Now that we’ve entered the final month of trading for 2016, it’s time for Goldman economist David Kostin to opine on what will happen in 2017 (mind you we still don’t know for certain if the Fed will hike or not this month, although it does appear fairly certain they will.) Following a tough 2016 that has beaten analysts down to the point of losing their minds, Kostin believes 2017 will see the S&P 500 reaching 2400 in Q1 before fading out to 2300. He still believes Op EPS growth will be 10%. The breakdown of his outlook comes in two parts, Hope and Fear. His “Hope” is geared toward “positive EPS revisions from lower corporate taxes, repatriation of overseas cash, less regulation, and fiscal stimulus.” On the other side, Kostins fears the restrictive nature budget deficits can have on tax reforms, along with rising inflation forcing the Fed to “tighten promptly”, and a continued rise in bond yields.
Kostin “fundamentals” breakdown is as follows:
- Economy: In 2017, US GDP will grow by 2.2%; PCE inflation will climb to 1.8%, and GS economics forecasts 1.4% fed funds by year-end.
- Earnings: Operating EPS will rise by 10% to $116 while adjusted EPS rises 5% to $123. Repatriated cash will help buybacks jump by 30%.
- Valuation: S&P 500 index trades at an elevated valuation (85th percentile) on most metrics. Median stock trades at the 98th percentile.
- Money Flow: Potential upside risk as investors shift assets away from bonds as rates rise and into domestic stocks as USD appreciates.
And his “strategies” breakdown:
- High US sales: Constituents have 100% US sales (vs. 73% for S&P 500) and are insulated from FX headwinds and trade policy risks.
- High tax rates: Constituents have the highest effective tax rates for past decade (38%) and will benefit from tax reform.
- Low labor costs: Stocks with low labor costs as % of sales (3%) should be insulated from a rising wage inflation environment.
- Strong balance sheets: Stocks with strong balance sheets (high Altman Zscores) will benefit in a rising rate regime.
Furthermore, Kostin sees the spread between operating EPS and adjusted EPS tightening further $12 to $7 and remaining at $7 for the next couple years. He also believes that 2.1% US GDP growth (which is much lower than what the Atlanta Fed’s GDPNow forecast was lowered to just last week) will contribute $5 to the S&P 500 pperating EPS estimate which he sees being $116/share in 2017.
At the end of the day however, it’s strickly demand that moves prices, not the fundamentals as we have learned, and Kostin is most bullish after witnessing an unprecedented in-flow of capital into equities which resulted in a massive ramp to Goldman’s proprietary Rotation Index indicator:
Surprisingly enough, after nearly a decade of this Fed driven rally, the strong balance names are the laggards, so should we be expecting all this investor demand for stocks to be contained to only the weak balance sheet firms?
As more and more people pile into stocks, remember, we’ll all get out in time once the market realizes it is upside down and backwards in it’s anlaysis.
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