Goldman’s Bear Case In 7 Steps: “We Are In The 98th Percentile Of Historical Valuations”

Having been on the fence about an upside case for the S&P for the greater part of 2016, Goldman’s chief equity strategist David Kostin finally threw in the towel earlier this week when, as we reported, Goldman raised its S&P price target from 2,100 (as of year end 2016) to 2,400 for mid-year 2017 on what it calls “Trump Hope” (as apparently does everyone else, see “The World Has Changed” – Average S&P Target Before Trump: 2,087; After Trump: 2,425“), which it then sees dipping to 2,300 by year-end 2017 on “Trump Fear.”
Having explained what “Trump Hope” means before, here is a quick recap of what “Fear”, according to Goldman Sachs whose former partner Steve Mnuchin will be running the US Treasury, looks like: by mid-2017 inflation will reach the Fed’s 2% target, labor costs will be accelerating at an even faster pace, and policy rates will be 100 bp higher than today. Rising inflation and bond yields typically lead to a falling P/E multiple. Congressional deficit hawks may constrain Mr. Trump’s tax reform plans and the EPS boost investors expect may not materialize. Potential tariffs and uncertainty around other policy positions may raise the equity risk premium and lead to lower stock valuations in 2H.
And here are the details, where as Goldman politely puts it, is where the “devil is to be found.” First, as Goldman warns, while investors have been focusing on the prospect of a lower statutory corporate tax rate, the firm’s US economist Alec Phillips notes that it will likely come with provisions that will offset much of the benefit of a lower rate. For instance, under the House Republican plan, several corporate tax incentives, such as the interest expense deduction, would be repealed. Furthermore, the plan proposes a redefinition of foreign and domestic income based on where sales, rather than production, occurs. Furthermore, under Mr. Trump’s plan, the deficit as a percentage of GDP would jump from 3.2% in 2016 to 5.0% in 2017 and 6.1% in 2018. The annual deficit will rise from a projected $590 billion in 2016 to $960 billion in 2017 and $1.2 trillion in 2018. Our US economics team has a more restrained baseline forecast that projects the deficit as a percentage of GDP will be 3.4% in 2017 and 4.0% in 2018 while the deficit will total $650 billion in 2017 and $800 billion in 2018.

This post was published at Zero Hedge on Dec 3, 2016.