Goldman Sachs: Increased Corporate Earnings Will Barely Affect Equity Returns

Increased Stock Prices

According to media outlets, Goldman Sachs’ strategists indicated that the increase in corporate earnings would be of no substantial benefit to stock prices owing to diverse policy hurdles. Reportedly, the bank’s strategists increased their initial S&P 500 profits expectation from now through 2020, but they stated that the increase wouldn’t have any substantial effect on equity returns.

David J Kostin, Chief U.S equity strategist of Goldman Sachs, expressly noted that the economy of the US was experiencing growth, a visible increase in corporate profits and even stock prices ought to keep increasing through next year.  Kostin, however, added that the impact or influence of the increase would be limited by certain constraining factors such as the strict monetary policy, rising trade tensions, a flattening of the yield curve and the coming congressional elections.

Media outlets reported that the investment bank estimated full-year earnings for 2018 as $159 per share which would amount to a visible increase from the initial $150 forecast. Reports further indicated that the increase was 19% higher than last year’s and brought the forecast slightly lesser than FactSet consensus’ 19.8% forecast.

The forecast indicated that price to earnings level would remain at an approximate of 17 times which meant that S&P 500 would end the year at about 2,850. Reports further indicated that 2019 would be at 3,000 which would make it 5.3% higher than the target for this year. Media outlets also reported that the forecast for next year would be about half of what investors’ market expectancy.

Goldman Sachs estimated full-year earnings for 2018 as $159 per share against the bank’s initial $150 forecast

Sources further claimed that the increase in stock price could be attributed to the rapid economic growth in US and growth of the global economy, extra assistance than expected from the 2017 tax cut and increased energy prices.

In addition to the increased earnings forecast for 2018, Goldman raised its 2019 forecast to $170 from $158 (7% growth) and the forecast for 2020 was raised from $163 to $178 (5% growth). However, Kostin reportedly stated that the increased profits would not increase multiples or the price that investors were willing to pay.

Market Obstacles  

Media outlets reported that the obstacles affecting returns included, rate hikes from the Federal Reserve, the likelihood that growth in the economy would reduce when tax cuts benefits begin to fade away and the fact that U.S. budget deficit was gradually increasing. According to Kostin, the uncertainty surrounding the current policy-making stood as a major risk for US equity valuations. He added that although the events did not seem like major risks, they, however, had strong effects on risk appetite and valuation.

Market obstacles affecting equity returns include rate hikes from the Federal Reserve and the increasing U.S budget deficit

Sources claim that the norm was for an increase in bond yields caused by an orderly growth of the economy to be accompanied by gains in the stock market. However, Kostin reiterated that if bond yields were getting higher, the problem wasn’t the absolute level of yields but rather how fast the rates were increasing. Kostin further advised that the market focus should be on whether the monthly gain was over 0.1% points every month and not on the benchmarked 3% yield level.

Sources also claimed that things had been tough for active managers because investors were putting their capital into ETFs and other index-related passive investments. Goldman Sachs reported that only 36% of high ranking managers had reached their benchmarks this year as mutual funds recorded only an average gain of 3.5%. Also, the bank stated that more managers who were for both growth and value funds had beaten the market with about 59% and 74% respectively although the firm expressly favoured growth over value.

Interest Rate Hike

The Chairman of Federal Reserve, Jerome Powell, stated last week that the low rate of unemployment and different evidence of looming inflation were strong indications for continued interest rate hikes. Media outlets earlier reported that the Fed declared a rate hike for the seventh time this month since 2015, and also gave a forecast for a rapid pace of increases in its lending rates. In addition, the Fed predicted four additional hikes as a result of the low unemployment rates and increased economic growth amid looming inflation.

While addressing a European Central Bank forum, Mr. Powell stated that as the economy recovered, there was clearly a need for a monetary policy which was highly accommodating. However, he mentioned that with the declining unemployment rates and considering the risks that could accompany, those were strong indications that they could keep increasing the interests rate.