David Kostin, the chief US equity strategist at Goldman Sachs, thinks there is good news coming in 2017, but investors shouldn’t be complacent.
Kostin and his team project that the S&P 500 will rise to 2,400 next year, though a late sell-off will bring the index down to 2,300 by year-end. Still, even that latter figure is a nearly 100 points above where the index stands today.
This solid outlook, however, does come with some caveats. As part of a note detailing their 2017 projections, Kostin and company pointed out three things that scare them and could weigh down markets.
The three fears are:
- “Rising budget deficit limits tax reform”: Trump has long been an advocate of corporate and personal tax reform. His pick for Treasury Secretary, Steven Mnuchin, said that corporate tax reform is priority number one. While the plan is sure to get pushback from Democrats, many deficit-focused Republicans may not be willing to slash rates down as low as Trump wants for fear of losing too much revenue. In fact, Goldman projects that a full implementation of Trump’s pan would cause the deficit to balloon to $1.2 trillion in 2018. Concern over the debt may prevent the full impact of tax reform from getting to corporations.
- “Rising inflation prompts the Fed to tighten steadily”: With core PCE inflation just above 1.7%, it appears that inflationary pressures are nearing the Federal Reserve’s goal of 2%. Even market-based measures of expected inflation have rebounded, as noted by Kostin. Thus, given the possibility of Trump’s stimulus in an already tight labour market and trade restrictions, inflation could push above the Fed’s goal. While Chair Janet Yellen has said she is willing to let inflation run hot, the Fed could see these inflationary pressures as worrying and raise rates faster than the market expects.
- “Bond yields continue to rise”: The carnage in the bond market has gotten gnarly since the election of Trump, with US Treasury yields hitting multi-year highs across the maturity spectrum. A continued sell-off would indicate the market sees a higher chance of rising interest rates and increased borrowing costs for companies.
While these aren’t necessarily the base case for Kostin, it’s always good to keep an eye on what could go wrong in order to avoid pitfalls.