Goldman Sachs says earnings look better, but the stock market doesn't

Myles Udland
Markets Reporter

Corporate earnings are set to improve into next year. But that might not do anything to help the fortunes of the stock market.

In a note to clients published late Wednesday, David Kostin and the equity strategy team at Goldman Sachs increased their forecast for corporate earnings in each of the next three years but did not increase their price target for the S&P 500.

“We raise our S&P 500 earnings estimates for each of the next three years,” Goldman writes.

Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., May 1, 2018. REUTERS/Brendan McDermid

“Economic growth, oil prices, and tax rates have been better than expected in 2018 and EPS will surge by 19% to $159. Profit growth will decelerate to 7% ($170) in 2019 followed by 5% growth to $178 in 2020. Our estimates trail bottom-up consensus growth of 21%, 10%, and 9%, respectively.”

All of which sounds good. Except that Goldman does not see this rewrite of the firm’s earnings forecast worthy of an increase in its price target for the S&P 500.

“Our forecast trajectory of the S&P 500 remains unchanged,” Goldman adds. “We expect a modest 3% rise to our year-end target of 2850 followed by a 5% gain in 2019 to 3000.”

So while Goldman expects the stock market to continue rising modestly, better earnings are not going to be the fuel that sends stocks another leg higher.

“The US economy is growing, corporate profits are rising, and stock prices should continue to climb through 2019,” Goldman writes. “However, the appreciation potential will be constrained by tightening monetary policy, a flattening yield curve, rising trade tensions, and the upcoming mid-term Congressional elections.”

On Thursday, stocks were lower across the board with the S&P 500 down about 0.5%. Year-to-date, the benchmark index is up 3%.

Double-digit earnings growth isn’t always a good sign for stocks

Goldman also isn’t the only firm to increase earnings forecasts without translating this improved profit outlook into necessarily higher stock prices.

In a late-May note to clients, Jonathan Golub at Credit Suisse upped his earnings expectations for this year and next for S&P 500 companies but held his year-end price target for the index steady at 3,000.

And both of these updates make us recall an observation made by Bank of America Merrill Lynch at the beginning of this year, which is that in years that stocks decline, earnings are up double-digits 50% of the time.

This year’s stock market — which has been choppy and frustrating for those not overweight tech stocks — may be confounding to some on the back of strong earnings. But history indicates this is not all that unique.

And why strong earnings don’t always translate into great years for the stock market shouldn’t come as a shock to many. Because if the stock market really is discounting future growth, by the time we get around to actually seeing companies do well, all that success has already been priced in. And the inevitable downturn has drawn nearer.

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland