Goldman: The 'fairy tale' scenario behind the tech bull market unlikely to last

Key Points
  • Goldman Sachs sent a note to clients at the end of last week entitled "Goldilocks and the three hikes: A fairy tale scenario behind the Tech stock rally."
  • The firm believes this odd mix of decent economic growth, yet declining interest rates that's supported stock prices can't last.
Goldman: The 'fairy tale' scenario behind the tech bull market unlikely to last

Goldman Sachs believes the rare combination of conditions supporting this bull market, especially the run in technology stocks, is about to end.

"The unexpected mix of healthy growth and declining rates represents a Goldilocks scenario for U.S. equities," wrote David Kostin, the firm's chief U.S. equity strategist, in a note to end last week. "However, just like in the fairy tale, this perfect scenario is unlikely to last."

The title of the June 9 note is "Goldilocks and the three hikes: A fairy tale scenario behind the Tech stock rally."

Goldman believes there are two possible endings to this tale and they both aren't great for stocks. Either the stronger growth causes the Federal Reserve to tighten more aggressively, reducing equity valuations or the current low-rate environment is "proven correct" and the pace of economic growth experiences a "significant slowdown."

The Fed is expected to raise interest rates at the end of its two-day meeting Wednesday. The 10-year Treasury yield has gone from above 2.60 percent in March to 2.21 percent Monday.

Goldman is clearly worried the financial markets are trying to tell us something about the state of the economy. Also in the note, Kostin and his team make the point there is another rare phenomenon happening now with certain well-capitalized stocks that occurred during the dot-com bubble and may point to slowing economic growth ahead.

States the note:

"Perhaps most remarkable is the outperformance of stocks with strong balance sheets alongside a rallying equity market and extremely easy financial conditions ... our basket of S&P 500 firms with Strong Balance Sheets (GSTHSBAL) has outperformed our Weak Balance Sheet basket (GSTHWBAL) by 520 bp during the last six months. Strong balance sheet outperformance in a 10%+ equity market rally is rare; occurring in only 5% of six-month stretches in the last 30 years. One notable episode was in 2000, at the Tech Bubble peak."

Some of the recent hot technology stocks including Nvidia and Facebook are in the Goldman strong balance sheet basket.

Despite some of this dire talk, Goldman does not expect something catastrophic to occur in the market yet or with technology stocks. Kostin predicts the will be 4 percent lower from here to 2,325 by the end of the year.

And the firm isn't quite ready to tell clients to sell big tech despite the declines Friday, but hints it may be time to buy bank stocks.

"If the current economic 'Goldilocks' environment persists, Technology and other growth stocks should continue to outperform, despite today's price declines. However, if investors recalibrate expectations for inflation and Fed policy to match the growth optimism suggested by the S&P 500 level, higher rates should lead to Financials sector outperformance," the note says.

Tech stocks were lower in premarket trading Monday.

WATCH: Top tech analyst Mark Mahaney weighs in on selloff

Tech pullback not a buying opportunity: Mark Mahaney