Goldmans' six top trades for 2012

Goldman Sachs’ global markets team has revealed six key trading recommendations for 2012, based on forecasts of a deeper recession in Europe, a slowdown in the US and below trend growth in China.

The team said its strongest market views are, unsurprisingly, based on the notion that market pressure for a solution to the eurozone crisis will dominate early on in the year.

Other themes include the possibility of more radical policy intervention via further QE in the US and UK, further currency intervention by the Swiss National Bank, and the relative resilience of parts of the emerging world.

1. Short European high yield credit

Goldmans is forecasting a downside of around 16% in European equity markets over the next three months. But its first key trade focuses on European credit: Goldman recommends shorting European high yield by buying protection on the iTraxx Crossover index.

A recession in Europe will put considerable pressure on European high yield firms in 2012, Goldmans believes, and tightening credit conditions will likely hit high yield borrowers disproportionately harder.

"European companies in general rely much more on bank loans than bond debt in their capital structures (by a ratio of roughly 4-to-1, according to our estimates).

"Thus, we think companies in Europe are more exposed to a contraction in bank balance sheets in 2012 than US companies were in 2008," the team said.

2. Short 10-year German bunds

Goldmans believes the eventual deeper fiscal integration in the euro area will result in a one-off transfer of credit risk to core economies, and could also prompt a more forceful policy response from the ECB, leading to its recommendation of moving outright short 10-year German bunds.

"We also like the ‘asymmetry' of the trade: in a euro-area ‘break-up' tail scenario, the financial sector in the creditor ‘core' countries will be confronted with severe impairments in their foreign holdings, which would worsen the state's fiscal position," the team said.

"In the middle ground between these two outcomes, where we find ourselves now, the ECB will be intermediating growing intra-Euro system imbalances. Through this monetary channel at the heart of EMU, the ‘shadow' credit risk of the core countries is already rising, and at an increasingly rapid pace."

With 10-year bunds currently yielding around 2.3%, the trade has a target of 2.8%, with a stop at 2%.

3. Long the euro vs the Swiss franc

Goldmans nonetheless recommends clients go long the euro against the Swiss franc, targeting a 1.35 exchange rate (up from a current level of under 1.23) with a stop-loss at 1.20.

The team sees two scenarios in which the trade could work: a continued weakening of the Swiss economy could force the SNB to raise its exchange rate peg from 1.20 to 1.30. Alternatively, a resolution of some sovereign tensions could reverse safe haven flows into the franc.