Over the weekend, we ran a post called “Goldman: S&P EPS Growth Will Flatline In 2019 If Trump Goes All In On China.”
The title says it all. If Donald Trump’s “very large” brain decides it’s a good idea to slap tariffs on everything China exports to the U.S., it could ultimately erase what Goldman projects will be 7% EPS growth for S&P 500 companies in 2019.
Unlike the Trump administration, Goldman relies on math when it comes to making claims about the likely effects of policy on corporate America. Here, for those who missed it, is how Goldman came to their conclusion:
Tariffs represent a threat to corporate earnings through higher costs and lower margins. For all US industry, roughly 15% of cost of goods sold is imported. Given S&P 500 constituent firms are more global in nature and have more complex supply chains than overall industry, we estimate imports account for roughly 30% of S&P 500 COGS. This estimate is consistent with the 30% share of S&P 500 sales generated outside the US. Imports from China account for 18% of total US imports.
Our baseline earnings forecast is S&P 500 EPS jumps by 19% to $159 in 2018 and climbs by 7% to $170 in 2019. Consensus bottom-up estimates are slightly higher at $162 (+22%) and $178 (+10%), respectively. For a top-down tariff sensitivity analysis, we conservatively assume no substitution to other suppliers, no pass-through of costs to consumers, no boost to domestic revenues, and no change in economic activity. Given those assumptions, a 25% tariff on all imports from China would lower our 2019 S&P 500 EPS estimate by roughly 7% to $159, flat vs. 2018. If forecast EPS drops to $159 and the forward P/E contracts by 5% to 16.4x, the S&P 500 would fall to roughly 2600 (-10% from current levels). If trade tensions spread significantly and a 10% tariff were implemented on all US imports, which would represent the highest rate since 1940s, our EPS estimate could fall by 15% to $145.
There really isn’t a whole lot that’s complicated about that. For one thing, Goldman makes it clear that their projection represents a kind of worst case scenario, at least from the perspective of corporate management (i.e., no import substitution and no pass-through to consumers). They say that explicitly. There’s no attempt to deceive.
As far as the rest of it goes, a first-year college econ major could understand it on the first read. If a third of your COGS is imported, well then, you’re going to get significant margin pressure in a protectionist environment. The only way you don’t get margin pressure is to upend your supply chain (i.e., source from locales that aren’t subject to the tariffs) or raise prices.
Well, one person who isn’t happy about that is Council of Economic Advisers Chairman Kevin Hassett, who said this on CNN today:
Got that? The analysis you read above is an example of Goldman acting at the behest of Democrats as part of a conspiracy against the White House.
Goldman, Hassett reckons, “almost at times looks like the Democratic opposition”.
That’s interesting because up until March, Goldman’s former No. 2 was running point for Trump on economic policy and was key in getting the tax cuts crammed through. Meanwhile, the guy who literally signs dollar bills is also from Goldman.
Of course you can forgive Hassett for mischaracterizing David Kostin’s estimates for what happens to corporate profit growth next year in the event Trump slaps a tax on all imported Chinese goods. Because as he (Hassett) readily admits, he hasn’t actually read the note cited here over the weekend and excerpted above.