Back on October 2, Council of Economic Advisers Chairman Kevin Hassett showed up on CNN to chat about trade and the impact of the China tariffs on the U.S. economy.
At one point in the discussion, CNN brought up a Goldman note that predicted S&P EPS growth would flatline in 2019 if the administration went all-in on Beijing by taxing everything China ships to the U.S. Goldman’s analysis was based on a kind of worst-case scenario involving no supplier substitution, no pass-through of higher input costs to consumers and no boost to domestic revenues.
This is one instance where the worst-case scenario isn’t far-fetched. After all, Trump has made it abundantly clear on any number of occasions that he’s willing to “go to $500 billion” on the tariffs and just last Monday, reports indicated that the administration would in fact publish a list in conjunction with taxes on the remainder of Chinese imports in the event a compromise isn’t struck when Trump meets Xi at the G-20.
As far as supplier substitution is concerned, it simply isn’t realistic to expect corporate management teams to rework their supply chains in the space of three months, no matter how hard Trump pushes. When it comes to passing higher input costs on to consumers in the form of higher prices, that’s probably the default option for dealing with margin pressure, but the problem with that is that if competitors don’t do the same, you risk losing market share.
In any event, the bottom line (figuratively and literally in this case) is that if Trump slaps tariffs on all Chinese imports it would be bad for corporate profits, especially at a time when margin pressures are already building from rising wage costs and higher interest expense.
But the above-mentioned Kevin Hassett doesn’t agree. Rather, he believes that Goldman’s common sense, math-based assessment is evidence of a Democrat conspiracy. Here, for those who missed it, is the actual clip of Kevin suggesting that Goldman works “for the opposition”:
Obviously, that’s absurd.
The other thing you have to take into account when you think about the outlook for corporate profits in the U.S. is that the fiscal impulse which helped drive record bottom line growth in 2018 is set to fade. In other words, profit growth would be decelerating anyway, especially with wage inflation picking up.
The point is, “no”, Goldman was not conducting “opposition” research and even if they were, Hassett wouldn’t know it because as you can see in the video, he openly admits to having not read the very note he was commenting on.
Ok, well on Thursday, Goldman is out with a sweeping assessment of the outlook for S&P EPS growth going forward and while they lift their outlook for 2018 adjusted EPS to $163 (from $159 previously), they warn that going forward, this year’s blistering pace is going to fade materially. Specifically, the bank sees S&P EPS growing at just 6% next year and 4% in 2020, both of which are well below consensus.
Here’s the summary:
We expect S&P 500 EPS growth will decelerate from 23% in 2018 to 6% in 2019 and 4% in 2020. Our top-down EPS estimates of $173 (2019) and $181 (2020) are below bottom-up consensus of $177 and $195, respectively. We forecast sales growth of +5% and +4% in 2019 and 2020, roughly in line with nominal US GDP growth and consensus estimates. We forecast margins will be roughly unchanged at 11.2% through 2020. However, consensus expects margins will expand during both of the next two years, at which point estimates will be 80 bp above our forecast (12.0% vs. 11.2%).
The rationale here is simple: The fiscal impulse is going to wane, leading to lower growth and wage pressures are going to erode profitability.
“Our US economics team expects average annual US GDP growth will equal 2.6% in 2019 and 1.6% in 2020, as the growth impulses from tax reform and financial conditions fade”, the bank writes, adding that “higher wages and inflation will be two consequences of the tight labor market as unemployment falls to 3.1% by year-end 2019, below the estimated natural rate of unemployment of 4.6%.”
Generally speaking, Goldman posits a relatively benign outcome in terms of the effect of tariffs and rising interest rates, so it’s not as if the above analysis is predicated entirely (or even mostly) on some kind of dour assessment on either of those fronts. Rather, this is just kind of “the way it is”, so to speak.
Now somebody get Kevin Hassett on the phone so he can try and explain how this is all wrong. Maybe Larry Kudlow can help.