Why Portfolio Managers And Executives Think Goldman’s 2021 S&P Forecast Is Too High

When Goldman asked domestic and international portfolio managers, hedge funds, sovereign wealth funds, and corporate executives what they thought of the bank’s 2021 outlook for US equities, those who said 4,300 on the S&P is too bullish generally cited inflation risk.

“They argue that the vaccine-supported US economic recovery we anticipate will lead to rising prices for goods and services, inflationary concerns will then spark a backup in Treasury yields, and that in turn will translate into lower equity valuations and share prices,” the bank’s David Kostin said, in a late Friday note.

As a reminder, Goldman’s outlook for the US economy was considerably more bullish than consensus prior to the latest round of coast-to-coast COVID lockdowns. Some banks are now revising their outlooks, at least for Q1.

It’s somewhat amusing (to me anyway) that after all these years, a sizable contingent of professional investors are still concerned about a problematic rise in inflation.

How many of these PMs who expressed such concerns were old enough to be investing other people’s money during the last serious bout of inflation in the US? Some of them, maybe. But probably not the majority.

And bonds have been in a bull market for damn near four decades.

So, irrespective of whether it’s the “right” call this time, it’s been the wrong call every time historically for all practical purposes, something SocGen’s Albert Edwards will gleefully remind you if you ask him.

For 20 years, pros predicted higher rates

Goldman was diplomatic in a note answering those who cited inflation risk in suggesting their 2021 S&P forecast is too high.

“PCE inflation has two components: Services (74%) and Goods (26%). Health Care spans both categories, comprising 23% of measured PCE, and its growth is likely to stay below 2% for the next several years,” the bank’s Kostin wrote, flagging “bipartisan support… to restrain medical services inflation [and] the launch of Amazon Pharmacy [which] will allow customers to compare drug prices and should serve to keep pharma inflation below 1%.”

Beyond that, Goldman sees “slight” deflation for goods over the next two years, and an 8% drop in prices for video, audio, and computers. As far as housing goes, Kostin reminded folks that “publicly-traded apartment REITs noted in their Q3 results that occupancy has stabilized at the expense of lower rents [and] the suburbanization trend will also serve to restrain rental inflation during the next few years.”

That latter bit is key. I’ve spent quite a bit of time in these pages documenting the de-urbanization trend and what it’s meant for rents. “Of the 100 largest cities for which we have data, 41 have seen rents fall since the start of the pandemic in March,” the latest national report from Apartment List says.

Rents in major “superstar cities” have collapsed. For example, this time last year, a 2-bedroom apartment in San Francisco would have run you around $3,200. Now, the price is down to less than $2,500.

I find this difficult to believe, but according to Apartment List’s data, the median 2-bedroom in New York City now costs less than one-third of what I once paid years and years ago. I suppose it depends on what’s meant by “New York City.” That could capture any number of disparate locales.

“During the same months last year just five cities saw a drop in rent prices, and only two experienced a decline of more than one percent,” Apartment List went on to say, discussing the impact of the pandemic, and noting that “even in the cities where rent growth has been positive through the pandemic, it has still been sluggish [with] 63 of the 100 largest cities currently registering slower year-over-year rent growth than at this time last year.”

The trend in affordable midsize cities is the opposite. Places like Boise, Toledo, and Memphis have seen prices increase, but the national trend is clear. And frankly, I’m not convinced that enough people want to move to Boise and Memphis to make an impact on the aggregate national trend.

In any case, that tangent helps to contextualize Goldman’s comments about suburbanization restraining rental inflation in 2021. It seems (highly) unlikely, in my view, that the availability of a vaccine is going to prompt large numbers of people to suddenly go flooding back into major cities, especially to the extent new suburbanites bought rather than rented.

As for whether the Fed’s “new” (and the scare quotes are there for a reason) inflation framework is likely to lead to runaway price increases, the answer is probably not. Indeed, it’s hard to believe that anyone can suggest as much with a straight face.

The Fed has yet to explain, in precise terms, what exactly the American version of AIT even means, other than to simply reiterate the spirit of AIT as a concept (i.e., other than to repeat that policymakers will tolerate hypothetical overshoots to compensate for years of undershoots).

“Under the Fed’s average inflation targeting framework, the policy rate will remain at 0-25 bp through at least 2023, although our economists forecast the first hike will not occur until 2025,” Goldman’s Kostin said Friday, adding that “a funds rate near zero, even if inflation rises to the Fed’s target, suggests any increase in Treasury yields will be limited.”

