After a year of upheaval in the market, the future seems as uncertain as ever, according to Goldman Sachs. The firm says that four key factors will determine the tactical and strategic direction of U.S. equities in 2019, including the Fed, trade policy, China's economy and corporate earnings. "What matters most to the performance of stocks is the marginal change in each of the variables relative to investor expectations," says Goldman in its latest U.S. Weekly Kickstart report. These variables are listed in more detail below.
4 Key Market Drivers
- If the Federal Reserve maintains interest rates at current levels
- Weak economic growth in China
- The U.S.-China trade dispute
- Slowing corporate earnings
Source: Goldman Sachs
Significance For Investors
Earnings revisions. "In the US, 4Q earning results and forward guidance have been mixed," the report observes. With about half of the companies in the S&P 500 Index (SPX) reporting 4Q 2018 results so far, 46% have beaten EPS estimates by at least one standard deviation, which is in line with historical averages. However, EPS estimates for the S&P 500 in 2019 have been cut by almost 4% in the last three months, including a 2% reduction in the past month alone.
Subsequent to the release of Goldman's report, the earnings outlook for 2019 got decidedly gloomier. The latest consensus estimates from stock analysts now point to a year-over-year (YOY) drop of 0.8% in S&P 500 profits during the first quarter of 2019, according to data compiled by FactSet Research Systems and reported by CNBC. At the end of Sept. 2018, the consensus was predicting an increase of 6.7%. The most recent YOY profit decline was in the second quarter of 2016.
Decelerating growth in China. "In aggregate, the economic data in China has been weaker than expected," Goldman writes. Regional trade flows are decreasing, and a China Current Activity Indicator developed by Goldman's economists is at its slowest pace since 2009. Despite anticipating that the Chinese government will respond with a program of fiscal stimulus, "near term risks are skewed to the downside," the report concludes.
Trade policy. While noting that the U.S.-China trade conflict remains a source of great uncertainty, the report does offer a ray of hope. Goldman has been holding discussions with clients, and most of those investors expect the U.S. and China to reach an agreement, thereby averting an additional round of tariffs that President Trump has threatened to place on Chinese goods if no deal is made. However, Goldman warns that stock prices will drop if the March 1 deadline passes without either a clear resolution or an agreement to postpone tariff increases.
Federal Reserve policy. In the wake of the Fed's announcement that it plans to take a more restrained approach to interest rate hikes, the fed funds futures market now has 87% confidence that the fed funds rate will be unchanged for the rest of 2019. It also gives a slim 2% chance to the possibility of another rate increase this year.
The Fed also announced last week that it is prepared to adjust the pace at which it reduces its massive bond portfolio, valued at $4.0 trillion and equaling 9% of the domestic bond market, per analysis by Goldman. "Our economists expect the terminal size of the Fed's balance sheet will be $3.6 trillion," the report adds. To put that in perspective, Goldman estimates that U.S.-based corporations will issue bonds worth $1.65 trillion in 2019.
Given the clear downward trends in U.S. corporate earnings and in China's economy, along with the continued uncertainties surrounding U.S.-China trade, downside risks appear to dominate in 2019. Accordingly, investors should proceed with caution.