GOLDMAN SACHS: Markets are about to get rocky — here’s how to use that to your advantage

REUTERS/Denis Balibouse

  • Goldman Sachs expects market volatility to come roaring back in 2018, which would unlock investment opportunities.
  • The firm conducted a series of analyses both predicting which areas of the market would move most and laying out which parts were being viewed the most bullishly.

Any investor will readily acknowledge that the market was starved of volatility last year. But fear not, says Goldman Sachs, which expects price swings to return with a vengeance in 2018, bringing with them plentiful money-making opportunities.

That’s welcome news for active managers who slogged through month after month of suppressed fluctuations. At a certain point, the CBOE Volatility Index, or VIX, became a poster child for market malaise as it sat near its lowest level on record. In Goldman’s mind, price swings can only get more pronounced from here.

“Coming off extremely low realized volatility in 2017, the options market is broadly bracing for a pickup in volatility this year,” Katherine Fogertey and the Goldman Sachs derivatives team wrote in a client note.

To help identify investment opportunities, Goldman uses a forward-looking analysis featuring multiple sets of data, largely based on options positioning on exchange-traded funds, most notably including (1) the areas of the market expected to see the biggest increase in volatility and (2) the areas where traders are currently the most bullish.

The areas expected to see the biggest increase in volatility

The rationale here is straightforward – price swings, by nature, create more opportunities for investors. But they also could lead to deeper losses for the ill-positioned, which is why this piece of Goldman’s analysis should be viewed in tandem with the section below. But before we get there, here are the four areas expected to see the largest spike in volatility:

  • Dow Jones Industrial Average – While an ETF tracking the Dow returned 28% in 2017 on realized volatility of 7, Goldman says the options market is pricing less than half of that return in 2018 on double the volatility.
  • High yield – Goldman says the options market is pricing in realized volatility of 7, double what it was during 2017.
  • Consumer discretionary – Goldman says the options market is pricing in volatility 73% higher than what was seen in 2017.
  • Technology – Options on the two biggest tech ETFs are implying “substantially less returns” in 2018 compared with last year, even though the market is expecting higher volatility for both.

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Goldman Sachs

The areas where traders are positioned the most bullishly

As you can see in the chart below, investors are the most bullish on energy, consumer staples and financials. And interestingly, they’re the most bearish on high-yield, one of the areas mentioned in the section above.

That suggests the move in high-yield being implied in 2018 will most likely be to the downside, providing a perfect example of why these two charts should be viewed in complementary fashion. In doing so, you’ll note that energy and oil ETFs are expected to move the most and traders are bullishly positioned on them.

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Goldman Sachs

While equity traders have enjoyed a nearly unimpeded stretch of strength, it’s inevitable that the going will get tougher in the future as volatility rebounds. To that end, Goldman’s two analyses outlined above go a long way toward unlocking where the potential profits may be.