Why Goldman Sees Bull Stampede Through 2020 Despite Recession Fears

While many investment strategists see rising dangers for the economy and stocks, Goldman Sachs predicts that the bull market will charge ahead through the end of next year, with the S&P 500 Index (SPX) reaching 3,100 by the end of 2019 and 3,400 by the close of 2020, for respective gains of roughly 4% and 14% from today. Goldman believes that the U.S. economic expansion is far from over despite the impact of the U.S.-China trade war and slowing global economies.

"Our economists expect that a US recession is unlikely during the next two years. They highlight the lack of economic imbalances and believe that elevated consumer spending and a smaller drag from inventory accumulation should boost economic growth through the end of 2019 and 2020," Goldman writes in a recent report.

Goldman's optimism comes as 60% of Americans responding to an ABC News/Washington Post poll say they fear that a recession will begin within the next year, and 43% believe that President Trump's trade policies have increased the odds, Business Insider reports.

Significance For Investors

In its report, Goldman largely dismisses investors' concern about the closely watched ISM Manufacturing Index, which recently dipped to 49.1, its lowest reading since Jan. 2016. Since a value below 50 indicates that the U.S. manufacturing sector is contracting, this is taken as a recessionary signal by some.

Goldman says the ISM number is a poor gauge of coming recessions and, in fact, stocks have risen sharply in the wake of many poor ISM reports. "The index has been an inconsistent predictor of US recessions during the past 40 years...In six of 11 instances since 1975 a recession did not occur despite the fact that the ISM fell below 50. On average during these episodes, the S&P 500 rose by 22%. Defensives outpaced Cyclicals by 150 bp, high dividend stocks outperformed, and Industrials returned 210 bp vs. S&P 500 within 12 months," said Goldman in its Weekly US Kickstart report. 

In particular, Goldman points out that, in the U.S. today, manufacturing now accounts for only 10% of nominal GDP, thus limiting its impact on the general economy. By contrast, consumer spending currently represents about 68% of U.S. GDP, per the Federal Reserve Bank of St. Louis, making it the leading driver of economic activity. As noted above, Goldman projects that consumer spending will remain strong.

Mislav Matejka, chief global equity strategist at JPMorgan, has a similarly bullish outlook on the economy and stocks. "We believe the market will rally into the end of the year. The key call is that the U.S. is not headed for a recession. The consumer is strong, interest rates are coming down and there are signs that global growth will rebound,” he told MarketWatch

Matejka also has an upbeat view on corporate earnings. “Most commentators think [profit] margins are high and therefore are bound to fall, and I am saying that unless there is a recession, there is no real reason for operating margins to contract,” he said. He notes that productivity has trended upward recently, a delayed effect of surging capital expenditures during 2017. He expects productivity to grow for at least several more quarters, neutralizing the negative impact of rising wages on profits.

To be sure, there are plenty of bears who disagree with Goldman and JPMorgan. Michael Wilson, chief U.S. equity strategist at Morgan Stanley, is one of them on Wall Street. "Slowing growth and margin pressures keep us cautious on equities and we see downside risk should labor markets weaken," he writes in a recent report. "To believe the market can move sustainably and materially above 3,000, we either need to see earnings growth reaccelerate or [valuation] multiples expand and we are skeptical of either of these things coming to pass over the next few months," he adds.

Looking Ahead

Given its outlook, Goldman has upgraded industrial stocks to overweight on the expectation that the sector will stabilize and even gain support from continued expansion of the overall U.S. economy. However, Goldman warns that the U.S.-China trade conflict presents a significant risk to industrials, since they tend to have greater average exposure to China than U.S. stocks in general.