Recession Fears …. If you ask some investors about whether they’re worried about a recession, some would say, “That’s so two weeks ago.” This is demonstrated by the S&P 500’s healthy 4.9% gain last week, which continued into today as the index climbed by as much as 1.25% to 1,941.82 in early afternoon trades. But while the calculated odds of a recession occurring in the next 12 months from among a multitude of sources are dropping rapidly, some are still worried despite the economic data that should put their minds at ease.
Image courtesy Google Finance
So if there is a recession, what will it do to the S&P 500? Goldman Sachs analysts weighed this question in their latest “Weekly Kickstart” report.
Recession Fears: Stock market versus economic recession
Goldman Sachs analyst David Kostin and his team noted that the Financials sector was the best performing last week with an 6.5% gain. Utilities was the worst, although it even managed a 1.7% gain, signaling that investors may be moving past their concerns. For the S&P 500 and all of its sectors to see gains last week is huge for one big reason.
Last week Morgan Stanley’s Ben Britz explained that what we were seeing was a stock market recession rather than an economic recession. This is an important distinction to make because all it takes is a scare that shifts investor sentiment toward the negative to spark a recession in the stock market. It also means that the broader economy isn’t affected and thus, as we’ve noted several times over the last month or so, what we saw was a sort of pseudo-recession that only impacted the stock market and was triggered by fear.
In other words, if the S&P 500 continues to grow, the stock market recession we’ve been observing might be over.
Below-average probability of recession
Kostin and team assign an 18% probability of a recession in the next 12 months and a 24% probability for the next two years. Those figures compare with average probabilities of 24% and 34%, respectively, and the 40% to 50% likelihood others are estimating that the market was pricing in (prior to last week’s gains). It’s important that the distinction be made here again as what they’re looking at is whether an economic recession will happen and if so, what it will do to the S&P 500 or the stock market in general (rather than the other way around).
The Goldman Sachs team also said that even though that don’t think it’s very likely that we will see a recession any time soon, investors are still concerned as they keep inquiring about it.
S&P 500 earnings expected to grow 11%
They’re estimating an 11% increase in earnings for the S&P 500, which would bring it to $117 this year, although interestingly, they’re expecting Energy to contribute more than half of that increase. Excluding the Energy sector, they’re estimating a 5% increase. This past year has been an atrocious one for Energy amid tumbling oil and gas prices, which have sent the sector’s earnings plummeting.
They’re projecting a 2% average expansion in the U.S. economy this year based on their baseline earnings estimates. For the world excluding the U.S., they’re projecting a 3.6% expansion rate.
Recession Fears: How U.S. GDP will impact growth
The Goldman team also looked at various macro components to determine how each would theoretically impact the S&P 500. For example, they think every 100 basis point shift in U.S. GDP growth will have about a $5 per share impact on their earnings forecast for the index if all other macro factors are held constant. On the other hand, if a recession does begin and GDP falls 1% or 300 basis points below their baseline, earnings would be $100 per share or a 6% decline year over year.
Kostin and team add that most investors think the impact from GDP would be worse on the index’s earnings than what it would actually be. They said one reason is because many sectors are not impacted by the economy as Telecom, Utilities, Health Care and Consumer Staples are relatively unaffected by GDP changes.
Interest rates and oil prices
They also say impacts on S&P 500 earnings from interest rates are also quite small with a 100 basis point shift in bond yield having an impact of only about 50 cents per share on overall earnings.
Once again, this impact is much smaller than what most investors expect, although of course it would have a greater impact on Financials. However, the other sectors’ earnings per share offsets approximately 60% of the change in Financials, they estimate.
The Goldman team also said changes in crude prices don’t have much of an impact on earnings either, although similar to how interest rates impact the Financials sector, oil prices’ impact on the Energy sector is offset by earnings contributions from the other sectors. They estimate that for every $10 change in the per-barrel price of crude, there’s a 29% impact on Energy earnings. However, for the full S&P 500, the impact shrinks to $1 per share because earnings from the other sectors offset most of that negative impact.