U.S. investors still have room to boost equities exposure if the economy comes in for a soft landing: Goldman Sachs

Goldman’s equity-sentiment indicator, which aggregates nine different positioning metrics including the net exposure of hedge funds, the net demand of foreign investors and flows into the active and passive equity funds, declined to 0.8 in the week ending August 18 after rebounding to 1.5 last month from negative 1.8 back in December. 

The “swift re-risking” by equity investors was driven by positive economic developments and optimism following the “widespread adoption” of artificial intelligence, said David Kostin, chief U.S. equity strategist at Goldman Sachs, in a Friday note. 

However, Kostin and his team expect the decline in the equity positioning measured by the sentiment indicator to be short-lived, because mutual funds and hedge funds will increase their exposures further “if the market environment continues to improve,” they said.

“Although hedge funds have lifted net exposures this year, net leverage currently stands below the average level of the last five years, suggesting there is room for funds to increase their equity length in the event that a soft landing continues to materialize,” they said.

Net exposure is the difference between a hedge fund’s long positions and its short positions, while net leverage is defined as net debt divided by annualized adjusted earnings before interest, depreciation and amortization (EBITDA).

“Similarly, mutual fund cash allocations remain 50 basis points above their all-time low of 1.5% in December 2021. If mutual funds cut their cash exposures to the 2021 low, that would represent an additional $49 billion of equity demand,” the analysts said.

Meanwhile, retail investors, who have increased their engagement in the stock market this year, would also increase their bullish bets as data from Finra show that margin balances increased in each of the first seven months of 2023 and are now at the highest level since February 2022, scaled relative to the market capitalization of the U.S. equity market.

Margin balance is the amount of money an investor owes their brokers for funds they’ve borrowed from them to purchase securities on margin.

However, retail traders have capacity to add “length” to their portfolios, as this level of margin balance is close to the five-year average and is still well below the peaks reached in March 2018 and October 2021, Kostin and his team said. 

Moreover, the reopening of the buyback-blackout window will provide a boost to equity demand in coming weeks, as nearly 85% of S&P 500 companies have emerged from the blackout window during the second-quarter earnings reporting season, according to data from Goldman’s Buybacks desk. 

An earnings blackout period is when certain executives or employees of a public company are prohibited from trading company stocks before and after quarterly or annual financial results are released. 

Goldman Sachs strategists two months ago lifted their S&P 500 target to 4,500 from 4,000, implying a 2.3% upside from the large-cap index’s closing level on Monday. The company was among the first Wall Street investment banks, brokers and research firms to boost year-end targets as the large-cap benchmark entered the bull market in early June. 

The S&P 500
SPX
ended 0.7% higher, at 4,399 on Monday afternoon, while the Dow Jones Industrial Average
DJIA
lost 0.1% and the Nasdaq Composite
COMP
gained 1.6%.