Goldman Sachs recommends top themes and trades for 2016

Goldman Sachs published its six recommended top trades for 2016 based on its related top 10 global market themes for next year, which are led by the fact it sees global growth being "more stable than it looks".

Despite disappointing growth in recent years, risky assets have appreciated substantially, the investment banking behemoth said.

"In 2016, we expect activity to continue to expand in the advanced economies, led mostly by the consumer."

As a result of high valuations and rising rates, especially in the US, risky assets will be less favoured and investment opportunities next year will be "centred around rotation between markets and across sectors", seeking 'alpha' more than 'beta'.

In short, Goldman's ten themes begin with the proposition that global growth will be more stable than it looks, with the economics team expecting 2015's post-crisis low of 3.2% global GDP to rise to 3.6% in 2016.

Second, US inflation offers "less downside risk than is priced". With the US economy having the least slack than other advanced economies, this is expected to "go a long way towards convincing bond markets that deflation risk is much lower than is priced".

Developed market monetary policy will begin to diverge, with the US raising rates and the UK and Japan staying dovish for longer and resulting in weaker currencies versus the dollar.

The price of oil offers a near-term downside risk but, by year-end 2016, upside. However there are major downside risks to oil, with a "growing risk" that oil inventories could swell to full capacity in the next 13 months and a worst-case $20/bbl downside risk scenario mooted.

"Relative value in commodities" is another theme, the ‘lower for longer’ theme for commodity prices predicted to continue, but with the additional ‘demand tilt‘ that China’s efforts to rebalance demand from investment to consumption should reduce demand for ‘capex commodities’ such as steel, cement, and iron ore much more than it reduces demand for ‘opex commodities’ such as energy and aluminum.

Other themes include a "limited upside" to US equities in 2016 as rallies in risk sentiment may be met by less accommodative monetary policy, aka the ‘Yellen call’.

Emerging market risk is predicted to "slowdown, not meltdown" in light of China's slowdown, lower oil prices hitting producing countries and pegged currencies. But an EM meltdown is not inevitable as this time more EM countries have borrowed in local currency and reserve buffers are bigger.

The ‘new normal’ is for less market liquidity in credit markets.

The final theme is that corporate earnings will turn out to have have suffered "only a temporary loss of mojo". Assuming operating profit margins continue recovering, "we see ample scope for renewed growth of revenue and earnings via the corporate sector’s beta to firming US and global GDP growth".

As a result, Goldman has set out the first six of its recommended top trades for 2016.

The first is a long bet on the US dollar versus an equally weighted basket of the euro and Japanese yen 100, with a spot target of 110 and a stop loss of 95.

Next is to continue its previous long bet on US 10-year ‘Breakeven’ inflation, played via the USGGBE10 Index.

Third is to go long the Mexican peso and Russian ruble equally-weighted versus an equal-weighted basket of South African rand and Chilean peso.

Top trade number four is to go long on 48 EM non-commodity exporters, the GSEMEXTD Index, and short a basket of 50 EM banking stocks, the GSEMBNKS Index.

Another bet is on a tighter spread between Italy and Germany long rates, via a bet on 5-year, 5-year forward Italian sovereign yields versus shorting 5-year, 5-year forward German yields, with an entry level of 160 basis points, a target of 100bp and stop-loss of 190bp.

Top trade number 6 is to go long large-cap US banks (which are mildly pro-cyclical, relatively well priced and lowly valued on a p/e basis) relative to the S&P500.