One of the problems with going on the record with a bullish or otherwise benign take on equities is that stocks are something the general investing public understands and pays attention to, so if you’re wrong, everybody is going to notice.
That’s as opposed to rates, or credit or FX, where analysts can pretty much be wrong with impunity – at least in the court of public opinion. Sure, you might lose your job, but unless you’ve squandered it all on coke and strippers, chances are you’ll be fine money wise, at least until you can get picked up by another shop.
There’s no obscuring your S&P call, though. Everyone with an online brokerage account understands what a year-end benchmark target is and if you’re an analyst, you can be absolutely sure Joe E*Trader didn’t bother to read the nuance or the fine print on your call, so if it’s wrong, well then get ready for finance Twitter to unleash its wrath.
It’s funny, because while retail investors and the handful of high profile social media personalities whose star has risen in the post-crisis era spend a lot of time maligning the doomsayers and ostensibly mocking them, there’s always this lingering sense of begrudging pseudo-respect for anyone who sounds smart in the course of calling for a crash. You see that all the time when verified Twitter accounts belonging to journalists (and even asset managers) retweet doomsday accounts they know are silly. It’s just as we put it on December 30:
If you spread fear, it looks like you have a deep knowledge of things. If you are calm, it is like being ignorant.
That’s from “Fear And The Market’s Perverse Fascination With Calamity“. In that post, we showed you the following chart which illustrated the stark juxtaposition between the S&P’s Q4 plunge and earnings growth.
Obviously, bottom line growth was exaggerated in 2018 by the tax cuts and everyone knew that 2019 would be different once the fiscal impulse waned and once the “three-headed margin Cerberus” (as we’ve hyperbolically described it) started to bite. Still, the disconnect between Q3 earnings growth of ~25% and Q4 S&P returns was truly remarkable.
Fast forward six weeks and the situation has almost completely reversed. Stocks have surged and analysts are now calling for negative earnings growth in Q1.
For Q4, earnings grew at a healthy 14%, but calls for an earnings recession are now all the rage. As documented here on several occasions over the past couple of weeks, analysts now expect profit growth to turn negative for the first time in three years when companies report results for the first quarter. For his part, Morgan Stanley’s Mike Wilson says the earnings recession is “already here.”
Well, Goldman is now on the record in siding with consensus that calls for an earnings recession might be overblown. Frankly, it seems obvious that the bank’s David Kostin was directly responding to Morgan’s Mike Wilson when he (Kostin) wrote the following in a Friday evening note:
We expect weak profit growth will be short-lived, and should improve in the back half of 2019. Some investors are skeptical about the current path of quarterly earnings estimates: EPS growth is projected to average 1% during the first three quarters before accelerating to 9% in 4Q. Part of this concern is well founded. Consensus EPS estimates are typically too optimistic and are lowered throughout the year, and analysts usually revise near quarters first. Estimates have been raised during just 7 of the past 35 years. Last year was a unique example as analysts incorporated a lower corporate tax rate. However, our model suggests the expected path of US GDP growth, oil prices, and the trade-weighted US dollar will support a rebound in EPS growth in 4Q 2019. Each of these variables will become less of a headwind to 4Q 2019 EPS growth given relative weakness in 4Q 2018.
So there’s that, and for those who missed it, here’s what Morgan’s Wilson wrote on Monday about the presumption of a “hockey stick” inflection in Q4:
The projected YoY EPS growth in 4Q19 is ~9.5%… compared to an average projected rate of growth of 1% over 1Q-3Q19, an inflection of ~8.5%. Since the early 00s, we have seen this kind of inflection happen a few times but these inflections were all related to 1) comping against negative or slower EPS growth or 2) tax cuts mechanically lifting the growth rate.
You can see why we say Kostin is talking to (or at least about) Wilson. And this would hardly be the first time. Back in August, for instance, Goldman used the same series of notes (i.e., their Friday evening “Weekly Kickstart” notes) to implicitly refute Mike’s call for a Tech correction.
Although Kostin would probably point to the fact that stocks went on to make new highs in late August and September, it’s safe to say Wilson had the last laugh as consensus Tech/Momentum/Growth longs ended up careening lower in October, setting the stage for the year-end risk asset rout.
To be fair, Goldman’s take on a prospective earnings recession isn’t as starkly opposed to Morgan’s as it might seem. Goldman has been vocally cautious on margins and in October and November, the bank repeatedly warned that earnings growth estimates for 2019 (as they stood then) were too optimistic. In fact, Goldman was cautious enough at one point to prompt a response from the Trump administration, whose Kevin Hassett accused the bank of producing “opposition research”.
So it wouldn’t be fair to suggest that Goldman is rampantly (or “overly” – if you will) bullish.
Rather, they simply note that “the market has already priced the slowdown in earnings growth and revisions have troughed.” Specifically, earnings sentiment looks to have inflected over the past couple of weeks and Goldman reckons “it would require another wave of negative revisions for earnings to weigh on the S&P.”
Further, the bank writes that the 4% aggregate EPS growth consensus is now expecting in 2019 (down from ~10% in September) “partly obscures the underlying growth in sales and pre-tax earnings, as well as the 7% EPS growth for the median company.”
Notably, the gap between median and aggregate there (3%) ranks in the 65th percentile versus history (going back 39 years). For Goldman, that “underscores the opportunity for fundamental investors.” Here’s Kostin one more time:
The wide distribution of earnings growth highlights the importance of fundamental stock-picking as a way of differentiating returns and reinforces our expectation for a shift from “beta” to “alpha”.
The takeaway is that there are opportunities if you’re willing to look for idiosyncratic stories that have the potential to serve as upside or downside catalysts.
But again, that’s nuance and unfortunately for Goldman, the general investing public isn’t going to remember that nuance if we do end up getting an earnings recession. Hopefully clients appreciate the finer points.
When it comes to what the financial media will invariably key on if/when the earnings recession story does pan out, you can bet people are going to remember that Morgan Stanley’s Mike Wilson “nailed it”.
And the good news for Mike is that if it doesn’t pan out, and we do in fact get a “hockey stick” inflection in Q4, he can always remind you that he called the 2018 Tech selloff.