Will the Goldman Sachs rally last?
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MoneyWeek Editor
John Stepek Jul 15, 2009
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Goldman: back on top
"It's the end of an era. Wall Street has changed forever." That's what one BNP Paribas research analyst said back in September 2008.
He was talking about the death of the investment banking industry. Hammered by the credit crunch, both Goldman Sachs and Morgan Stanley had converted status from being investment banks to being commercial banks, so that they could tap the Federal Reserve for cheap loans.
Fast forward less than a year, and as Mark Twain might have put it, it seems that reports of the death of investment banking might have been exaggerated.
Goldman Sachs is back on top – and the markets are rebounding with it…
Financial crisis? What financial crisis?
Goldman Sachs might have had a wobbly couple of months back in 2008, when it had to run to Warren Buffett for some very expensive funding and convert from being an investment bank to access aid from the Fed.
Will the Goldman Sachs rally last?
But that's all behind it now. On Monday, Wall Street's new favourite analyst, Meredith Whitney, issued a 'Buy' recommendation on the stock. Whitney is widely credited with predicting the banking crisis after she pointed out that Citigroup was in a terrible mess at a time when everyone else was still pretending it wasn't. So she's now seen as some sort of banking guru. So when she turned from bear to bull - though only on Goldman - it got traders excited.
As expected, Goldman delivered. Profits soared in the second quarter. So Goldman staff won't be going hungry this year, with average pay per employee looking set to come in at around $1m this year, according to City AM.
Goldman has always been controversial, and no more so than during the financial crisis. There's the small fact that its ex-chief, Hank Paulson, was the man behind the banking bail-out, for example. Or the way that it always seems to come out on top, regardless of how bad the financial storm. In fact, in the current issue of Rolling Stone, journalist Matt Taibbi describes the bank as being "a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money."
That might be a little strong. But you do have to wonder what happened to the notion that we were going to attempt to reform the financial system so that the sort of collapse we saw less than a year ago wouldn't happen again. As Cris Sholto Heaton points out in Friday's issue of MoneyWeek, the profit rebound has come about because Goldman has increased its "Value At Risk" – in other words, it's using that cheap money to take on even bigger, bolder bets. Of course, at the same time, it's also winning those bets, so it's hard to deny that the company is good at what it does.
Should we be expecting a fresh market slide?
We'll be looking at how Goldman makes its money and what it says about our financial system in more detail in a future issue of MoneyWeek. But for now, let's turn back to the markets. After sliding since the start of June – a number of emerging markets are now back in 'bear' mode, having fallen by more than 20% - the Goldman bounce has given them a spurt of fresh life. Will it continue, or can we expect a fresh slide?
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Investment expert Marc Faber has some interesting points to make in his latest Gloom, Boom and Doom report. He reckons that most stock and commodity markets became over-bought at the start of this month, so a correction was on the cards.
However, while the correction might continue, he can't see new lows being made "for now." In fact, with vast sums of easy money being pumped into the economy, "I am not ruling out the possibility that economic statistics such as car sales, home sales, and export volumes could actually surprise on the upside for a while."
That's not to say that any recovery will be sustainable – it won't. But as Faber points out, in a long-term bear market, it can take years for markets to hit their final lows. Japan is probably the best example, certainly in recent history. "The Japanese Nikkei Index bottomed out for the first time at 15,000 in 1992." It then made new lows in 1998, 2003 and of course last year, falling to 7,000.
So how do we get out of this? "Probably the best medicine for revitalising the economy in the long term would be to slash government expenditure and cut taxes at the same time, which would allow the more dynamic private sector to expand at the expense of the largely unproductive government sector," reckons Faber.
We'd agree with him. Trouble is, this is also extremely unlikely. The prevailing opinion is that in a downturn the government must spend more to compensate for the private sector cutting back.
Where to invest in this uncertain market
So if it looks as though stocks are going to be stuck in a long, volatile, downward-trending range, then what can you invest in, if you're not a rampant day trader? Well, for us, it comes back once again to defensive stocks. Even during Japan's years of misery, research by Societe Generale suggests that buying stocks with decent dividend yields and strong balance sheets still produced strong returns.
You can read more about the defensives we like here (Seven safe stocks that will last longer than the rally). And you can also learn how to profit from the next big change in consumer behaviour – the return of thrift – in this week's issue of MoneyWeek, out on Friday. If you're not a subscriber, claim your first three issues free here.
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