And that’s to say nothing of WAM extension, which is now widely expected to come at the December FOMC meeting. Also consider that if the GOP holds the Senate, the size of fiscal stimulus will be constrained, which will hurt aggregate demand, serve as another factor weighing on bond yields and, ultimately, tamp down domestic inflation.

Forgive me, but if I were going to push back on Goldman’s year-end target for the S&P in 2021 (which, again, is 4,300) I’d be more inclined to cite the deflationary impact of scarring on the economy, structural damage to the labor market that could lead to permanently depressed demand, or the prospect of vaccine rollout taking longer than expected due to logistical challenges.

Time will tell, but I’m not sure “red-hot inflation” needs to be on anyone’s list of 2021 worries.

Goldman Sees ‘Roaring ‘20s Redux.’ S&P To Hit 4,600 In 2022


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3 thoughts on “Why Portfolio Managers And Executives Think Goldman’s 2021 S&P Forecast Is Too High

  1. it is ironic that the market’s need to climb a wall of worry has the market focused on inflation when the majority of inflation is in the price of assets not needed or owned by the vast majority of the population. As an example the MEDIAN PE of the SP500 is 34.4. That is insane inflation of stock price. Yes, we could have that median PE drop back down to the long-term average if earnings double over the next year. Alternatively, we could have the price of stocks drop in half. Maybe the average stock investor believes that he/she should never get paid back in his/her lifetime via earnings… Or, as Goldman seems to believe — one should not get paid back in via earnings in one’s child lifetime either.

  2. Here is my observations about NYC and large urban area rental market. It comes from actual experience since I live in yuppy Brooklyn in a coop. The folks selling and moving out are folks that would have likely done so anyway. The pandemic just acted as an accelerant. In our coop the leavers this year have been couples with 2 kids who are getting past the 1st grade and have a parent who is moving in or retirees who were likely to leave anyway for sunnier/cheaper locales. The demand side is low since who wants to move into a city right now in the teeth of a pandemic? That has accelerated the movement out- but it has just hastened things for a cohort that was moving away anyway. What happens when the disease gets under control? My bet would be cities would be even more attractive. The real office rents will be effectively lower, since many companies will now use a hotel hybrid model in the future. I can tell you from experience, working from home full time is no panacea. But there is an attraction to more flexible work arrangements where you come into the office 2-4 days per week. Once entertainment and services really reopen in 1-2 years I would bet anything that NYC as a global center of commerce will bounce right back. The young folks and businesses will continue to want to relocate where a diverse and well educated labor force is in place. And the rents and pricing of housing has only become more attractive. This will take a number of years (probably 3-5) to become evident. Memphis and Boise will do fine as long as the regional economies there are doing ok. So will many other mid-sized cities. But the big ones also will be doing fine. The areas left out will be areas/regions without much pull of a university, government or manufacturing base to help them- just as it has been for some time. There could be an exception to an area open and encouraging of new immigrants.

    As far as inflation goes- you might get a small bounce from some trends cited such as a temporary post pandemic bounce with an easier monetary policy. But the demographics in the US augur against a major price surge everywhere and for everything. Relative prices of goods and services may fluctuate but a high persistent overall inflation rate just does not appear to be in the cards with the kind of aging/slow growing population in the developed world. Right now deflation is still a greater risk for what we look forward to- absent some major policy changes.

  3. If inflation remains subdued the corps can’t raise prices on sales and operating profit growth will be driven by op leverage and productivity. While wage gains will remain subdued in spite of the (hopeful) productivity gains. Therefore earnings growth will be challenged and investment will probably remain weak. But rates may stay tame (but how much lower and therefore how much PE expansion can happen from here?).

    If inflation picks up rates go higher killing PEs and selling prices and wage gains might increase and potentially earnings could go higher.

    But can interest rates stay this low for a sustained period? There was an old saying 10yrs should equal nominal GDP. So if you think we are in a 1.5% real growth world with 1% inflation can 10 yrs be at 1% forever?

    Even today, the real return after tax of 10 years are not attractive unless you think deflation takes hold but then what happens to profits?

    If you own a home inflation means something different than if you want to buy a home. If you are poor it is different than if you are wealthy.

    The tail winds of decent profits (mainly helped by certain sectors) and lower and lower rates may just be in the process of being shaken up. Each person, investor will make their decisions but t is not monolithic.

    Personally, these are tough times to be a professional investor. ONe can imagine a number of future paths though most are not as attractive as many suggest.

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