With the new year just six weeks away, the eggheads at Goldman Sachs have crunched the numbers and come up with the first six of their top trade recommendations, which they say are good for at least the first three to six months of 2016.
Admittedly, these strategies are complicated and clearly designed for the more sophisticated, professional trader. That said, every investor will benefit from understanding the thinking behind them.
1. Go long US dollar against an equally-weighted basket of euro and yen at 100, with a spot target of 110 and a stop loss of 95. Annual carry is positive at around 1%.
Put simply, Goldman believes the dollar will keep rising versus the euro and Japanese yen. Stronger economic growth will force the US Federal Reserve to raise interest rates faster than expected next year. In Europe and Japan, however, weaker economic growth will mean another 12 months of ultra-loose monetary policy. Goldman reckons this is one of the more durable themes for 2016.
2. Stay long 10-year US break-even inflation (USGGBE10 Index, or Treasury Inflation Protected Securities (TIPS)), opened on 10 November 2015 at 1.60%, with an initial target of 2.0% and a stop on a close below 1.40%.
According to the inflation swap market, headline inflation in the US will not hit the Fed’s 2% target until 2020, says Goldman. Option markets assign a 40% chance it will be below 1% for the next five years. That might be too pessimistic, certainly if better growth drives wages and prices higher.
3. Go long an equally-weighted basket of MXN (Mexico Peso) and RUB (Russian Ruble) versus short an equally weighted basket of ZAR (South African Rand) and CLP (Chilean Peso), with an entry level of 100, total return target of 110 and stops at 95. The expected return, including carry, is around 10%.
There’s limited downside to currencies exposed to crude oil like the Mexico Peso and Russian Ruble, but Goldman anticipates further weakness for currencies where commodities are tied to capital expenditure, like the Chilean Peso and South African Rand.
4. Go long a basket of 48 non-commodity exporters (GSEMEXTD Index) and short a basket of 50 EM banks stocks (GSEMBNKS Index). We will monitor this trade as the ratio between the two indices, currently at 1.12, with a target of +15% (1.30) and a stop loss of -7% (1.04).
Weak commodity prices, slowing Chinese growth and high debt will continue to hold back growth across emerging markets (EM). Buy a basket of non-commodity EM exporter stocks and sell the largest EM banks.
5. Go long five-year, five-year forward Italian sovereign yields vs short five-year, five-year forward German yields, with an entry level of 160bp, target of 100bp and stop loss of 190bp.
Low eurozone interest rates have caused long-dated yields to fall across Europe, yet sovereign spreads remain "quite steep". The difference between five-year rates in Italy and Germany is 50 basis points (bp), but five years into the future it’s over 150bp. Goldman thinks a stronger Italian economy will tighten the spread - so buy Italian debt and short Germany.
6. Go long large-cap US Banks through the BKX Index relative to the S&P500, indexed at inception to 100, with a target at 110 and stop loss at 95.
US banks remain relatively well-priced, trading just above book value and with a price/earnings (PE) ratio below the overall market, and at about median levels versus history. They’re also off their recent highs, unlike other possible equity plays on the US domestic growth theme.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.