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The Tell: Shrinking margins could spell trouble for stock-market returns: Goldman Sachs

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Shrinking margins are a downside risk to stock-market returns as hotter-than-expected inflation readings and what’s expected to be another outsize interest-rate hike bring mounting uncertainties to earnings, according to Goldman Sachs strategists. 

Last week’s hot inflation print “stoked concerns about the outlook for equity valuations and profitability,” wrote strategists led by David Kostin, chief U.S. equity strategist. The analysts expect the S&P 500’s SPX net profit margins “will contract by 25 bp (basis points) in 2023 to 12%, alongside positive but decelerating economic growth,” they said, in a Sept. 16 note.

The consensus expects the index’s net profit margins to climb to a new high of 12.8% in 2023, according to FactSet data, but Goldman strategists believe these forecasts are “too optimistic and will be cut”. 

The S&P 500 ended last week below the 3,900 level, which was viewed as an important area of technical support and could trigger a deeper slide to the index’s 2022 low at 3,666.77 set on June 16. The S&P 500
SPX,
+0.52%

suffered a 4.8% weekly fall, while the Dow Jones Industrial Average
DJIA,
+0.51%

logged a 4.1% drop and the Nasdaq Composite
COMP,
+0.56%

declined 5.5%.

See: ‘Some twisted logic about valuation multiples’: Stock-market investors appear complacent as rates rise, warns Morgan Stanley

Meanwhile, Morgan Stanley’s Michael Wilson, one of the Wall Street’s most vocal bears who correctly predicted this year’s stock market selloff, suggested that “reality” has not been priced in yet, as “investors may face a volatile path in the absence of an ‘event’ to clear the decks”. 

The S&P 500 rallied off the June lows and reached a high of 4,305 in mid-August, but then the retreated back below its 50-day moving average (see chart below). According to strategists led by Wilson, it is not a good sign. 

SOURCE: BLOOMBERG, MORGAN STANLEY RESEARCH

“We are oversold again and that means bear market rallies can continue to occur in the absence of a market clearing event that forces capitulatory behavior,” wrote Wilson in a Monday note. “We remain bearish both fundamentally and technically on a 3-month basis, more neutral on a 9-12 month basis and open minded on a day-to-day basis.” 

“With that backdrop, we continue to recommend owning more defensively oriented companies with earnings stability and high operational efficiency,” he added.

See: Stocks may be headed for more pain as second half of September is historically ‘very bearish’

U.S. stocks were struggling for direction on Monday, as investors await the central bank’s meeting that kicks off Tuesday. Markets are pricing in a hike of 75 basis points, with futures showing a 18% chance of a full percentage point increase, according to CME’s FedWatch Tool. The Federal Reserve is expected to make its decision on Wednesday at 2 p.m. Eastern, followed by a press conference from Chair Powell.

The Dow Jones Industrial Average and the S&P 500 were each flat in late afternoon trading on Monday, while the Nasdaq Composite gained 1%.

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