The most notable aspect of investing in 2017 has not been the nearly straight upward climb to record after record in the major market indices, but rather the exceptionally low volatility in a broad spectrum of asset classes, according to Goldman Sachs Group Inc. (GS). The S&P 500 Index (SPX) had gone through 371 consecutive trading days without a drawdown of at least 5%, the third longest such streak ever, through the December 15 date of Goldman's most recent U.S. Weekly Kickstart report. Meanwhile, 12-month realized volatility for the S&P 500 is at its lowest since 1966, Goldman adds. (For more, see also: House Passes GOP Tax Reform Plan.)

Goldman indicates that their High Sharpe Ratio basket of stocks outperforms both minimum volatility strategies and the S&P 500 as a whole during periods of low volatility. Better yet, Goldman says, this basket has beaten the S&P 500 in 72% of all 6-month periods since 1999, generating an average annualized excess return of more than 700 basis points. Among the current 50 constituents of this basket are these eight, with their actual YTD 2017 returns and their expected 2018 returns:

  • Advanced Micro Devices Inc. (AMD): -11% YTD, +41% expected
  • Skyworks Solutions Inc. (SWKS): +28%, +26%
  • CBS Corp. (CBS): -8%, +22%
  • CVS Health Corp. (CVS): -8%, +20%
  • DISH Network Corp. (DISH): -16%, +38%
  • Merck & Co. Inc. (MRK): -2%, +17%
  • Incyte Corp. (INCY): -4%, +57%
  • Salesforce.com Inc. (CRM): +52%, +17%

Goldman calculated these figures based on prices as of December 14. The report does not articulate a theory behind their empirical findings regarding High Sharpe Ratio stock performance.

The Methodology

Goldman computed expected returns based dividing analysts' consensus price targets for all the S&P 500 stocks by their current prices. What they call prospective Sharpe Ratios are these expected returns divided by each stock's implied 6-month percentage volatility. The High Sharpe Ratio basket is an equal-weighted, sector-neutral portfolio of the 50 S&P 500 stocks with the highest prospective Sharpe Ratios. (For more, see also: Stocks Could Rise as Much as 27% in 2018.)

The median stock in this basket has an expected return of 21% and a prospective Sharpe ratio of 0.8, while the values for the median S&P 500 stock overall are 6% and 0.3, respectively. As Goldman describes it, this basket "offers 3x the expected return of the median S&P 500 stock with similar implied 6-month volatility." This basket is rebalanced every six months, with an average of 36 new constituents each time; this time there were 39.

Recent Performance

For the YTD through December 14, this basket has beaten the S&P 500 by only about 200 basis points (23% versus 21%), as opposed to the 700 bp average annual outperformance since 1999, as cited above. "Laggards often screen into the High Sharpe Ratio basket because of large expected upside to analyst price targets," they say by way of explanation. The basket also has trailed both the median large-cap core mutual fund and the S&P 500 based on risk-adjusted returns in 2017. Goldman attributes this to underweight positions in information technology.

The median stock in the basket has returned only 8% YTD, versus 19% for the median S&P 500 stock. However, the median 6-month implied volatilities are similar, at 26% versus 22%.

Looking Ahead

Goldman's analysis of indicators suggests that equity volatility is likely to remain below its historical average for as much as 12 months into the future. Moreover, they find that low volatility strategies lag not only during periods of low volatility, but also in the midst of rising interest rates and a flattening yield curve. As a result, they recommend that investors avoid minimum volatility strategies going into 2018.

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