- The stock market is delicately balanced between bullish sentiment and bearish gloom.
- Goldman Sachs has laid out what the S&P 500 is likely to do in two possible situations.
- The bank has also named some stocks you should buy, whichever scenario comes true.
The stock market is delicately balanced between bullish sentiment and some gloomy bear market scenarios as we head toward the final quarter of 2022.
The bull case broadly states that June saw the cycle low for the S&P 500 at 3667 as fear over inflation and Federal Reserve rate rises hit a peak. With the US CPI appearing to have topped at 9% in July, there’s reason to believe the end of the bear market is close.
On the other side is the argument that there is another leg lower to come as investors panic at the persistence of high inflation and as the Fed hikes rates more aggressively than earlier forecast. The bears say this could be compounded by weakening in the jobs market, which has held up very well until now.
With these two very different but plausible scenarios, it makes a lot of sense for analysts and strategists to model for different situations when trying to produce stock market forecasts.
This is exactly what the equity strategy team headed up by David Kostin at Goldman Sachs has done. They have made new forecasts for the S&P 500 and company earnings based on both a base-case scenario and a bearish recession scenario.
It is important to keep in mind that a base scenario is the one considered likely to be correct, therefore Goldman believes on the balance of probability a deep recession can be avoided and we will see the hoped-for soft landing over the coming months.
As shown here, the base scenario’s forecast for the S&P 500 at year-end is 4300, while the recession scenario forecast is a deep new low at 3150.
Kostin and colleagues also laid out how US economic growth, S&P 500 earnings per share, and Treasury yields are likely to shake out in 2023 under both scenarios.
There is a particularly stark difference in the earnings forecast, with the base scenario seeing S&P 500 earnings per share growth of 3% next year and the recession scenario causing a dramatic 11% earning fall across the index.
Economic growth will be in a very different place in each of the outcomes of course. In the base case Goldman has US GDP growth at 1.2% in 2023, while in the recession scenario there would be a contraction in GDP of 1% over the full year.
Ten-year Treasury yields should hit 3.3% in nominal terms and 0.5% in real terms under Goldman’s base scenario. Under the recession scenario, Goldman sees yields at 2% in nominal terms and negative 0.5% in real terms. Clearly, investors will need to take very different actions depending on which of these scenarios plays out.
Goldman has three broad investment picks for the base scenario of a soft landing. Firstly, the bank says investors should target the quality end of the stock market. These are the companies which have the strongest balance sheets, stable sales growth, high return on equity and low earnings deviation. Examples include Alphabet, Comcast, and T- Mobile.
Second, Goldman tips ‘under-owned value stocks.’ These are the S&P 500 value stocks that mutual funds are most underweight according to Goldman analysis. This group includes Pfizer, AT&T, and Ford Motor.
The third string tipped by the bank for its base scenario is stocks on its ‘Hedge Fund VIP list.’ These are the stocks that “matter most” to the performance of long/short hedge funds. The include Amazon, Meta Platforms, and Visa.
In the recession scenario, Goldman’s recommendations are different. It says investors should focus first on what it calls stable growth stocks. These are companies in the Russell 1000 which have the most consistent 10 year earnings growth. They include Sirius XM, Omnicom Group, Warner Bros Discovery, Domino’s Pizza, AutoZone, and Home Depot.
Secondly, Goldman tips strong dividend payers to be a good buy in a recession. Examples here are Lumen Technologies, Verizon Communications, Interpublic Group and Best Buy, Whirlpool Corporation, and Tapestry.
The third recession scenario tip from Kostin and co. is to sell — or short — companies which are burning cash and may need to raise new money soon. Many of these can be found in the pharma and biotech sectors. Goldman’s examples here include Phathom Pharmaceuticals, Agios Pharmaceuticals, and TG Therapeutics.
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