What's ahead for US equity markets?

By Market Index
Mon 17 Oct 22, 7:02pm (AEST)
Source: Unsplash

Key Points

  • Goldman Sachs expects equity market performance to continue to mirror uncertainty around inflation
  • The broker is expecting to see a notable decline in corporate margins
  • The broker recommends investors move towards stocks that tend to do well within markets defined by tighter financial conditions

While it's been a bleak year for the US stock market which, despite some short-term rallies, is still firmly entrenched in bear market territory, David Kostin, US equities strategist with Goldman Sachs Research expects equities to move higher and volatility to decline once the path of inflation is clearer.

Meantime, Kostin expects equity market performance to continue to mirror uncertainty around inflation.

Following the recent continuum of short-staged rallies and sell-offs, the S&P500 has been down as much as -25% peak to trough and is currently bouncing around the lower edges of that range.

Having concluded that the Federal Reserve (The Fed) will continue hiking rates between now and early 2023, Goldmans expects the S&P500 to close the year between 3,400 and 3,600 points.

Lurch to cash

Having also concluded that this uncertainty isn’t going to abate any time soon, Kostin is witnessing investors moving from a TINA (there is no alternative) to a TARA (there are reasonable alternatives) mindset.

Kostin notes with the rise in short-term interest rates, cash is starting to look relatively more attractive as an investment.

What investors will be taking particular note of this earnings season, adds Kostin is an anticipated decline in corporate margins.

“With the interest rates on short-term cash positions [alone] starting to approach 4%, [cash has] a pretty attractive rate of return…compared with the risk-adjusted returns you're going to be getting in [the] equity market,” he reminds investors.

“This earnings season will be very consequential… and the idea of a decline in margins is definitely not anticipated by the consensus expectations.”

4% third quarter earnings growth

During third quarter earnings season, which kicked off on 14th of October, Goldmans is expecting earnings growth to be around 4%, with strong benefits from energy companies showing earnings growth of more than 100%.

However, once earning from the energy sector are removed, Goldmans expects earnings to be down around -2%, the first-time earnings have declined since the recovery from the pandemic.

Contrary to consensus expectations, the broker’s analysts expect the strong US$ and higher labour costs to contribute to declining corporate margins, which the US market hasn’t witnessed for some time.

While some major companies have already preannounced negative guidance, Kostin expects similar sentiment to reverberate more broadly within management conference calls following earnings season.

Tilt to higher quality

Kostin recommends investors moving towards stocks that tend to do well within markets defined by tighter financial conditions; including higher bond yields, wider credit spreads, a stronger US$ and lower equity prices.

Companies that tend to do well within this environment, notes Kostin include those with stronger balance sheets, higher return metrics, less drawdown and more stable growth.

“At the start of the year the equity market traded at 21x forward earnings and today the market is trading at 15x forward earnings,” notes Kostin.

“The big multiple compression has been concentrated in particular in the higher growth companies that have de-rated by 50% to 60% and have been heavily concentrated in [long duration] technology stocks.”

S&P500 Index


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