… but not their price targets.
On Tuesday, Goldman’s Rocky Fishman suggested that if you’re in the camp who thinks the S&P is going to have a tough time climbing markedly higher than the bank’s 3,000 year-end 2019 target, then you could do worse than overwriting your position to generate some income.
Specifically, Fishman recommended “replacing [that] uncertain, and hard-to-achieve, upside with known income [by] selling Dec-2019, 2900-strike calls vs. existing long positions for $149 (indic. bid, ref. Sep. future 2775).”
Assuming the S&P stays below 3,049 (which would be ~10% higher from here), that strategy (i.e., overwriting your position) would fare better than an outright long.
Fast forward to Thursday and Goldman is sticking with their 2019 3,000 SPX target, but they are upping their earnings outlook, citing a variety of factors which basically boil down the usual suspects.
In the post linked above, I rattled off the positives and negatives as follows:
There are reasons to be bullish: record corporate earnings, fiscal tailwinds (even if you think the myopia inherent in late-cycle fiscal stimulus is dangerous over the longer term), re-risking by the systematic crowd and of course buybacks.
But the threat of a trade war and a steady tightening of financial conditions bodes ill, and emerging markets are looking decidedly shaky. Oh, and don’t forget that the biggest bullish technical of all (the supply/demand distortion that goes along with the QE “flow” effect) is fading. Indeed, as BofAML reiterated in the wake of the ECB decision, global QE will turn negative on a YoY basis starting in March of next year and when you think about dollar liquidity, do note that steady USD appreciation effectively mutes the effect of ECB and BoJ asset purchases in dollar terms.
Goldman’s updated profit forecasts generally reflect that assessment of the balance of risks. Here are the positives and the rationale:
The current state of the US economy is strong and the backdrop remains supportive for equities. The Conference Board’s measure of consumer confidence stands at the highest level in 15 years and only exceeded the current reading in the late 1960s and the late 1990s Tech bubble. The Small Business Optimism Index (NFIB) is at the highest level in the 45-year history of the survey with the exception of a single reading in September 1983. Payroll growth is robust. At 3.8%, the current unemployment rate is the lowest since the late 1960s. Our economics team forecasts the jobless rate will fall to 3.3% in 2019, the lowest level since 1953.
We are boosting our S&P 500 EPS forecast for 2018 to $159 (from $150) reflecting a 19% jump from last year. Stronger-than-expected earnings in 2017 and 1Q 2018, faster US and global growth, higher oil prices, and a slightly larger boost from corporate tax reform explain the upward revision. We also lift our 2019 EPS forecast to $170 (from $158) for 7% growth, and our 2020 estimate to $178 (from $163) for 5% growth. Despite the large positive revisions, our top-down estimates are still below the consensus bottom-up forecasts of $161, $176, and $192, respectively.
This call comes with all the usual color re: buybacks and tech as two key drivers of the constructive outlook.
On buybacks, Goldman is sticking to their $650 billion forecast which, they note, is “the highest level on record and will account for 26% of total cash spending.” That 26% figure is also unchanged.
“Investors have become increasingly focused on whether buybacks are masking the true pace of earnings growth,” the bank continues, before reminding you that “the S&P 500 buyback yield (i.e., buybacks as a share of market cap) has generally been flat post-crisis.”
Tech (with financials) is largely responsible for EPS growth:
And is of course the leader in topline growth:
As far as headwinds, it’s the same story.
As ever, there are trade concerns, but Goldman thinks that in the absence of further escalations, things should generally be fine, noting that “tariffs represent only a modest threat to S&P 500 earnings, but further escalation could pose downside risks.”
Margin pressures are mounting and ultimately, it seems unlikely that things can get much better from here, especially given political pressure to distribute the windfall from tax cuts to workers (i.e., do something – anything really – to reverse the trajectory that’s seen labor’s share continually eroded).
“For much of the post-crisis era, corporations have captured an increasingly large share of profits relative to workers [and] we forecast S&P 500 margins will peak in 2019 but remain roughly flat in 2020 and 2021,” Goldman notes.
Of course if everyone is still content to let companies execute record buybacks, then it would certainly appear that we haven’t reached the tipping point in terms of labor grabbing the torches and pitchforks.
In any event, the fact that Goldman has upped their EPS forecast but not their target for the S&P obviously means multiple contraction or, at the very least, no multiple expansion. Here’s the bank on that:
Corporate profitability is at or near all-time highs when considering both net profit margins and return on equity (ROE). Both offer support to elevated equity multiples despite the S&P 500 index valuation ranking in the 87th percentile relative to the past 40 years and the median stock at the 97th percentile. However, valuation metrics that compare equities to bond yields, such as the equity risk premium (ERP) and yield gap, are below-average given that bond yields remain historically low (Exhibit 31).
We expect S&P 500 valuation multiples will remain unchanged from current levels through 2019. Our year-end S&P 500 price targets of 2850 in 2018 and 3000 in 2019 imply a forward P/E multiples of 17x in both years. Our valuation forecast incorporates a combination of a tightening Fed, higher bond yields, above-trend but decelerating economic growth, and policy uncertainty.
Ultimately then, you’re left to ponder the relative merits of the EPS forecasts here. That is, in the absence of room for valuations to balloon, the price targets by definition rest on the profit outlook.
So you know, draw your own conclusions when it comes to whether the balance of risks support the case for higher earnings. Of course the worst case scenario (because we had to throw this in) is multiple contraction on top of disappointing bottom line growth.