Goldman Asks: ‘What If?’

Goldman’s year-end target for the S&P is 4,300. The index is already there.

That suggests the benchmark could end 2021 somewhere other than 4,300, marking an exceedingly rare example of sell-side forecasts missing the mark. (I’m kidding, of course. Sell-side forecasts miss the mark all the time.)

The first half of 2021 underscored the extent to which forecasting is just a drunken dart game. “People were already worried about equities six months ago,” Bloomberg’s Lu Wang remarked, in a piece about rally “haters.” “Now, after the S&P 500 Index defied everything from nosebleed valuations to inflation to post one of the best first halves ever, they’re downright paranoid,” he added.

It’s impossible to make a list of everything that could go wrong. Attempting to enumerate all of the factors that might conspire to push stocks higher still in the back half of the year is similarly futile.

That said, there are some obvious questions we can ask around inflation, rates and taxes, which Goldman’s David Kostin addressed using a series of “What ifs” in a recent note called… well, called “What If?”

If you follow Goldman’s research, you’re familiar with their take on inflation. Higher input costs and wage bills weigh on margins, but historically, revenue growth compensates. Although equities traditionally perform best in low inflation environments, elevated inflation that’s falling can be fertile ground for robust returns (see the table, below).

The concern is always the same, though. While stocks can cope in an environment characterized by persistently elevated inflation, much depends on the Fed. “More Fed tightening than we now expect [could] reduc[e] equity valuations,” Kostin said, in his latest, before recapping Goldman’s house view, which is pretty run-of-the-mill.

The bank expects a taper announcement in December, followed by trimmed monthly asset purchases early next year. Liftoff won’t occur until the second half of 2023, Goldman reckons. Assuming that (rather benign) outlook for policy is correct, a dramatic de-rating is unlikely. “We expect the S&P 500 P/E will be roughly flat during the next year, resulting in equity prices appreciating roughly in line with EPS growth,” Kostin wrote.

When it comes to rates, Goldman’s S&P target assumes 10-year yields at 1.9% by year-end, with a stable P/E multiple of ~22. This is where it’s possible to quantify potential deviation. “If interest rates remain roughly flat through the end of this year, our S&P 500 dividend discount model would suggest a fair value of 4,700, or 9% above our current baseline,” the bank said, adding that “if interest rates were to overshoot our forecast and end the year at 2.5%, but nothing else were to change, our DDM would imply a fair value of just 3,550, or 17% below today’s price.”

How about taxes? Specifically, Goldman’s clients are curious to know what happens if tax reform doesn’t pass.

The bank has long assumed that a less aggressive version of the Biden administration’s tax proposals eventually becomes law, taking effect in 2022 and ultimately reducing S&P earnings by 5% versus current tax law.

Under what Kostin calls a “no tax reform” scenario, and assuming a year-end P/E of 21.3 for the index, fair value for the S&P would be closer to 4,500.

Note that we’re really just splitting hairs. Consensus expects 2022 EPS of $211. Under Goldman’s “no tax reform” scenario, next year’s index-level profits would be $212, essentially in-line with the bottom-up estimate.

Circling quickly back to inflation, it’s worth noting (I guess) that Goldman “believe[s] labor supply will rebound significantly by year-end as coronavirus concerns continue to diminish and temporary supplemental unemployment benefits expire.”

That, you’ll note, is becoming the key macro question in the US and it has obvious ramifications for inflation.

For their part, Goldman is sticking with the contention that a reduction in labor market frictions “should ease wage pressures and reduce investor concerns about persistently high inflation in coming years.”

Take it for what it’s worth and do yourself a favor: Remember that no matter how flawed you may find other people’s assumptions and forecasts, yours probably aren’t any better. Especially not right now.