In December Goldman Sachs was bullish. But now with mean reversion a thought on the minds of investors, hedging comes into view, a report from the investment bank highlights. The team of analysts is cautious as it considers hedging as the world’s economic and political realities might crash into the hope US political policy goals are all going to be achieved to perfection. The resulting impact from powerful forces moving in opposite directions, as evidenced by recent divergent opinions between US Treasury Secretary Steven Mnuchin and President Donald Trump, is motivation to consider portfolio protection methods. They are still overweight equities, but just recommending caution.

On a technical basis, mean reversion occurs when an asset prices move significantly beyond their average range, sometimes taking place over a short period of time

With the MSCI World index up by nearly 7.5% in December and up 4.62% year to date, investors might look to be thankful for performance normally generated over the course of a year occurring in a few short months.

From the standpoint of Goldman’s mathematically calibrated mind, considering all the risks in the world and stocks having been priced to perfection and beyond, now might be the time to raise cash.

In a report titled “How concerned are we? Our views on the continued equity rally,” the report looks at the outsized returns that have occurred over a short period of time and then juxtapose to risk.

“We continue to believe the key risks are growth momentum slowing, disappointments in US policy, rates rising too far too fast, and European politics,” they wrote, noting the risks are not necessarily imminent but they recommend Overweight cash.

Mean reversion

Mean reversion – The common stock market rally meme called into question

With the US stock market benchmarks continuing to hit new all-time highs almost as regularly as a bell opening and closing trading, there is one indicator hitting all-time highs that has Goldman concerned.

With the stock market climbing on the back of the Trump rally, January measures regarding policy uncertainty were reported at all-time highs.

The investment bank noted that Trump policy “has not disappointed yet in a material way.” The “yet” in that statement is relative to the hope investors have for “supportive fiscal and tax policy,” which is driving the current rally. Goldman’s concern is that what happens if Trump policy hopes don’t materialize into reality. With the markets pricing in not just success, but absolute, uncompromising victory – a political rarity – Goldman thinks hope might not be the best word to base an investment thesis.

“We continue to think that not all positive expectations will be met in the US,” which triggered a rotation out of the S&P 500.

Signs of cracks in potential US policy hopes are starting to appear. Steven Mnuchin was less than enthusiastic for Trump’s border adjustment tax on CNBC Thursday morning, and then President Trump re-iterating his support via Twitter later in the day. Trump has categorized China as a “currency manipulator,” but Mnuchin on Thursday said there is “no judgment yet.” Who wins this policy discussion and when victory is determined could have market implications.

Mean reversion concerns not just based on Trump administration, but also political concerns in Europe as well as interest rates rising rapidly

It is not just the US political situation that concerns Goldman Sachs. Looking at Europe, there is significant political risk that has been largely shrugged off by markets. To hedge political risk, the investment bank recommends short the EUR / USD currency spread as opposed to shorting equities.

Another risk on the growing list is that interest “rates rise too far, too fast,” with the US Federal Reserve likely to pull the trigger on rate hikes sooner rather than later, with Goldman noting a better than 50% chance for a hike in May. To hedge rate risk, Goldman recommends moving into cash to a greater degree.

Overall Goldman remains Overweight stocks, but “the risks of growth momentum slowing, US policy disappointment, rates rising too far too fast, and European politics” are all problematic. “In our view, equities have rallied in part because none of these risks have realized but we still see risk that they may.”