McGraw-Hill vs. Goldman: The Redux
On April 18th, I posted this note about Goldman’s take on S&P’s outlook change on US debt.
There is a saying in Telugu, “dongalu dongalu oollu panchukunntlu” (Just like thieves divided the villages among themselves to rob). True to this age old maxim, Wall Street banks and the ratings agencies robbed us of our retirement nest eggs, drove most of us jobless, and kicked us out of our homes in a collaborative manner. No matter what they do now, they are not going to be trusted or respected by those with an iota of sense.
If ratings agencies were to be trusted, today would be a watershed event. S&P just downgraded US debt outlook to “Negative” from “Stable” citing a “material risk that US policy makers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013” and concern that even once agreement is reached, it might still “take a number of years before the government reaches a fiscal position that stabilizes its debt burden.”
Duh!A big Duh!
This time, their collaborative thieves at Goldman Sachs disagree with S&P. From Zero Hedge:
Not surprisingly, after eagerly pushing rating agency opinions to clients buying CDOs from Goldman, the firm’s economists are now eagerly trying to talk it down: “Clearly, the US fiscal situation is unsustainable unless a large, multi-year fiscal tightening is implemented. However, there is no information in today’s report about the fiscal situation that was not already known. Academic research has generally found that rating agency actions lag market pricing, rather than lead it. Any relevance of today’s announcement is a) as a potential catalyst for renewed market focus on these issues, particularly if the other agencies follow suit, b) a signal of a nonzero probability of an outright ratings downgrade over the next few years.” And who was the research conducted by? Moody’s? A Princeton Ph.D. academic? Yes, we know the country is screwed. But we can sure do without this condescending BS.
They say there is honor among thieves. But these thieves, are something!
Goldman didn’t appear to say much on the actual downgrade itself. However, they cut S&P 500 targets. Here is Goldman’s reaction.
We reduce our 2012 S&P 500 earnings forecast to $102 per share (from $104) and lower our year-end 2011 price target to 1400 (from 1450) due to downward revisions of GDP growth estimates in the US, Europe, and Asia, along with our commodity strategists’ 2012 Brent crude oil forecast of $140/barrel. Our 2012 global GDP growth estimate is now 4.4%, down from 4.6%. We maintain our 2011 EPS forecast of $96 based on strong earnings momentum in 1H 2011 despite weaker than expected economic growth. We expect 15% S&P earnings growth in 2011 and 6% in 2012 driving 17% upside for the index through year-end 2011 and 21% return for the next 12 months.
We expect profit margins to peak in 2011 at a level slightly below our previous estimates. Our estimates for S&P 500 margins remain 8.9% in 2011 and are now 8.7% in 2012, down from 8.8%. That view differs starkly from bottom-up consensus expectations for 9.1% margins in 2011 rising to 9.6% in 2012. We now forecast margins will decline in five sectors including Materials, Information Technology and Consumer Discretionary.
We lower our S&P 500 sales per share estimate by 1% to $922 ex-Financials and Utilities. Our revenue growth forecasts are now 10% in 2011 and 7% in 2012 and are generally in-line with consensus expectations for 12% growth in 2011 and 6% sales expansion in 2012. The most notable change in our sector sales estimates a -4% revision in Materials sector.
Commodity prices remain a headwind. Goldman Sachs Commodities Research’s forecast for Brent crude to rise 21% to $140/barrel by year-end 2012 is premised on the view that global GDP growth above 3.5% will create a supply-demand imbalance and push oil prices higher until demand rationalizes. High oil prices boost our aggregate sales estimates, benefiting the Energy sector at the expense of lower sales and margins for other US firms.
The current S&P 500 correction is the 15th such pullback since 1975. The index stands 12% below the April 2011 high of 1364, so the drop is 620 bp smaller than the median correction of the past 35 years. At 97 days, the current episode is in-line with the average duration of past corrections.
Multiple contractions during prior market corrections suggests the current forward P/E multiple of 11.3X could be near a valuation-multiple bottom: (1) during the financial crisis, S&P forward P/E bottomed at 10.8X in October 2008; (2) in April 2010 the P/E reached 11.5X as the market digested Europe sovereign credit concerns and slowing US growth; and (3) our uncertainty-based P/E estimate suggests a fair P/E between 9X and 11X. If we are nearing valuation support levels, continued downside risk wouldshift to earnings estimate revisions as well as attendant macro risk premium.
Hey, it comes from the best and the brightest on planet Earth, so it must be accurate. Right? Just as a reminder, I present this chart once again.
Forget the fact that Goldman disagreed with S&P outlook in April. This time, for all you know, Goldman forecast may prove accurate.
Nevertheless, caveat emptor.