A couple of weeks back, Goldman unveiled their 2020 outlook for US equities.
The bank’s baseline calls for the S&P to hit 3,400 by year-end, representing a roughly 10% gain from earlier this month.
To be sure, David Kostin included plenty of references to the possibility that stocks could suffer a hefty decline in the new year. Indeed, his downside case sees US equities diving a harrowing 16% in the event the market is forced to price in a total rollback of the tax cuts under a Democratic sweep.
“Our model suggests a complete reversal of the tax cut would translate into 2021 EPS of $162 rather than our current estimate of $183”, Kostin said, adding that “a unified federal government post-election could prompt investors to assume the tax cut is reversed”. When you throw in multiple contraction to 16X, you end up with SPX 2,600.
Goldman’s economic outlook calls for above-consensus growth in the US in 2020, an assumption that helps inform their forecast for domestic equities.
In a note dated Friday, Kostin addresses a series of common client questions about the bank’s take on US stocks, staring with what a slower pace of growth would entail. Remember, Goldman sees the US economy expanding 2.3% in 2020, easily ahead of most estimates and more than triple some of the more pessimistic outlooks (e.g., SocGen’s).
The short answer is that on the bank’s estimates, “every 1 percentage point (pp) change in US GDP growth equates to roughly $5 of S&P 500 EPS”.
If growth averages what consensus expects (1.8%) versus the 2.3% Goldman is looking for, the bank’s top-down EPS estimate would fall to $171. The multiple forecast (18X) would stay the same in a moderately less favorable growth outlook, Kostin reckons. You can do the math on that yourself.
What about relative performance? Is it finally time for the rest of the world to catch up to the US locomotive, as our good buddy Kevin Muir suggested earlier this week?
Goldman’s take on that is mixed. “In 2020, our expectation of continued growth stock and Tech sector outperformance supports US equity market upside [but] we expect US outperformance will narrow”, the bank says.
Specifically, their forecast calls for 6% EPS growth in the US, which “is only modestly higher than Japan (5%) and Europe (2%), and lower than Asia ex-Japan (12%)”.
How about the nascent Value rotation that made a cameo in early September and again during the first week of November as yields surged, triggering seismic factor rotations and imperiling consensual positioning in a variety of bond proxies?
As a reminder, the valuation gap between Value and equity expressions tethered to the “slow-flation” macro theme (and thereby to falling bond yields) has reached bubble proportions, meaning any bond selloff is a risk for crowded positioning.
“The valuation spread between high multiple and low multiple stocks is the widest it has been since the Tech Bubble”, Goldman says, underscoring the points made above, before warning that timing a bursting of that bubble is difficult (and that’s an understatement – there are many market participants who have been waiting on a Value renaissance for years on end).
Goldman continues, noting that “during periods of very strong or accelerating growth, investors embrace the risk of low valuation stocks because even lower quality stocks can successfully generate EPS growth in rapid GDP growth environments [and] during periods of weak economic activity, investors tend to cut their equity exposure, benefitting under-owned, low valuation stocks relative to their more expensive peers”.
The problem is the same as it ever was. Growth is expected to be moderate and inflation subdued in 2020, which could argue for more of the same, although there are no shortage of high-profile calls for the bubble in Min. Vol./Low. Vol. stocks to burst amid a sustained pro-cyclical rotation (that’s one of Marko Kolanovic’s big calls, for example).
Another question Goldman’s clients have asked is what would happen if buybacks were to meaningfully decelerate. A serious decline in buybacks could be bad – after all, the corporate bid is by far the largest source of demand for US equities. Nobody wants to imagine a world without buybacks, but Goldman did just that earlier this year, and Kostin reiterates the points he made then. To wit:
Specifically, a large decline in share repurchases would likely lead to slower EPS growth and wider trading ranges with higher volatility. During the past 15 years, the gap between EPS growth and earnings growth for the median S&P 500 company averaged 260 bp (11% vs. 8%). Prohibiting buybacks would also reduce downside support for equity prices since firms could no longer step in to repurchase shares when their stock prices tumble. During the past 25 years, the 20th percentile return for stocks within the S&P 500 has averaged -27% (annualized) during blackout periods compared with -16% when companies can freely buy back their shares. Realized volatility is also higher during blackout vs. non-blackout periods.
Finally, the bank says a few words about overweighting industrials and remaining neutral on financials.
In the end, the overarching message from Goldman’s year-ahead equities outlook is that as long as the market doesn’t get the impression that i) a progressive Democrat is going to wrench the keys to the Oval Office from Donald Trump’s (smallish) hands, and simultaneously, ii) Democrats are likely to seize control of both chambers of Congress, stocks should do well.
That’s not to say that the bank is a fan of some of the Trump administration’s policies – indeed, Goldman has repeatedly warned about the deleterious effects of the trade war on margins, global growth and, more recently, C-suite confidence.
It’s more that the bank expects some thawing of the economic Cold War between the world’s two largest economies and doesn’t believe the election will result in a united government. As long as power is split between the two parties, the odds of a worst-case scenario on either side are low.
Median returns, you’ll recall, are higher under divided than unified governments.