Goldman Sachs analysts believe the positioning-driven recovery of risky assets, particularly equities, post-Brexit is likely to fade, and hence, they remain defensive in their asset allocation. Christian Mueller-Glissmann and colleagues point out in their July 11 research piece titled “Risky risk appetite reversal; Bonds to Neutral over 3-months” that post-Brexit, while risky assets have rallied again, risk-off assets too are making new highs.

Global risk appetite indicator still negative

Mueller-Glissmann and team created a global risk appetite indicator to track risk appetite on a real-time basis and across both regions and assets. The indicator is based on 1y rolling z-scores of several indicators of risk appetite across assets. The GS analysts explain that a sharp rise in the index can send a warning signal that investors have more risk appetite and are potentially exposed to a correction if consensus views are tested. They note that owing to a lack of growth and reflation since 2014, investors have become increasingly pessimistic, which led to less risk appetite, with the indicator mostly in negative territory. They argue that the lack of bullish positioning, coupled with the search for yield, is likely to help stabilize equities in drawdowns:

Risk appetite Asset Allocation, Goldman Sachs

The GS analysts point out that the risk appetite indicator can help “trade” a range-bound market when valuations and sentiments are the key driver and fundamentals are stable. As can be deduced from the following graph, since 2015, the 3-month return on the MSCI World has been closely linked to the level and momentum of the risk appetite indicator. The analysts note that before the referendum, the indicator sent a bearish signal after the relief rally following the Fed’s dovish surprise in February. They say that with the recent “risk-off,” the indicator has turned more neutral:

Drop in risk appetite

Asset allocation: Goldman Sachs remains Neutral equities over 3- and 12-month horizons

Mueller-Glissmann and team believe the market is increasingly treating Brexit as a negative local growth shock but a positive global rate shock, which will drive easier monetary policy. The analysts remain defensive in their asset allocation and believe the positioning-driven recovery of risky assets, in particular for equities post-Brexit, is likely to fade. They still believe equities are fragile and stuck in their “fat and flat” range with little return potential but the potential for drawdowns. The GS analysts believe a lack of positioning in equities, coupled with the strong search for yield has driven a reversal of risk appetite for equities from very low levels. The GS analysts remain Neutral on equities over 3- and 12-month horizons, but they would trim risk on continued strength and with further normalization of risk appetite in equities.

Considering the strong search for yield, the analysts also upgrade bonds to Neutral for 3-months, though they remain Underweight bonds over 12 months:

Return forecasts

The GS analysts stay Neutral commodities over both 3 and 12 months. They have revised up their gold price targets to US$1,300/1,280/1,250/oz over 3/6/12 month on the back of Brexit. The analysts remain Overweight credit on both a 3- and 12-month horizon as they argue that relative valuations appear cheaper than in equity and the carry is attractive. The following table sets forth their asset class forecast returns and performance:

Forecasts by asset class