As Goldman Sachs goes, so goes the market

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By Don Vialoux
'Too big to fail' firm has become too big to ignore

G oldman Sachs Group Inc. has been at the forefront of news lately due to allegations surrounding creation of subprime mortgage products and investment positions placed against these products. Those who benefited are alleged to have made billions of dollars. Events and negative news on Goldman were one of the reasons why equity markets were reeling that week. Investors are losing faith in the company.

This "too big too fail" firm has clout in the marketplace. Over the past 10 years when Goldman's shares recorded a daily rally of 5% or more, the S&P 500 gained an average of 2.39%and increased 91% of the time. Gains of this magnitude certainly did not occur on quiet days or during isolated events.

The same holds true when Goldman's stock had a bad day, losing 5% or more. The ripple effect through equity markets saw the S&P 500 Index lose an average of 2.81% and the S&P 500 Index drop 94% of the time. When Goldman moves, the market follows.

Stances on equity markets, sectors and individual equities taken by Goldman are highly followed and have the strength to influence the direction of recommended equities.

Stock components of the Dow Jones Industrial Average that received recommendation upgrades by the firm over the last 10 years, gained an average of 1.84% on the day of the upgrade. Conversely, equities lost 2.30% on the day when the company's analysts downgraded Dow Jones Industrial Average stocks.

However, responses to new equity ideas only have a shortterm impact. Many investors who purchased equity investments marketed by the company beyond the first day of a new idea have experienced greater success. If holding a stock that plummets as a result of a Goldman downgrade, the 2.3% one-day loss quickly levels out to a loss of only 0.4% within one month of the demotion as investors partake to the cheaper equity.

The "too big to fail" has become "too big to ignore." When investors observe that Goldman has lost faith in a particular investment, traders react. Stocks taken off its "recommended list" have dropped an average of 5.35% during the day of removal, even though a "market perform" or a "market outperform" rating is maintained. Lost prestige due to removal from its recommended list has a significant negative impact. Question: with the company's ability to move markets on individual securities, is there reason to oblige the company to disclose its interest in these securities?

The bottom line is that it is detrimental to act as a contrarian to new equity ideas offered by this company. Investors take great faith in the strength and intuition that Goldman brings to the marketplace.

How can we increase our odds of success by following opinion changes offered by this financial giant?

First, May is documented as the worst performing month for Goldman's shares, losing as much as 5% on average during the past 20 years. May represents the period that the stock tops out following seasonal gains in anticipation of strong first quarter earnings.

The January to April period of seasonal strength in Goldman coincides with a period of seasonal strength by the S&P financial services sector that has generated an average return per year of 8% over the past 10 years.

Second, seek alternatives to Goldman in the month of May and invest in gold. During Goldman's period of weakness in May, gold usually rallies as a safe-haven investment prior to more volatile summer months for equity markets.

Third, when Goldman is subjected to news and scrutiny, step back. Public interest in the stock gauged by the number of Internet searches performed on the term "Goldman Sachs" shows that attention is high. If attention increases, volatility in its stock will increase, placing severe pressure on its value. Losses averaging 20% over a two-month period following a period of notoriety have been the norm based on history.

Goldman Sachs leaves a giant footprint on equity markets when it takes action. Investors may not have Goldman's insight on equity selections, but they can develop a plan designed to profitably respond at the appropriate time to its actions.

Read more: http://www.financialpost.com/story.html?id=3003035#ixzz0nOOzSDRX

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