Goldman’s 2023 Recession EPS Case Is BofA’s Base Case

“The larger risk to 2023 EPS is a recession,” Goldman’s David Kostin said, in the course of cutting the bank’s forecast for US corporate profit growth.

With Q2 earnings season now mostly complete, Goldman maintained its EPS forecast and S&P 500 target for this year, but turned more cautious on 2023, when aggregate S&P EPS will be $234, according to Kostin. Previously, he saw $239.

That’s not a singularly dramatic cut, and it won’t grab any bombastic headlines in the mainstream financial press, but it’s worth a mention. It does, after all, reflect a halving (from 6% to 3%) of Goldman’s house forecast for US corporate profit growth.

The figure (below) gives you a sense of the disparity between Kostin’s recession scenario and what company analysts currently project for next year, broken down by sector and aggregated.

Kostin’s macro assumptions for the bank’s baseline include average US real GDP growth of just over 1% (slower than the 1.6% the bank previously assumed), a flat dollar relative to year-end 2022, “elevated” oil prices, a decline in core CPI to just 2.9% and an unemployment rate that’s only “slightly” (Kostin’s word) higher.

Some of those macro projections could turn out to be optimistic. “The larger risk to 2023 EPS is a recession, in which case S&P 500 EPS could potentially fall by 11% to $200 and the index could fall to 3,150,” Kostin wrote. That’d mark a shallower earnings decline than the median over the past eight recessions. Inflation, Goldman said, would keep revenue steady, but 126bps of margin contraction in a recession would push earnings decidedly lower.

Do note: Goldman’s recession scenario for US corporate profits matches BofA’s base case, as conveyed in a target cut delivered midway through last month, when Savita Subramanian adopted a Street-low 3,600 year-end 2022 target for the S&P and cut her year-ahead EPS forecast to just $200.

The figures (above) are from Subramanian’s July 14 update. In an August 1 note, she maintained her 3,600 year-end 2022 target despite July’s big advance on Wall Street. “We view this as a bear market rally, which is common, occurring 1.5 times on average per bear market since 1929,” she said.

The relative buoyancy of bottom-up consensus EPS for next year continues to be the subject of considerable debate. Estimates have come down. When Subramanian cut BofA’s top-down forecast last month, bottom-up consensus was at $250 for 2023. Now, it’s at $244.

“In aggregate, consensus 2023 EPS estimates have been lowered by 2% since the start of Q3 [with] Communication Services experienc[ing] the largest EPS cuts, while Energy estimates have been boosted by 7%,” Goldman’s Kostin noted. The bank expects “additional negative revisions in coming months, particularly due to overly optimistic margin forecasts.” Currently, bottom-up consensus implies record profitability for corporate America in 2023, which seems implausible for obvious reasons.

Last week, Morgan Stanley’s Mike Wilson revisited August of 2008 to make a point about how far behind the curve bottom-up consensus can be. “Bottom-up NTM EPS in early August 2008 were down just 4% at that time from the peak,” he said. “It’s almost hard to fathom how estimates weren’t already lower given what was going on.”

In his latest, Kostin was a bit less colorful. “Consensus estimates are almost always too optimistic initially,” he said, adding that “analysts are moving quickly to reduce 2023 estimates,” though, with revision sentiment now falling sharply.