(Bloomberg) -- Investors should consider hedging the rally in the S&P 500 for recession-related risks, say Goldman Sachs Group Inc. strategists, citing several equity indicators.
Bullish option positions look crowded, the rally has been narrow, valuations remain high, overly optimistic growth expectations are being priced in and overall investor posture isn’t light anymore, strategists including Cormac Conners and David J Kostin wrote in a note dated June 20.
“We prefer to maintain upside exposure to equity while utilizing the options market to hedge the potential 23% downside in a recession scenario,” they wrote. There’s a one in four chance of recession over the next 12 months and if that prospect become more likely, the S&P 500 could decline to 3,400, they added.
Kostin, Goldman’s chief US equity strategist, said in February that European and Asian stocks are better for investors to buy than US shares this year due to an expected drop in corporate profits. That call hasn’t panned out so far.
The S&P 500 has outperformed benchmarks in Europe and Asia this year, entering a bull market in June, despite warnings of a recession that’s likely to hit next year. Bulls have instead focused on a pause in interest-rate hikes, while a frenzied buying of technology stocks tied to an expected boom in artificial intelligence’s usage has also trumped all macro concerns over the market.
Some of the Wall Street’s key strategists, including Morgan Stanley’s Michael Wilson and JPMorgan Chase & Co.’s Marko Kolanovic, have for months remained wary of the ongoing rally.
Still, the base case of Goldman’s team is for the S&P 500 to rise to 4,500 by the end of this year, implying a gain of about 2.5% from here on.
Investors should buy an S&P 500 put spread collar — an options strategy that involves buying a downside put and selling an upside call — to hedge a long equity portfolio, Goldman strategists wrote.