Many investors and market watchers are concerned that a recession may be lurking ahead for 2019 because a downturn can trigger or deepen bear markets. Goldman Sachs, for its part, sees no major contraction ahead, but the firm does forecast a significant slowdown in U.S. GDP growth. This is just one of a long list of headwinds that Goldman Sachs outlines in the commentary and charts in its latest U.S. Weekly Kickstart report. Investopedia focuses on 6 of these powerful forces, which threaten to rein in stock prices in 2019 and beyond: in addition to a slowing U.S. economy, the others are decelerating economic growth in China, a drastic downshift in corporate earnings growth in the U.S., accelerating inflation, rising interest rates, and increasing wage costs.
6 Red Flags Ahead
|U.S. real GDP growth slows from 2.9% in 2018 to 1.6% in 2020|
|China's real GDP growth slows from 6.6% in 2018 to 6.1% in 2020|
|S&P 500 earnings growth slows from 23% in 2018 to 8% in 2019|
|Core inflation rises from 1.9% in 2018 to 2.2% in 2019-20|
|10-Year U.S. Treasury Note yield hits 3.5% in second half of 2019|
|U.S. unemployment rate drops to 3.2% in 2019, creating more wage pressures|
Source: Goldman Sachs
Significance For Investors
While corporate tax reform, including tax rate reductions, have placed U.S. corporate earnings on a higher plateau, the huge year-over-year (YOY) growth rates in profits posted in 2018 will not be replicated going forward for the vast majority of companies. Overall, based on rolling up consensus estimates for each individual company in the S&P 500 Index (SPX), Goldman calculates that earnings growth for the index as a whole will drop from 23% in 2018 to 8% in 2019.
Several sectors are expected to endure declines of more than 15 percentage points each in their annual earnings growth rates, per Goldman: energy will go from 102% to 25%, materials from 32% to 4%, financials from 29% to 10%, information technology from 23% to 5%, and communication services from 21% to 3%. As Nicholas Colas, co-founder of DataTrek Research, told CNBC: "Equity markets are saying to companies that the easy money already has been made. In 2019, they'll have to work for it."
Because China has become the world's second-largest economy next to the U.S., and since it is a major buyer of goods and services offered by U.S. corporations, an economic slowdown there has major negative ramifications for U.S. companies, as well as for the overall U.S. economy. Goldman projects real, inflation-adjusted, GDP growth rates in China to remain relatively strong in 2019 and 2020, at 6.2% and 6.1%, respectively. However, this is on a decelerating path, having been 6.9% in 2016 and 6.6% in 2017.
Increasing trade tensions between the U.S. and China are a related source of concern, as China has responded to U.S. tariffs on its goods by retaliating in kind. "A major trade war would lead to a significant reduction in growth," Bank of America Merrill Lynch warned in a note to clients during the summer, as quoted by CNBC. "A decline in confidence and supply chain disruptions could amplify the trade shock, leading to an outright recession," the note added.
"Inflation...will rise from 1.9% this year to 2.2% in each of the next two years, a level slightly above the central bank’s [the Federal Reserve's] 2% objective." — Goldman Sachs
In previous reports, Goldman has warned about rising costs being a major headwind for stocks going forward. This is where the upward trends in general inflation, wages, and interest rates are matters of major concern, since they will depress profit margins. Increases in input costs generated by new U.S. tariffs on imported goods are another source of pressures on margins, and Goldman has been recommending stocks with high profit margins, as detailed in another Investopedia article, as well as stocks with high returns on equity (ROE), as we summarized in an additional report. Moreover, rising interest rates will make bonds more attractive relative to stocks, and depress equity valuations.
Goldman essentially is predicting slowdowns in both the economy and the stock market, rather than a recession and a bear market crash. Meanwhile, Lawrence Summers, a longtime economics professor at Harvard and former U.S. Treasury Secretary, has told CNBC that a slowdown in U.S. growth is a "near certainty" and that "the recession risk is nearly 50 percent over the next two years, maybe less." Given the divergence of opinion, investors would do well to prepare for the worst.