Goldman Slashes S&P Target, Says ‘Investors Have Been Mauled’

Investors “have been mauled,” Goldman’s David Kostin said, looking back on what, so far anyway, is a truly regrettable year for equities and a potentially epoch-making macro moment for bonds.

I’ll save readers some suspense. I won’t bury the lede. Goldman cut its S&P target to 4300 from 4700 (figure below).

Goldman’s new price target implies modest upside by year-end. Thanks to Friday’s rally, Kostin’s three-month target (4000) implies no near-term upside, consistent with the notion that, at least locally, stocks “could become a meat-grinder of forlorn hope,” as someone quoted by CNBC put it.

A breakdown of this year’s near-bear market plunge in the index shows the entirety of the rout can be blamed on the rise in real rates, which has bled valuations and overwhelmed all other factors. Forward multiples have contracted by 24%.

Goldman has two downside scenarios, one involving a recession and one in which the US economy skirts a downturn, but multiples contract further on additional increases in real yields.

In the recession scenario, Kostin sees the S&P falling to 3600. “If, by year-end, the economy is poised to enter a recession in 2023, a combination of reduced EPS estimates and a wider yield gap would drive a lower index level,” he wrote.

If the economy doesn’t succumb, but reals keep moving higher, valuation compression would push the S&P to 3800. Kostin mentioned 2018, when Jerome Powell discovered that 1% on 10-year reals was the breaking point (figure below).

“If the Fed is forced to hike by more than our economists expect and real rates rise to 1%, similar to the peak reached during the last cycle in 2018, our macro model suggests that higher rates will more than offset the lower yield gap,” Kostin said. “In this scenario, the forward P/E would equal 16x, the lowest level since 2020.”

Notably, Goldman raised its 2022 EPS forecast to $226, representing growth of 8%. That’s still below bottom-up consensus, as is the bank’s 2023 index EPS forecast.

Despite a number of high profile misses and guide-downs, Q1 earnings were, in aggregate, much better than expected. EPS growth was 11%, more than double expectations (figure below).

But some worry the profit outlook for corporate America is increasingly bleak, as consumers are pinched by high prices and corporates by rising costs.

For their part, Goldman raised additional concerns. “Our economists’ 2022 real US GDP growth forecast is below-consensus and China’s zero COVID policy poses a clear downside risk to EPS growth,” Kostin remarked, adding that a stronger dollar is a headwind for corporate top lines.

Price target cuts are becoming more pervasive, as Wall Street reassesses the outlook amid a burgeoning crisis of investor confidence. The spread between strategists’ year-end forecast for the index ballooned wider in 2022 (figure below).

That’s quite a bit of ground to make up. Nerves are frayed and it’s worth reiterating that many market participants have never seen an environment in which the vaunted “Fed put” was struck materially lower than spot.

Kostin reiterated the notion that, for now, higher stocks aren’t consistent with the Fed’s efforts to tighten financial conditions, which means that although manic rallies (like Friday’s bounce) are inevitable, especially with so much dry kindling for squeezes scattered about, sustainable rebounds that push the index materially higher are anathema for Powell.

“Much higher equity prices in the near-term would ease financial conditions and be antithetical to the Fed’s goal of slowing economic growth,” Kostin wrote.

Read more: Higher Stocks ‘Antithetical’ To Fed’s Goals, Goldman Says