The Goldman Sachs equity team no longer expects the market to be lower from current levels at the end of the year.
Load Error
But the Morgan Stanley team still says there is more deceleration in earnings to come and that rather than riding to the rescue, AI may actually pressure margins.
Goldman strategist David Kostin boosted his target for the S&P 500 (SP500) (NYSEARCA:SPY) (IVV) (VOO) to 4,500 from 4,000 for 2023. That’s almost 5% above current levels.
“Our unchanged 2023 EPS forecast of $224 assumes a soft landing and is above the top-down consensus of $206,” Kostin said. “GS Economics assigns a 25% probability of recession in the next 12 months, compared with 65% for consensus. The P/E multiple of 19x is greater than we expected, led by a few mega cap stocks. But prior episodes of sharply narrowing breadth have been followed by a “catch-up” from a broader valuation re-rating.”
“Our unchanged 2023 EPS forecast of $224 assumes a soft landing and is above the top-down consensus of $206,” Kostin said. “GS Economics assigns a 25% probability of recession in the next 12 months, compared with 65% for consensus. The P/E multiple of 19x is greater than we expected, led by a few mega cap stocks. But prior episodes of sharply narrowing breadth have been followed by a “catch-up” from a broader valuation re-rating.”
“One of our market breadth indicators compares the distance from the 52-week high for the aggregate index vs. the median stock,” he said. “On this measure, market breadth has recently narrowed by the most since the Tech Bubble. Following 9 other episodes of sharply narrowing breadth since 1980, the S&P 500 typically traded sideways during subsequent months as rotations continued within the market.”
“In addition to below-average returns, drawdowns have also been larger than average in these experiences. Eventually, however, a ‘catch up’ has been most common, with S&P 500 valuations and prices increasing alongside a reversal of intra-market momentum.”
© Provided by Seeking Alpha
The bear argument
Morgan Stanley strategist Mike Wilson remains bearish on the broader market and further laid out his case for an continuation of an earnings recession in a pair of notes.
Wilson has a 3,900 S&P price target for the end of 2023.
“With the S&P 500 rally now crossing the 20% threshold, more are declaring the bear market officially over,” Wilson said. “We respectfully disagree due to our 2023 earnings forecast.”
“While our 2023 (S&P EPS) forecast was also lower than consensus six months ago, that spread is greater today as we have cut our 2023 forecast further, while the rest of the Street, and the buy side,have raised theirs,” he said.
Over the past 70 years earnings recession tend to bottom at -16%, “the exact decline we are forecasting for 2023,” Wilson noted, adding that “historical analysis suggests it’s unlikely that the earnings recession will stop and reverse at current levels.”
“The boom/bust period that began in 2020 is currently in the bust part of the earnings cycle – a dynamic that we believe has yet to be priced during the bear market that began 18 months ago and has been largely related to just higher interest rates,” he said. “In other words, margins and earnings will decline rapidly as inflation falls – so be careful what you wish for.”
In an “ironic twist, we think the Fed’s potential pause on rate hikes could serve as the perfect book end to this bear market rally. In many ways, it’s often easier to travel than arrive at the destination. On that score, Wednesday’s Fed meeting and presser could serve as an important turning point for price momentum.”
“We think many investors are making two key assumptions that may be at risk,” Wilson added. “First, that the impact of interest rate hikes on growth is behind us; and second, that several areas of the market, including consumer cyclicals (XLY), tech (XLK) and communications services (XLC), experienced their own earnings recession last year and are likely to see accelerating earnings growth even as other parts of the market suffer.”
© Provided by Seeking Alpha
AI impact
Neither strategist was sold on a strong near-term impact from AI for the broader market.
The consensus view of re-acceleration “stems mostly from some large companies sounding more optimistic about 2H23, combined with the newfound excitement around Artificial Intelligence and what it means for both growth and productivity,” Wilson said.
“While individual stocks will undoubtedly deliver accelerating growth from spending on AI this year, we do not think it will be enough to change the trajectory of the overall cyclical earnings trend in a meaningful way. Instead, it may pressure margins further for companies who decide to invest in AI despite flat or decelerating top-line growth in the near term.”
The “potential profit boost from AI has improved the distribution of equity outcomes by expanding the right tail,” Kostin said. “Our economists’ estimates regarding the potential productivity boost from widespread AI adoption suggest that AI could lift the trajectory of S&P 500 annual average EPS growth over the next 20 years to 5.4%, 50 bp higher than our dividend discount model currently assumes.”
“However, we do not expect this scenario will be fully priced in the near term,” he added. “One reason is that significant uncertainty exists regarding the timing of widespread AI adoption, the boost that adoption may provide to profit growth, and the degree to which regulatory policy, taxes, and interest rates might offset that boost.”
“Furthermore, the narrowness of recent market breadth and the similarity between the current valuations of some AI beneficiaries and the former multiples of the Dot Com Boom leaders suggest that some of this future benefit is already being priced.”
More on the stock market
Now read: The Massive Stock Market Liquidity Drain Has Only Just Begun