The stock market surge has delivered a rare signal. Here’s what history suggests happens next, says Goldman Sachs.
As the U.S. stock market registered more record highs this week, it threw up a seldom-seen technical and sentiment signal that may cause bulls to pause for reflection.
In a note published this week, a team of Goldman Sachs analysts led by Andrea Ferrario said the heightened risk appetite and strong equity market momentum are combining in a way not replicated since the turn of the millennium.
Most Read from MarketWatch
Goldman’s risk appetite indicator, or RAI, measures investor risk appetite using high-frequency data across five main categories: fixed income, equity, liquidity, commodities and credit.
It’s particularly useful as a contrarian tool when sharp falls can suggest traders are too cautious, and a rally may ensue.
However, the RAI this week rose to 1.1, surpassing the levels at the start of this year and reaching the highest point since 2021. It’s only been above 1 for 2% of the time since 1950, Goldman said.
And, importantly, the current high RAI reading coincides with a relatively sharp rise in equity momentum plays. The iShares Edge MSCI USA Momentum Factor ETF CL:MTUMCL is up 33% from its March 30 trough, while the S&P 500 SPX is up 18.25%. This has produced a momentum z-score of above 3. Z-scores measure a price relative to its history — or, to be more technical, how many standard deviations a data point strays away from its average.
This risk and momentum combination makes “the current backdrop exceptional,” Goldman said. “[T]his is the first time that both risk appetite and momentum performance have been at such elevated levels since the start of 2000.”
What does this message signal? “Historical analogues point to more limited upside for the broad equity market and more volatility for momentum,” said Goldman.
The bank noted that, since 1962, there have been eight episodes with an RAI above 0.9 and a U.S. equity momentum z-score above 2.0. Three out of those eight episodes were eventually followed by a bear market within the following two years.
“That said, in 1999 and 2021 equity prices peaked almost 12 months after the moment when RAI and equity momentum first reached elevated levels,” the analysts said
Furthermore, the analysts stressed that, as with elevated valuations, an elevated RAI (even coupled with high equity momentum) “is not a sufficient indicator to time the peak of the market, in our view.”
That may be the case now, as earnings have become a more important driver for equities and valuations are supported by higher corporate profitability.
