Goldman: Most Are Bearish, And Few Are Outperforming, Steamrolled By Late-Cycle Correlation Breakdowns

Some actionable observations from Goldman trader Rich Privorotsky who summarizes his recent client trip (“most clients sound bearish but it’s unclear that they are  bearishly positioned”), lays out his concerns about the deflationary H2 eating away profits (“pricing power will be a critical narrative into the back half, if PPI is falling it usually means margin compression and we’ve already seen early cycle industries like Chemicals, Paper/packaging, and shipping/trucking warn on demand decelerating“), where we are in the cycle (“yes we are late cycle not the start of a new cycle“), why trading late cycle is so difficult (“there are no great blueprints for this period, the cycle can extend a lot longer than people can expect and the divergences/correlation breakdowns are not as uncommon as I would have thought“), and why everyone’s P&L sucks (“the last month has felt like a broad based risk stop in across the equity complex, few have outperformed this rally this year and most remain pessimistic but I think now are much more balanced in their positioning”).

We excerpt from the Privorotsky note below:

What struck me most was not the lack of equity move but the continued weakness in the rate market. 2yr real rates are nearly topping out at 3% while risk assets are absorbing the move fairly constructively. Typical seasonality (in equities) suggests that this early part of July is meant to be some of the strongest of the year, however I would note that that is usually predicated on a relatively weak period during the last couple week of June (which clearly did not happen).  

Feedback from marketing has been that the last couple weeks were all about risk squaring, underweight were squashed and there is a lot of uncertainty about the path forward. Most clients sound bearish but it’s unclear that they are  bearishly positioned.

Got very little pushback on the dis-inflation narrative, the drop in China factory gate prices, the inflation surprises clustering to the downsides and the very visibility disinflation in emerging markets. Pricing power will be a critical narrative into the back half, if PPI is falling it usually means margin compression and we’ve already seen early cycle industries like Chemicals, Paper/packaging, and shipping/trucking warn on demand decelerating.

Arguably the late cycle industrials are the most at risk, their robust backlogs are the ones that could get cut if the de-stocking downstream spreads upstream. Owning defensives wholesale is tricky, in pockets like the staples pricing power is eroding as consumers down trade and the ability to push price at the expense volumes appears to have come to the end of the runway. Still appetite for up in quality (think strong balance sheet + pricing power Is where you look…ie healthcare/aero/defense and the parts of tech that aren’t trading on 40x p/e) as well as attractive carry (ie local em bonds).

Lots of questions on Japan, get the impression that the long only community is not as long as it would like to be there.

Late cycle is just really difficult to call (yes we are late cycle not the start of a new cycle imo), there are no great blueprints for this period, the cycle can extend a lot longer than people can expect and the divergences/correlation breakdowns are not as uncommon as I would have thought. The conclusions are largely the same though, US exceptionalism centered on the premise of a labor market that will decelerate slower/not at all relative to the drop in inflation, a secular story in Japan, consensual views on China’s continued economic malaise and a lack of interest in Europe ( I did flag the glaring disconnect between economic surprise/hard data and equity markets in the geography).

On the China front the underweight is once again clear and the debate will be whether the Politburo delivers a big bang stimulus to stable growth for the back half, think lots of reasons to expect that not to happen but that is the right tail risk.   With a fresher pair of eyes the last month has felt like a broad based risk stop in across the equity complex, few have outperformed this rally this year and most remain pessimistic but I think now are much more balanced in their positioning. Watching OPEC, FOMC minutes and Williams.