The sharp market downdraft has forced many Wall Street firms to reconsider, and even revise, their forecasts. While Goldman Sachs sees a recovery in stock prices by the end of 2018, their longer-term view is very sobering, given their expectations of sharply slower economic and corporate profit growth, as well as increased stock market volatility, punctuated by steep selloffs. Goldman cites 6 major headwinds for stocks in its latest U.S. Weekly Kickstart report, as are summarized below. Together, these headwinds threaten to undermine and cripple the bull market's growth.
6 Big Headwinds For Stocks
|U.S. GDP growth rate decelerates to 1.6% by 4Q 2019|
|Corporate earnings growth rate falls by more than 50%|
|Sharply narrower market breadth|
|Rising volatility and increased risk of big sell-offs|
|Key stock sectors showing increased weakness|
|Falling housing starts and new home sales|
Source: Goldman Sachs
Significance For Investors
The slowdown in U.S. GDP growth that Goldman foresees is partially the result of anticipated interest rate hikes by the Federal Reserve. The futures markets are pricing in one more rate increase in 2018 and two in 2019. Goldman also notes that GDP growth has slowed in emerging markets and Europe over the course of 2018, which is causing decreased demand for the output of U.S. companies. Cyclical industries are being hit the hardest, particularly the materials sector, which derives 49% of its revenue from abroad. Materials stocks are down by about 15% year-to-date.
Housing starts are a key leading economic indicator, and they fell by 5.3% in September, while new home sales dropped by 5.5%, per Goldman. Rising interest rates are weighing on the housing sector. Mortgage rates, now about 5%, are at their highest level since 2011, and a measure of housing affordability is near its lowest level in 10 years.
"3Q earnings results have been healthy so far, but investors have shifted their focus from 22% EPS growth in 2018 to the deceleration to 9% growth in 2019." — Goldman Sachs
Consensus estimates indicate that full year EPS growth for the S&P 500 will drop from 22% in 2018 to 9% in 2019, but Goldman believes that 7% is a more likely figure for 2019. "Consensus has almost always been too optimistic in its EPS estimates," the report says, observing that 2018 has been one of only six years since 1985 in which analysts' revisions have gone upward, on average. Meanwhile, investors and managements increasingly have raised concerns about cost pressures going into 2019, from rising wages and other input expenses. Goldman adds that the share price boosts being enjoyed by companies that beat 3Q earnings estimates are rather muted by historic standards, suggesting that investors are indeed focused on the increasingly cloudy outlook for 2019.
Goldman finds that market breadth has declined sharply, and now stands at less than 9% of its 35-year average. Looking at market history going back to 1980, they calculate that, in the aftermath of a big drop in breadth, the typical stock market drawdown from peak to trough over a six-month horizon rises in magnitude from 4% to 11%.
Goldman is sticking to their year-end 2018 forecast of 2,850 on the S&P 500 Index (SPX), which would represent a 6.2% gain from the open on Oct. 29. They write: "the recent sell-off has priced too sharp of a near-term growth slowdown. We expect continued economic and earnings growth will support a rebound in the S&P 500." They add that 48% of the S&P 500 firms are out of their blackout windows and now able to resume their share repurchase programs, which should help to prop up equity prices. However, looking ahead, Goldman sees the headwinds listed above gaining force in 2019.
Meanwhile, Goldman is at the pessimistic end of the spectrum regarding U.S. GDP growth in 2019. While they see a steady decline to a 1.6% growth rate by 4Q 2019, economists surveyed by The Wall Street Journal see growth dipping to 2.5% in 1Q 2019 and 2.3% in 3Q 2019. The Federal Reserve is projecting that growth will slow to 1.8% by 2021, per the WSJ, still above Goldman's forecast for 4Q 2019.