Goldman Sachs strategists anticipate that stock-market volatility — which is already higher than normal — will remain elevated in the months ahead. The implication is that returns adjusted for the risk and volatility investors tolerate will be lower.Goldman preemptively rebalanced its basket of stocks with the highest expected risk-adjusted returns and flagged the 11 names atop the list. Click here to sign up for our weekly newsletter Investing Insider.Click here for more BI Prime stories.
Don’t expect the stock market’s whipsawing to subside anytime soon. That’s the message from Goldman Sachs’ top equity strategists to clients as coronavirus-related headlines continue to fling the market around. While the strategists do not expect a return of the ugly days in March when the economy first shut down, they foresee stocks being more fickle than normal in the months ahead. Two key gauges show that volatility remains historically high following the historic crash in March. First, the S&P 500’s price variation on a one-month basis — so-called realized volatility — is currently near 28, which is above its long-term average of 13.Similarly, the CBOE Volatility Index (or VIX) that tracks options-market activity is near 33, higher than its long-run average of 19. The investing implication of these trends is that equity investors are poised to get less bang for their buck after returns are adjusted for the risks taken. “Consensus expects 9% upside to the typical stock over the next 12 months and volatility should remain elevated through the rest of the year, suggesting low risk-adjusted returns in the coming months,” said David Kostin, the chief US equity strategist, in a recent note.Goldman Sachs has preemptively updated its strategy that targets stocks with the highest risk-adjusted returns, based on a gauge known as the Sharpe ratio. The strategists led by Kostin calculated it by dividing the consensus 12-month price target among analysts with the six-month volatility implied by options traders. A higher ratio indicates a more attractive return relative to risk-taking and the prevailing level of volatility.
What makes this strategy even more attractive is that market-wide Sharpe ratios are near their lowest levels in history. Prior to the steep sell-off in stocks on Friday, the S&P had returned -5% year-to-date with annualized realized volatility of 46% for a risk-adjusted return of -0.1 — in the 27th percentile since 1950. Kostin noted that the High Sharpe Ratio basket has underperformed the S&P 500 this year by six percentage points largely because it held a large number of value stocks. But since May, the basket has beaten the benchmark index by 441 basis points due to the improvement in economic data and value-stock performance. Its longer-term track record is also promising: the basket has beaten the S&P 500 in 66% of semi-annual periods since 1999 by 271 basis points on average, Kostin said. The freshly rebalanced basket includes 31 new stocks that are mostly in the healthcare, media, IT services, aerospace, and defense industries.”The median constituent in the basket is expected to generate roughly 3x the absolute return of the median S&P 500 stock during the next 12- months (+24% vs. +9%),” Kostin said. Listed below are the 11 new additions Kostin flagged because they have the highest Sharpe ratios:Edwards Lifesciences (EW) Northrop Grumman (NOC)Western Digital (WDC) Merck (MRK)Cigna (CI)Ulta Beauty (ULTA)Concho Resources (CXO)Hartford Financial Services (HIG)Allstate (ALL)Universal Health Services (UHS)Boston Scientific (BSX)Read more:
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