debt becomes more expensive, meaning its borrowing costs fall, which makes it less of a credit risk. 'With 'plain vanilla' credit assets trading at their post-crisis tights, we also expect demand to rotate to more complex assets that can offer incremental carry, such as the junior mezzanine IG tranche,' says Goldman. 'The choice of a tranche that is relatively low in the capital structure is partly informed by our view that macro volatility is likely to continue to hover around current low levels in 2014.'

Go Long Japanese, US, and European Banks

Originally introduced: December 4

Target: 20%

The trade: Buy BKX, SX7E, and TPNBNK bank stock indices

The logic: 'Two forces that supported the banking sector in the U.S. in 2013 are also likely to be present more broadly in major DM economies (U.S., Europe and Japan) in 2014,' says Goldman. 'The first is a significant pick-up in economic growth, which from a DM perspective, is mostly about domestic demand strength (along with fading fiscal headwinds in the U.S. and Europe). The second is a continuation of accommodative policies by major central banks that will keep short-term rates anchored and maintain easy financial conditions, even if the forward outlook for incrementally more policy accommodation is different in the three regions.'

Check out last year's picks...

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