Goldman Cuts S&P Target: ‘Lower Earnings, Lower Price’

“Lower earnings, lower price,” Goldman’s David Kostin said, summing up the rationale behind the bank’s decision to cut its S&P target for 2022.

Kostin delivered the news around a half hour after the closing bell sounded on another tough week for war weary investors. The conflict in Ukraine and attendant commodities chaos introduced a new variable into an already complex equation for monetary policymakers. That, in turn, left traders flying almost completely blind.

Extreme ambiguity around the longer-term macro outlook had already compressed horizons. Regular readers know the story. Lacking visibility on inflation and thereby bereft when it comes to long run macro forecasting, traders have instead focused exclusively on the Fed and short-term monetary policy as the only thing to which odds can be assigned.

But thanks to the war, even that myopic endeavor is an exercise in futility. On one hand, the growth outlook has worsened, arguing against aggressive tightening. But the surge in raw materials prices (figure below) represents yet another inflation shock.

Central banks are boxed in. The ECB on Thursday decided to move ahead with plans to accelerate the time table on ending net asset purchases despite the war in Europe. The Fed will hike next week, of course, but it’ll be all about how it’s packaged.

One way or another, the stagflation tail risk is now very much in play. And that, ultimately, is what informed Goldman’s new outlook for US equities. “A surge in commodity prices and a weaker outlook for US and global economic growth lead us to lower our EPS estimates,” Kostin said. The bank cut its outlook for US growth earlier in the week.

Although Goldman only reduced their 2022 S&P EPS estimate by $5 (to $221 from $226), that modest reduction masked considerable cuts below the surface, offset by a fairly large upgrade to the bank’s profit outlook for energy (figure on the left, below). Kostin slashed EPS estimates for consumer-facing sectors and industrials by 8%, citing “reduced consumer demand and lower profit margins” and “sensitivity to economic growth and rising input costs,” respectively. Goldman’s aggregate EPS estimate for the index is now below consensus both for this year and 2023 (table on the right).

The good news is, large-cap US equities (as a monolith) aren’t really exposed to Russia, let alone Ukraine. Nearly three quarters of index sales are domestic. One problem, though, is that some companies have shuttered their operations in Russia entirely.

More importantly, the historic surge in commodities means higher input costs, weaker consumer demand and slower growth, all of which bode ill for corporate profits.

“Many investors voice concerns that the spike in both energy and materials commodity prices will weigh on already-decelerating consumer demand and tip the economy into recession,” Kostin said, noting that “from a historical perspective, during a recession S&P 500 EPS typically falls by 13% from peak-to-trough before rebounding by 17% during the subsequent four quarters.”

There’s plenty more in the full, 17-page note, but the bottom line (no pun intended) is just as Kostin said in the first four words: “Lower earnings, lower price.” The bank’s 2022 target for the index is now 4,700 (table below). It was 4,900.

Obviously, Fed tightening has the potential to exacerbate the loss of economic momentum. And that’s to say nothing of the impact on risk assets from tighter financial conditions. Goldman’s base case assumes real yields stay negative throughout 2022 despite Fed hikes and the onset of balance sheet rundown.

If you’re wondering whether there’s a downside scenario, the answer is “yes.” In a recessionary environment where profits fall and multiples compress, the S&P may drop to 3,600, Kostin said, noting that’d be “in line with the median historical peak-to-trough price decline of 24% around past recessions.”