Doomsday predictions for the US economy have poured into the Federal Reserve’s battle against inflation over the past year. Predictions of an impending “severe recession” from the likes of Elon Musk, or even “another variant of a Great Depression” from New York University economist Nouriel Roubini, have led most Americans to believe that a recession is inevitable this year.
A number of U.S. bank CEOs, including JPMorgan Chase’s Jamie Dimon and Bank of America’s Brian Moynihan, also reaffirmed their fears for the future of the economy last week, arguing in earnings reports that a “mild recession” is likely on the way. is. But Goldman Sachs still predicts a “soft landing” in the US, taming inflation without triggering a recession. Even with the Fed’s aggressive rate hikes raising borrowing costs for consumers and businesses, Goldman believes the economy is strong enough to continue growing.
But the investment bank’s chief U.S. equity strategist, David Kostin, said in a note to clients on Monday that a “soft landing” doesn’t mean investors should flock back to the stock market. Kostin argues that the 2023 S&P 500 will end at 4,000 as there has been no progress from the beginning of the year. And he warned that the path to get there, even without a recession, will see the blue-chip index fall another 10% to 3,600 in the first quarter.
After a “lackluster” earnings season in the fourth quarter, the “trend of weakening corporate profitability” will continue next year due to high interest rates and declining profit margins, Kostin said. And if a recession does come, stocks have a long way to go to fall.
“On a hard landing [the] S&P 500 could fall 34% to 3,150,” Kostin wrote, noting that “S&P 500 peak-to-trough declines an average of 30% during recessions.”
A call without consensus
Goldman Sachs chief economist Jan Hatzius explained his “out of consensus forecast” for a “soft landing” this year in an interview with the Atlantic Council last week, arguing that US GDP will increase by 1% in 2023 for a few key reasons.
First, he noted that inflation expectations — or how much consumers expect prices to rise — remain “well anchored,” meaning overall inflation should continue to slow in the coming months. In previous periods of high inflation, consumers’ fear that prices would continue to rise led them to demand higher wages, which in turn kept inflation high. Hatzius said that in 1979, public inflation expectations were around 10%, but in January they fell to just 4%, according to the University of Michigan.
Second, Hatzius expects real disposable income — inflation-adjusted after-tax earnings available to spend — to rise 3% over the next year as inflation falls, which should keep the economy growing at a slow pace. Third, he argued that there will be some “free” sources of disinflation, including diminishing pandemic-induced supply chain problems and rent increases, which will offset higher prices for other things.
Finally, Hatzius said the delayed effects of the Fed’s rate hikes, which many on Wall Street have been warning about, are already showing and the economy will have weathered its worst “resistance” by the end of the first quarter. Some economists and business leaders argue that only interest-rate sensitive sectors like the housing market have so far really felt the effects of the Fed’s rate hikes. They say it takes time for other sectors, such as manufacturing, to experience some impact, but not for Hatzius.
All this means Wall Street’s consensus forecast of a 65% chance of a recession in the next 12 months is too pessimistic, he argued.
“We estimate that number to be about 35%,” he said. “Which is not low. It’s certainly two or three times the normal chance in any given year, but clearly lower than the consensus.”
A ‘soft landing’ and ‘hard landing’ portfolio
With so much discussion about a potential recession in the US, Kostin laid out two sample portfolios in his Monday note for investors to prepare for any outcome.
In one portfolio, investors can “hope for the best” with a basket of stocks that should outperform the market as a whole if the US avoids a recession, including some growth-oriented stocks. In another, they can “anticipate the worst” with more defensive stocks.
Kostin said he favors sectors that are “isolated” from the risk of slowing economic growth and high interest rates, including energy, health care, telecom services and consumer staples, regardless of portfolio. But the focus of his soft-landing basket is on companies with “low valuations and strong balance sheets.”
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