Goldman Sachs believes the economy will indeed make a soft landing – but adds that the S&P will be flat for a full year

Doomsday forecasts for the US economy have been inundated over the past year amid the Federal Reserve’s fight against inflation. Predictions of an impending “severe recession” by figures like Elon Musk, or even “another flavor of a Great Depression” by New York University economist Nouriel Roubini, have led most Americans to believe a downturn is inevitable this year.

A number of US bank CEOs, including JPMorgan Chase’s Jamie Dimon and Bank of America’s Brian Moynihan, also confirmed their fears about the future of the economy last week, arguing in earnings reports that a “mild recession” was likely to loom. However, Goldman Sachs continues to forecast a “soft landing” in the US – one in which inflation is tamed without triggering a recession. Even as the Fed’s aggressive rate hikes increase the cost of borrowing for consumers and businesses, Goldman believes the economy is strong enough to continue growing.

But the investment bank’s chief US equities strategist, David Kostin, said in a note to clients on Monday that a “soft landing” does not mean investors should flock back to the stock market. Kostin argues that the S&P 500 will end at 4,000 in 2023 after making no progress since the beginning of the year. And he warned that even without a recession, getting there will see the blue-chip index fall another 10% to 3,600 in the first quarter.

After a “lackluster” fourth-quarter earnings season, Kostin says the “trend of weakening corporate profitability” will continue next year due to high interest rates and declining profit margins. And if a recession does happen, stocks still have a long way to go.

“On a hard landing [the] The S&P 500 could fall 34% to 3150,” Kostin wrote, noting that “the S&P 500 declines an average of 30% peak to trough during recessions.”

An out-of-consensus call

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 in 2023 will be off will increase by 1% for a number of important reasons.

First, he noted that inflation expectations – or how strongly consumers expect prices to rise – remain “well anchored”, meaning headline inflation is likely to decelerate further in the coming months. In previous periods of high inflation, consumers’ fears that prices would continue to rise prompted them to demand higher wages, which in turn kept inflation high. Hatzius said public inflation expectations were about 10% in 1979, but in January they fell to just 4%, according to the University of Michigan.

Second, Hatzius expects real disposable income — the after-tax inflation-adjusted income available for spending — to rise 3% next year as inflation falls, which should allow the economy to continue growing slowly. Third, he argued that there will be some “free” sources of disinflation, including easing pandemic-related supply chain problems and rent increases that would offset higher prices on other things.

Finally, Hatzius said the lagged impact of the Fed’s rate hikes, which many on Wall Street have been warning about, is already here and the economy will be through the worst of its “cushion” by the end of the first quarter. Some economists and business leaders argue that only interest-rate-sensitive sectors like the housing market have really felt the impact of Fed rate hikes so far. They say it will take time for other sectors like manufacturing to have an impact – but not Hatzius.

All of this means that Wall Street’s consensus forecast of a 65 percent chance of a recession over the next 12 months is overly pessimistic, he argued.

“We estimate that number to be around 35%,” he said. “That’s not a little. It’s definitely two or three times the normal probability in any given year, but obviously lower than the consensus.”

A soft landing and hard landing portfolio.

With so much debate surrounding a possible US recession, Kostin laid out two sample portfolios in his Monday note that could allow investors to prepare for any outcome.

In a portfolio, investors can “hope for the best” with a basket of stocks that should outperform the broader market if the US avoids a recession, including some growth-oriented stocks. On the other hand, they can “anticipate the worst” with more defensive stocks.

Kostin said he prefers sectors that are “insulated” from the risk of slowing economic growth and high interest rates, including energy, healthcare, telecom services and consumer staples, regardless of the portfolio. But the focus of his “soft landing” basket is on companies with “low valuations and strong balance sheets.”

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