Goldman Sachs Stock: Don’t Be A Bear Here (NYSE:GS)

Investors fretting about Goldman Sachs’ (NYSE:GS) disappointing Q4 earnings release miss a critical point about its investment banking and asset and wealth management franchise.

Critically, market volatility has continued to subside toward April 2022 lows, as measured by the S&P 500 Volatility Index (VIX). Bears could argue that the collapse could be forming up as a preamble to a bear trap on the VIX side of the house against over-optimistic equity bulls.

Possibly. The VIX has found support three times over the past year at the current levels: April, August, and December.

As such, market operators could potentially leverage the recent pullback as an opportunity to ensnare buyers in another trap, sending the VIX higher and, concomitantly, the S&P 500 (SPX) (SPY) down further.

Accordingly, we discussed this in a recent SPY article, articulating that the market is at a critical juncture. Therefore, whether buyers could conjure enough upward momentum to help lift its current recovery could be affected by how the VIX progresses from here.

However, before buyers subscribe to the bearish thesis that the VIX could be “exploding” upward from here, consider also that investors could be de-risking their bets and hedges, as they anticipate a less hawkish Fed moving ahead. As such, it’s possible that the drop in the VIX is closely related to the reversal conditions in the credit default swaps (CDS), indicating that “large investors are moving back to a more risk-on stance in the credit markets. This typically bodes well for stocks as well.”

Why does it matter to Goldman Sachs? Of course, it matters. Management highlighted several times in its earnings commentary, suggesting how the market volatility in 2022 impacted its key revenue and profitability drivers.

For instance, CFO Denis Coleman articulated: “On the equity side of the equation, obviously, asset markets moved around quite severely, particularly at the end of the year, which drives prime brokerage balances.”

CEO David Solomon added:

I think one of the things we’re dealing with, and it’s overamplified in our very capital market-centric business, is that 2021 was not normal. The second half of 2020 and 2021 were not normal. They were way inflated by the massive fiscal stimulus that created kind of, I’d call, on the spectrum of activity, excess activity, pulled a lot of activity forward. And then because of market disruption, we’ve tightened monetary conditions meaningfully in 2022. It’s the first year in over 50 years that both fixed income and equity markets were down. We had the S&P down 20%, the NASDAQ down 30%. You had a real change in asset values across the spectrum. And when that happens, it takes a period of time for people to adjust. (Goldman Sachs Q4 earnings call)

So, management clearly highlighted to analysts why the company underperformed its estimates markedly, as it also dealt with elevated costs and an unprofitable consumer segment.

Despite that, the key growth imperative remains in its asset and wealth management business, as the company seeks to build out a higher fee-based business, diversifying from its balance-sheet heavy capital markets business.

The WSJ also reminded investors not to be distracted about where the company’s key growth imperatives are as Solomon & team recovers its profitability in 2023/24. It added:

Much of the conversation lately around Goldman Sachs has focused on its foray into consumer banking and lending. Yet the reality is that the consumer business isn’t a huge factor in Goldman’s overall performance in metrics such as return on equity. The unit remains relatively small in that equation, and as of the fourth quarter consumed less than 4% of the common equity allocated to its three business units. The firm’s still-evolving business in asset management is a much bigger stumbling block. Asset and wealth management accounted for roughly a third of the firm’s allocated common equity in the fourth quarter – and the return on that equity was slightly negative in the quarter. The firm had significantly lower revenue in its equity and debt investments from a year prior, reflecting tough market conditions. – WSJ

Fair enough. The company had an “abnormally good” year in 2021 driven by the pandemic-fueled craze, and an “abnormally bad” year as Powell & his FOMC went on a rampage to raise interest rates.

Therefore, could 2023 emerge as a better year for Goldman Sachs, as deal activity could potentially return?

We believe so. If market volatility continues to slide further without a VIX “explosion,” it suggests that buyers have returned to a risk-on mode, which could help lift buying sentiments on more capital markets-sensitive stocks like GS.

As such, we don’t expect GS to revisit its lows in October and see a consolidation phase moving ahead.

With GS’ NTM normalized P/E of 10.1x in line with its 10Y average of 10.3x, we don’t think GS is undervalued. However, constructive price action suggests that GS buyers have continued to support the stock despite its post-earnings selloff.

As such, it’s possible that GS could continue to outperform if market operators anticipate more sanguine macro conditions that could improve the deal-making environment in 2023/24.

While waiting for a further pullback could be more rewarding from a reward/risk perspective, a high-quality capital markets stock like GS trading at its 10Y average remains reasonable in our view.

Rating: Buy (Reiterated).