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November 10, 2014

Goldman Upbeat About The US, Cautious About Europe

By Economy Watch

A note sent to select clients of the investment bank juggernaut Goldman Sachs urged investors to buy stocks now, as more jobs and a resurgent U.S. economy could tip equities even higher in the next few years.

In their note, Goldman Sachs told investors that a rise in aggregate income would lift consumer spending, which in turn will lift U.S. retail and financial stocks. The bank said that U.S. GDP growth for 2014 could see a reacceleration in 2015 thanks to more money in consumers’ pockets that in turn will lift revenues for publicly listed companies.

“Distressing” Metrics Remain

Many analysts have warned that higher aggregate demand is necessary as the U.S. economy becomes more self-reliant on the end of the Federal Reserve’s QE policy. An economist at an investment bank said last week at a private meeting that economic metrics are “distressing”, and added that the price-to-sales ratio, a key indicator of overvalued stocks, showed that the S&P 500 has become too pricey.

Reaching a 1.8 ratio in recent weeks, the S&P 500 price-to-sales ratio is at its highest point since the dot-com bubble in 1999, and some analysts have expressed concern that the historically lofty ratio could indicate a limit to stock prices in the near term. The median P/S ratio for the S&P 500 is 1.43.

Unemployment, Wage Hikes to Cheapen Sales

However, some analysts have countered that quantitative easing has created a “new normal” in which P/S ratios fundamentally change for the S&P 500, rendering its historical median irrelevant. In its note, Goldman Sachs argued that the P/S ratio, while artificially high, would fall in 2015 and 2016 amidst greater purchasing power in the U.S.

The investment bank also noted that recent moves to raise the minimum wage in five Republican-dominated states would also improve economic conditions for companies. Last week, Alaska, Arkansas, Nebraska, South Dakota, and Illinois voted for minimum wage hikes, which some economists at Goldman Sachs believe could be the tipping point that pushes the Republican-dominated House of Representatives and Senate to cross the aisle and agree to a nationwide minimum wage hike.

While higher minimum wages could boost aggregate demand, Goldman Sachs also told clients that falling unemployment would help companies’ revenue growth. On Friday, the Bureau of Labor Statistics announced that the U.S. unemployment rate fell to 5.8% in October as the economy added 214,000 jobs. The labor force participation rate also rose 0.1% month-over-month to 63.8%. However, the unemployment rate has not fallen to pre-recession lows and the labor participation rate remains at its lowest point since the late 1970s.

Goldman Unloads its Hedge Fund Holdings

The investment bank’s optimism has also driven the bank to cut its exposure to hedge funds. The bank sold $285 million in hedge fund holdings in the third quarter of 2014, both in an attempt to avoid short exposures and to help it adhere to the Volcker Rule restrictions on banks’ proprietary investments. The rule requires Goldman Sachs divest all but 3% of its own holdings from hedge funds by July 2015. Goldman currently has $11.4 billion in hedge funds.

Despite an upbeat outlook for the U.S., Goldman Sachs remains cautious about European stocks. Late last week it released a note to investors arguing that Europe will continue to face a fiscal drag, with long-term nominal growth of 2.5% in Italy, 3% in Spain, 3.5% in Germany, and 4% in France.

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

Courtesy Economy Watch 

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