Goldman’s David Kostin has seen enough.
With the S&P in an ostensible bull market amid early evidence of improving breadth, Kostin raised his year-end target for the benchmark to 4,500 from 4,000.
Although 2023’s rally in US equities, which this week found the rebound from October’s lows breaching the 20% threshold, remains very narrow, the situation is likely to resolve in a “catch up” as gains “broaden beyond mega-cap tech,” Kostin said.
To be sure, there’s nothing egalitarian about this year’s gains on the S&P. There’s the so-called “Magnificent 7” and then there’s everything else. Indeed, one of Goldman’s breadth indicators has narrowed by the most since the dot-com boom.
Looking back more than four decades, nine similar episodes of sharply narrower breadth found equities trading sideways amid rotations and churn. Returns were below average and drawdowns relatively pronounced, but as Kostin noted, a “catch up” outcome tends to materialize eventually, with valuations and prices rising and intra-market momentum reversing.
As a quick aside: Kostin was no Pollyanna this cycle. He was cautious on consensus margin forecasts and generally avoided positing anything like an overtly benign outcome from what continues to be a daunting macro-policy conjuncture. Goldman’s US econ team continues to be much more optimistic than consensus about the odds of a US recession, and Jan Hatzius harbors a generally upbeat view on the prospects for a soft landing. But the corollary is a “higher for longer” Fed funds trajectory. (Goldman’s baseline out to mid-2025 is ~100bps above the market-implied policy path.)
Even in a soft landing scenario, Kostin only forecasts 1% earnings growth for the S&P in 2023, to $224. That’s materially higher than his top-down counterparts ($206), but pretty much in line with bottom-consensus ($221). For 2024, Kostin says consensus is still too high. He expects just 5% EPS growth next year in the soft landing scenario.
Although he said this year’s re-rating in equities is more aggressive than he expected, it’s perhaps justifiable by slower inflation and steady growth. We can debate whether inflation has, in fact, slowed where it counts (e.g., on various “super core” measures), but so far anyway, the US economy is resilient. That could change overnight. And indeed, I generally expect that it will, although I can’t tell you which “night.” For now, though, you can dismiss belabored attempts to suggest the economy was “already in a recession” in Q1. It wasn’t.
It’s not necessarily a bad omen that bottom-up consensus EPS estimates for 2024 are almost surely too high. Estimates are almost always cut over the course of the forecast horizon. That’s the game, so to speak. As Kostin noted, Goldman’s outlook for US corporate profits next year suggests a 4% negative revision to consensus, “which would be consistent with the typical pattern and is unlikely to be a catalyst for lower prices.”
Like BofA’s Savita Subramanian, who on Friday wrote the bear market’s obituary, Kostin said the equity risk premium could fall from here, assuming growth stays resilient and inflation doesn’t inflect for the worse (again). “A declining equity risk premium will likely offset slightly higher real interest rates and support current equity multiples,” he said. Although the five largest stocks trade near 30x, the other 495 trade at 17x, which is generally consistent with Goldman’s projection for the index.
Kostin’s new target represents 5% upside for the index through year-end. “This return will continue to face stiff competition from cash (yielding 5%) and IG credit (5%), each of which carries less risk,” he said. Goldman’s three- and 12-month targets are 4,300 and 4,700, respectively.
I want to remind readers, in closing, that contrary to the derisive narratives popular in some corners, there’s a simple reason why sell-side targets for US equities tend to reflect gains year in and year out — namely, stocks rise over time. There are other reasons, of course. But Occam’s razor is handy.
For all the futility of timing the market, there are sure a lot of folks trying to time the market. GS is bullish, Marko, Hartnett and Wilson bearish. I guess Tom Lee is the only one to actually listen to.
Selling rakes is ultimately futile. Sure, you can clean up the leaves, but every autumn, they keep coming back. And in the end, nobody is going to remember that I successfully cleaned them up on innumerable occasions. But, inexplicably, there are people right now, all over this country (all over the world, in fact!) selling rakes at home improvement stores. I can’t get to the bottom of it. I’ve tried. I’ve asked and asked, but the rake people just keep feeding me some line about “Well, people seem to want these rakes, and I keep getting a pay check to sell them, so here I am, in this handsome orange vest with this name tag. Do you want a rake?”
“My life seemed to be a series of events and accidents. Yet when I look back, I see a pattern.”
? Benoît B. Mandelbrot
Reality is such that we have to take the measure of it and consider a hypothesis to test it. What can happen? How the impact of high interest rates in the US office real estate market?
It’s something about which we’re mostly aware, but it hasn’t hit the fan yet, so to speak. I’m working at home for the remainder of my career. But what is going to be the ongoing model for working? My company, which is headquartered in New York city, has 300,000+ employees, most of whom are working from home. They previously used a working model of onsite and off-site workers, and that’s still the case, though the balance may differ. Depending upon how they want to manage their far-flung staff, they can be flexible.
But there’s a lot of paper being held by banks for empty office buildings in major US cities. Here in Chicago, I’ve heard that some of those buildings are being converted to living space. But the other shoe has not yet dropped in regard to the COVID impact on the broader office real estate market. There’s a lot of money, and a lot of debt, in those properties.
GS seems to like going first with the predictions. I have faith the market will come around. But there are questions that can come back to bite the market on the fanny. The jury is still out, I reckon. At the very least, it’s not going to be a smooth and fast recovery. There are too many potential macro variables in the wild, like Greedflation, war (including nuclear), demographics, education, wealth distribution, the political collapse of Russia and their economic failure that can affect the economy in the coming months.
Goldman may well be correct in the end. But it won’t be easy. There are real possibilities that a very bumpy road is ahead.
H-Man, your right about Occam’s razor to explain equities gains — over time the glass always remains half full.
Last week there were two telling articles on the property markets in the WSJ. One highlighted the growing weakness in demand for warehouses and distribution properties. The other looked at a potential GLUT of new residential property completions, especially in the southeast.
As I tediously lectured my younger replacement-in-training, that is an eerie echo of the end of the tech bubble. Real estate developers and portfolio managers have started to accept that office space overcapacity was becoming a problem, but many felt OK because most of their properties were industrial/distribution and residential holdings. Now those safe havens are starting to look much less safe.
No different from when the tech bubble started to deflate. Many of us shrugged when the stocks valued solely on “eyeballs” started to collapse. After all, we owned “quality names” like Cisco, Microsoft and Nortel. No pets.com for us!
You know the end of that story! Every last tech stock was pummeled and underformed for years after. Even those that were actually profitable. Might we be seeing a similar script playing out in the commercial real estate market??
Just because it has not immediately happened does not mean it won’t.
You bet, Derek! My sentiments exactly. The bear may be behind us, but we’re not on easy street.
Now I’m keen to see how the Fed looks at the road ahead and what action they will take as a result.