Goldman Sachs: Paradise Lost

Goldman Sachs note that “following a determined effort by the Fed to curb elevated inflation, financial conditions have tightened dramatically. WACC has spiked by 200 bp to 6%, the highest level in a decade and the largest 12-month rise in 40 years. It will remain near the current level in 2023. Sharply reduced valuation for public and private firms is one painful consequence.”

• “Our baseline forecast assumes a soft landing for the U.S. economy. We estimate 2023 S&P 500 EPS will remain flat at $224 and the index will end next year at 4,000 with an unchanged P/E multiple of 17x ranking in the 74th percentile vs. history. Higher real rates but a narrower yield gap means the relative valuation of equities vs. bonds will rank in the 85th percentile. We forecast a lower near-term path for stocks as rates rise. Our 3-month target is 3,600. But the tightening cycle will end in May and investors will shift their focus to growth in 2024. Our 6-month target equals 3,900.”
• “We expect in a recession the S&P 500 would trough at 3,150.”
• “The combination of a flat return under our base case and large downside in a recession means investors should remain cautious. (1) Own defensive sectors with low interest rate risk (Health Care, Consumer Staples, and Energy). (2) Own stocks with leverage to decelerating inflation. (3) Avoid unprofitable long-duration equities. (4) Own firms with resilient margins. (5) Avoid stocks with vulnerable margins if the recent decline in SG&A reverses”