Goldman Lifts S&P Price Target, Sees 3,400 In 2020, Slashes EPS Outlook

There’s good news and there’s bad news in Goldman’s revised outlook for US equities.

The good news is, the bank is lifting their year-end 2019 target to 3,100 (from 3,000 previously) and introducing a 2020 year-end target of 3,400. According to the bank’s David Kostin, then, US equities have another 3% to run this year and 10% upside next. Goldman sees a stable forward P/E of 17.6x in 2019 and a bit of valuation expansion (to 18x) in 2020 as rates stay low and uncertainty is “more than offset” by what the bank assumes will be an ongoing US expansion.

The bad news is, the bank is slashing their S&P earnings forecasts. Specifically, Goldman sees S&P EPS growing by 3% to $167 this year and 6% to $177 in 2020. That latter figure is well below consensus. The bank also introduces a 2021 S&P EPS forecast.

(Goldman)

“Halfway through the year, economic growth has been below-trend, oil prices have been range-bound, and tariff uncertainty has not abated”, Kostin writes, explaining why the bank now expects 2019 EPS growth to come in at the low end of their initial 3% to 6% range. The lion’s share of the downward revision comes courtesy of weaker-than-expected economic activity, oil prices, and margins, he says.

For context, here’s a simple visual that gives you a lay of the land, so to speak (estimates are consensus):

Goldman’s updated outlook hits all the usual talking points, including the bit about aggregate EPS growth figures painting a somewhat misleading picture due to the overrepresentation of Tech.

“In contrast with just 2% 2019 EPS growth for the aggregate index, consensus expects the median S&P 500 company to grow EPS by +6% this year”, Kostin notes, adding that “2019 S&P 500 EPS growth would be 50 bp higher excluding AAPL and 120 bp higher excluding Info Tech”, which are expected to see EPS growth decline 4%. The cynics among you will say that’s tantamount to saying “Well, if you just strip out all the bad news…“, but it is a useful point about the extent to which Apple and Info Tech distort things both in good times and in bad.

(Goldman)

As far as 2020 goes, Goldman explains why their estimates are much less optimistic than the street as a whole.

“2019 EPS growth estimates have plunged from 10% in 3Q 2018 to 2% today, while 2020 EPS growth estimates have actually risen during that period (+10% to +11%)”, the bank warns.

(Goldman)

Ultimately, Kostin says the bank’s forecast for quicker economic growth and a well-behaved (i.e., not too strong) dollar will likely help shore up EPS growth next year, but even in the context of that relatively upbeat assessment, the bank thinks “consensus estimates still appear too high”.

Goldman provides a bit more color on that. “In 2020, we expect negative revisions to margin estimates as wages, materials costs, and tariffs continue to pressure company profitability”, they write, before observing that “since 1985, FY2 EPS revisions have become increasingly negative after August as investors and analysts shift their focus to the following calendar year”. In other words, after Q2 reporting season, reality starts to set in.

Kostin spends the rest of the note’s 28 pages digging deeper and updating all of the numbers that are usually included in these revised outlooks.

When it comes to profitability, headwinds remain. The bank sees margins declining this year (39bp worth of contraction) before rebounding a bit in 2020.

Input costs are rising and as the bank writes, the NABE survey “shows that the net share of respondents reporting rising wages and materials costs is well above the net share reporting rising prices charged”. That’s a harbinger of margin pressure.

Meanwhile, the US is obviously at full employment, which means wage pressures are building – or at least they should be. “Labor costs account for 13% of revenues for the median S&P 500 firm and we estimate that a 100 bp acceleration in wage growth would reduce S&P 500 EPS by roughly 1%”, Kostin says.

And then there’s the tariffs. Goldman has long warned that an “all-in” scenario that finds Trump imposing duties on the entirety of Chinese imports would be a decidedly unwelcome development. Kostin reiterates that. “If the trade war escalates and a 25% tariff is imposed on all imports from China, current S&P 500 EPS estimates could be lowered by as much as 4%, assuming no substitution, pass-through of costs, or major impact to economic growth”, he says, recapping the bank’s previous work on the subject.

There are myriad potential mitigating factors (supplier substitution, raising prices, etc.) but the point is that more tariff escalations would add uncertainty to the outlook for profitability.

(Goldman)

There’s a lengthy (and characteristically nuanced) discussion on buybacks, but in the interest of brevity, this is what you need to know:

(Goldman)

The largest source of US equity demand (i.e., the corporate bid) is alive and well and should top $900 billion in 2019. (Real life “plunge protection” – no conspiracy theories needed.)

All told, Goldman’s updated outlook for US equities paints a mixed picture. The EPS outlook is far from sanguine, but considering how much traction the “earnings recession” narrative has gotten this year among pessimists, Goldman’s forecasts are relatively constructive.

As far as the price targets go, they’re higher. And one imagines that’s all the confirmation bias those of an optimistic persuasion will need.

---