- Whiplash in the stock market has sent mixed signals to investors about whether the bottom is in.
- "Corrections rarely turn into bear markets unless the economy is heading into a recession," Goldman Sachs' David Kostin said.
- These are the three factors investors should follow to gauge if stocks are ready to resume their uptrend, according to Goldman Sachs.
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Last week's whiplash in the stock market was extreme, with the Nasdaq 100 trading in a 7% range before finishing the week virtually flat.
Investors are receiving mixed messages from the market, with investor sentiment nearing extreme pessimistic levels while positioning in stocks remains elevated. The whiplash comes as the Federal Reserve prepares to tighten monetary policies with higher interest rates.
Investors have shown eagerness to buy the near-10% decline in the S&P 500, as corrections during periods of economic expansion often represent a solid buying opportunity, according to Goldman Sachs.
"An investor buying the S&P 500 10% below its high, regardless of whether it was the trough, would have gained a median return of 15% during the subsequent 12 months (positive 76% of the time)," Goldman Sachs' David Kostin said in a Friday note.
The market declines tend to be solid buying opportunities because "corrections rarely turn into bear markets unless the economy is heading into a recession," he said. But volatility remains elevated and there's no guarantee that stocks won't continue to trend lower as the Fed combats rising inflation with higher interest rates and begins to roll off bonds from its balance sheet.
These are the three factors investors should follow to gauge if stocks are ready to resume their bull market uptrend, according to Goldman Sachs.
1. Positioning
"The troughs of equity market corrections are often marked by depressed levels of positioning. Although equity investor length has declined sharply in recent weeks, it still remains elevated vs. history. Hedge fund leverage data shows a sharp recent de-risking, with net leverage falling to the lowest level since October 2020. But it remains higher than at any time pre-pandemic."
2. Monetary Policy
"Messaging or economic data providing confidence that Fed tightening will not dramatically exceed current market expectations would represent a positive catalyst for equity prices. Investors have had to adjust expectations dramatically since September, when markets priced just one 2022 hike and a more gradual QE taper. Clarity that expectations are appropriately calibrated would allow investors to increase equity risk."
3. Earnings
"Data reaffirming the outlook for earnings would also provide a catalyst to support equity prices. 34% of S&P 500 companies have now reported 4Q EPS and 52% of them beat consensus estimates by more than a standard deviation (vs. a historical average of 49%). However, implications for the forward growth outlook have been mixed. Of the 44 companies that provided formal FY1 EPS guidance, 23 (52%) have guided above consensus and 21 (48%) have guided below."
