Goldman’s Clients Fear ‘More Bearish’ 2023

Goldman’s clients — some of them, at least — are more pessimistic about equities in 2023 than the bank.

“Our base case is the S&P 500 will fall to 3,600 in H1 before rallying to 4,000 by year-end. Many clients expect a more bearish outcome,” David Kostin said, in his latest.

I wouldn’t describe as Kostin as bullish. He expects no earnings growth for corporate America in his base case for next year, and Goldman’s year-end target for the S&P suggests no upside for US equities. Additionally, the bank is adamant that consensus is too optimistic on margins.

But, Goldman doesn’t have a recession as their base case. Instead, they (still) see a soft landing. “There are clearly some factors that could lead to a worse market return in 2023 than our base case forecast,” Kostin conceded. Recession is at the top of the list.

If the US enters a recession, the S&P would likely trade down to 3,150 and earnings would fall low double digits (figure on the left), Kostin wrote. Multiples would contract to 14x (figure on the right).

Usually, Goldman noted, stocks and multiples trough before analysts are done cutting earnings forecasts.

A recession isn’t the only way things could turn out worse than Goldman’s base case. Kostin also said that although the bank’s outlook for margins isn’t especially upbeat (they see 58bps of contraction), profitability could suffer even more “as sales growth slows and costs structures normalize.” To put some numbers on it, index-level earnings generally fall by $15 for every 100bps of margin compression. (Morgan Stanley’s Mike Wilson sees 150bps of margin compression next year in his base case.)

Finally, Kostin flagged the risk that the Fed will hike rates more than expected. Goldman sees Fed funds peaking at 5.25% (higher than market pricing), but it’s obviously possible that inflation stays stubborn and the Fed refuses to “admit defeat.” If 10-year reals rose to 2%, multiples could contract to between 15x and 13x, Kostin said.

“The S&P 500 P/E has closely tracked the path of real interest rates this year,” Goldman wrote. “If the real 10-year UST rose to 2% and the yield gap widened to the level at the start of 2022, the P/E multiple would drop to 13x.”

So, those are the downside risks. There are, of course, any number of upside “risks” to the bank’s outlook, one of which is a “much more dovish Fed,” which could, among other things, open the door to a dramatic re-rating.

The problem with any bull case that involves Fed cuts is that the economic backdrop which would compel such a policy pivot would presumably be quite dire. The bar to cut rates in 2023 is extremely high given policymakers’ fears of being remembered for failing to quell inflation on the first try. The kind of downturn necessary to override those fears would likely be very bearish for risk assets.

“With the labor market and wage growth still too hot to be consistent with the Fed’s 2% inflation target, it seems unlikely that the Fed would ease substantially next year barring a severe downturn in the economic and earnings outlooks,” Kostin remarked.