How do you make money when stocks are falling, the credit markets are frozen, private equity titans are muted, and investment banks are treading water in an ocean of debt? All is not lost, Goldman Sachs promises. 

Late last week, Goldman published a note titled “US Equity Views: Hung bridges and deathly hallows.” Below the headline were the words: Sentiment, fundamentals, and three trade ideas.  The note’s tongue-in-cheek Harry Potter references caught the attention of Thomson’s Dan Primack, who concurred wholeheartedly with trade idea No. 1.
     
From Goldman’s note, the top “trade idea” in this credit market craziness:

    “1. Buy 22 pending LBO deals for 36% percent average annualized return. It is  impossible even for a wizard like Harry Potter to reconcile two facts: Stocks cannot BOTH melt down because the market fears financial institutions will have to fund and hold levered loan commitments while at the same time shares of target companies sell off on the belief the same transactions will not close. This inconsistency presents an attractive entry point for investors. The stock market assigns a roughly 62% probability that the deals will be consummated. We believe the likelihood of closing is much higher. ”

In other words, snap up shares of TXU, Alltel, FirstData, because the deals are going to get done, despite the credit market shake-up.

Interestingly, Goldman’s “hung bridge” reference points to not just bridge loans in the market, but a host of equity bridge loans for which banks are on the hook. Goldman, knowing its M&A power keeps it from bending too far for sponsors, has avoided the low risk, low return equity bridges like the plague, unlike competitors JPMorgan and Citigroup.

While trade ideas No. 2 and No. 3 are not M&A related, per se, here they are anyway.

    “2. Buy the 20 most Concentrated Hedge Fund holdings. Stocks in the S&P 500 with the highest hedge fund ownership concentration trailed the market by an average of 113 bp during seven previous pullbacks. But stocks in the hedge fund holdings basket outpaced the S&P 500 during the month following the pullback on 6 of 7 occasions. The illiquidity of some of these positions may explain why during sharp sell-offs the shares lag. S&P 500 has retreated 4.5% since peaking on July 19th while the “crowded” hedge fund positions have dropped more than 8%, a difference of more than 352 bp. When the rebound comes, these stocks should outperform.

    3. Buy US stocks with high percentage of foreign sales. The world is growing faster than the US, and investors should buy stocks that capitalize on this trend. Our basket of 45 stocks in nine sectors is expected to generate faster sales and faster earnings than the S&P 500 but the shares trade at a market multiple. ”

(Image: Goldman Sachs Website)