Doomsday forecasts for the U.S. economy have flooded in over the past year amid the Federal Reserves battle against inflation. 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 a downturn is inevitable this year.
A number of U.S. bank CEOs, including JPMorgan Chases Jamie Dimon and Bank of Americas Brian Moynihan, confirmed their fears about the economys future last week as well, arguing in earnings reports that a mild recession is likely on the way. But Goldman Sachs is still forecasting a soft landing in the U.S.whereby inflation is tamed without sparking a recession. Even with the Feds aggressive interest rate hikes raising borrowing costs for consumers and businesses, Goldman believes the economy is strong enough to continue growing.
But the investment banks chief U.S. equity strategist, David Kostin, said in a note to clients on Monday that a soft landing doesnt mean investors should flock back to the stock market. Kostin argues the S&P 500 will end 2023 at 4,000, having made no progress at all from the start of the year. And he warned that the path to get there, even without a recession, will take the blue chip index down another 10% to 3,600 in the first quarter.
After a lackluster fourth-quarter earnings season, the trend of weakening corporate profitability will continue next year due to high interest rates and falling profit margins, according to Kostin. And if a recession does come, stocks have a long way to fall.
In a hard landing, [the] S&P 500 could fall by 34% to 3150, Kostin wrote, noting that S&P 500 peak-to-trough declines average 30% 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 U.S. GDP will rise 1% in 2023 for a few key reasons.
First, he noted that inflation expectationsor how much consumers expect prices to riseremain well anchored, which means overall inflation should continue to slow in the coming months. In previous periods of high inflation, consumers fears that prices would continue to rise led them to demand higher wages, which in turn, kept inflation elevated. 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 incomeinflation-adjusted after-tax income available for spendingto rise 3% over the next year as inflation falls, which should enable the economy to continue slowly growing. Third, he argued that there will be a few freebie sources of disinflation, including fading pandemic-induced supply chain problems and rent increases, that will offset higher prices for other things.
Finally, Hatzius said that the lagged effects of the Feds rate hikes that many on Wall Street have warned about are already here, and the economy will be past the worst of the drag by the end of the first quarter. Some economists and business leaders argue that only interest rate sensitive sectors like the housing market have truly experienced the effects of the Feds rate hikes so far. They say that it takes time for other sectors, like manufacturing, to experience any impactbut not Hatzius.
All of this means that the Wall Streets consensus forecast for a 65% chance of a recession over the next 12 months is overly pessimistic, he argued.
We put that number at about 35%, he said. Which is not low. Its 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 potential recession in the U.S., Kostin laid out two example portfolios in his Monday note that could allow investors to prepare for any outcome.
In one portfolio, investors can hope for the best with a basket of stocks that should outperform the overall market if the U.S. avoids a recession, including some growth-focused stocks. In another, they can anticipate the worst with more defensive stocks.
Kostin said he prefers sectors that are insulated from the risk of fading economic growth and high interest rates including energy, healthcare, telecom services, and consumer staples no matter the portfolio. But the focus of his soft landing basket are companies with low valuations and strong balance sheets.
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