Although this is less true than it was before the Volcker rule, there are two Goldmans. Broker-Goldman facilitates trading or securities issuance on behalf of its clients. Investor-Goldman allocates the firm's capital. The former earns a return based on level of client activity, while the latter needs to make smart decisions. The former is -- in the words of a former partner -- "always bullish;" the latter is bullish or bearish, based on the prevailing market.
Guess which Goldman you're better off listening to when the two conflict -- as they do now?
Meet Broker-Goldman's prime permabull
At the beginning of January, Goldman senior investment strategist Abby Joseph Cohen told the Barron's Roundtable that "fair value for the S&P 500 is about 1,500". That call could well turn out to be about as useful as her 2008 Barron's Roundtable prediction that the S&P 500 would finish the year at 1,675 – she was wrong, but only by roughly half. (The index finished the year at 903.)
Admittedly, very few people foresaw the tsunami that tore through asset prices in 2008, but the subprime crisis was already well under way at the end of 2007. Given the magnitude of banks' exposure to the problem -- these experts were at the financial crisis's ground zero! -- and the fact that financials were the largest sector in the S&P 500 at the time, you'd have thought the bulls might at least slow down. Broker-Goldman and Cohen, undeterred, called for a 14% rise in the market.
"Always bullish!"
Cohen and/or the group she oversees (the authoritative-sounding "Global Markets Institute") appear almost congenitally incapable of being anything other than bullish. Perhaps they're simply following the edict of former partner Roy Zuckerberg, who once told a Goldman trainee: "In the securities business, there's only one way to be -- and that's bullish! Always bullish!"
GMO Chairman Jeremy Grantham isn't always bullish, but he has a very good record with regard to long-term predictions; he says the S&P 500 is presently worth 910. I'm throwing in with Mr. Grantham here: I don't know the nuts and bolts of GMO's valuation method, but 910 is almost the exact estimate one obtains using the Shiller P/E, one of the best long-term indicators of value.
The S&P 500's fair value: 905?
The Shiller P/E, or cyclically adjusted P/E (CAPE), uses average inflation-adjusted earnings over the prior 10-year period. Going back to 1881, the CAPE's average is 16.4. Apply that to 10-year average real S&P 500 earnings of $55.20, and you get 905. Some people argue that the early CAPE data is useless, but even if we use the CAPE's average since 1945, that barely gets us to 1,000 for the S&P 500. Telling investors the index's fair value is 50% higher than that is like encouraging someone to jump out of a plane without a parachute.
With Goldman, it's a case of "Do as I do, not as I say." You're much better off watching Investor-Goldman's actions than listening to what Broker-Goldman says. Last month, Goldman CFO David Viniar told Wall Street analysts, in reference to its $170 billion in excess cash: "Our No. 1 choice will be to find opportunities to use the capital profitably, and if not, we would probably give some more back."
From buyer to seller?
While competitors JPMorgan Chase (NYSE: JPM) and Bank of America (NYSE: BAC) are focused on raising their dividend, Investor-Goldman deploys its cash into risky assets such as loans, real estate, and other distressed securities. Unfortunately, investor exuberance has pushed prices high enough to hamstring the investment bank's search for value. In fact, the firm says that given current prices, it may well reverse tack and begin selling some its assets. If Investor-Goldman is a seller, it's not because it thinks it's getting less than fair value.
It's stocks, too!
But what do distressed assets have to do with stocks? Unfortunately, the astonishing comeback of investors' animal spirits is not contained to distressed assets. As successful distressed investor Howard Marks told investors at the Columbia Investment Management Conference last Friday, "I think equities are less overdone than credit, but I think it's time to act prudently." [Emphasis mine.]
The exuberance hasn't escaped the smart money's notice, and they're seizing the opportunity. On January 27th, Nielsen Holdings (NYSE: NLSN) became the largest private-equity backed IPO ever in the U.S. On the same day, Demand Media (NYSE: DMD), an Internet "content factory" that has never earned a profit, popped 33% on its first day of trading.
Fair warning
In summation, I'll return to Howard Marks, who declared on Friday that, in the fourth quarter of 2008, "all you needed was capital and nerve. Today, if all you have is capital and nerve, you're going to get in trouble." Buyer beware.
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