GS Finance’s $6.25 million bearish Gears linked to homebuilders ETF offer contrarian play

By Emma Trincal

New York, Nov. 7 – GS Finance Corp.’s $6.25 million of 0% bearish capped buffer Gears due Nov. 1, 2024 linked to the SPDR S&P Homebuilders ETF represent a contrarian bet on a sector that has been outperforming the overall market, advisers said.

If the ETF declines, investors will gain 3% for every 1% decline of the ETF, subject to a maximum return of par plus 32.65%, according to a 424B2 filing with the Securities and Exchange Commission.

If the ETF finishes flat or gains by no more than 10%, the payout will be par.

Otherwise, investors will lose 1% for each 1% gain of the ETF beyond a 10% buffer, subject to a minimum return of 10%.

A different kind

“Obviously this is for someone who has a negative view on the sector and who’s trying to monetize their viewpoint,” said Tom Balcom, founder of 1650 Wealth Management.

“We don’t really do sector plays. I’ve seen many notes tied to sectors, but they don’t tend to be bearish. Most bear notes are linked to a broad index. So, this is a little bit different.”

The underlying ETF, which is listed under the ticker “XHB,” has been outperforming the S&P 500 index in 2017, 2019, 2020 and 2021. It underperformed the broad index by 10 percentage points last year but is now up 26% so far this year versus 14% for the S&P 500 index.

Rate-sensitive

Buyers of the note probably believe that the bullish trend is not sustainable, said Balcom.

“If mortgage rates continue to be high, there will be additional pressure on the sector,” he said.

Mortgage rates remain elevated, which hurts the interest-rate sensitive homebuilders, he added.

“If you think rates will remain high, it makes sense to be bearish.”

On the other hand, a decline in long-term rates as seen last week would have the opposite effect, he noted.

Contrarian hedge

Balcom said he does not have a view on the direction of interest rates. But other factors than interest rates may have an impact on the fund’s share price.

“In Florida where we are, home prices have not come down. Housing prices vary from state to state. Immigration has boosted demand for housing quite a bit. There are still a number of bullish factors playing out. I wouldn’t take a sector bet like this one and certainly not a bearish bet,” he said.

The rationale behind the deal may just be contrarian.

“It could be that the sector has done so well, you think it’s due for a pullback,” he said.

“Or you could use it as a hedge. I guess it could be a way to protect your position. If you happen to have exposure to XHB and don’t want to sell, you can certainly use this note to hedge your position.”

Fundamentals

A financial adviser did not think the fundamentals warranted a bearish view on the sector. Only a negative outlook on the economy could explain the position.

“It’s simply a bet on the economy. You have to believe that we’re going into a recession within the next 12 months,” he said.

The sector is cyclical and therefore particularly vulnerable to recessions, he noted.

“At the same time, homebuilders have been extremely resilient. And that’s because there is a deficit of new homes. There’s a huge demand for homes despite the higher mortgage rates.”

Families and individuals alike are buying houses for various reasons, such as investment, rental, “Airbnb income,” he explained.

“There’s just not enough supply to meet all that demand. So, prices remain high.”

For this reason, this adviser would not consider the notes.

“It makes sense if you think rates will continue to be high or if we’re in a recession. But when you look at the fundamentals of the sector, the imbalance between supply and demand doesn’t make the bearish case very compelling.

“Besides, we’re getting closer to the end of the rate cycle. As mortgage rates start coming down, demand for homes will continue to grow. These factors make this note a bit risky despite the buffer.

“The only justification for such trade is really if we enter into a recession,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. and UBS Financial Services Inc. are the agents.

The notes settled on Oct. 31.

The Cusip number is 36266M492.

The fee is 2%.

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