GOLDMAN SACHS: The stock market will become a drag on the booming US economy in 2019, and there's one way traders can safeguard their portfolios right now
- The stock market is poised to swing from being a boost for the US economy to becoming a drag in the first half of next year, according to strategists at Goldman Sachs.
- They used a proprietary Financial Conditions Index to gauge the impact of stock prices and other variables on gross domestic product.
- They further offered a recommendation for traders as stock-market volatility picks up.
When does a stock-market plunge become damaging to the economy?
That's a question that economists at Goldman Sachs, like many financial pros, have pondered amid the market's rout in October.
Their answer indicates that stocks are set to shift from having a neutral effect on gross domestic product to becoming a drag in 2019.
"Looking ahead, our baseline expectation is a decline in the equity impulse to real GDP growth to about -0.25pp in the first half of next year," Jan Hatzius, the chief economist at Goldman, said in a recent note to clients.
The pass-through from stocks to the economy happens through the tightening or loosening of financial conditions. Hatzius and his colleagues devised a proprietary Financial Conditions Index (or FCI) to examine how variables including equity valuations, credit spreads, risk-free interest rates, and exchange rates impact US GDP.
For examples of what the index's pass-through to the economy looks like, Hatzius pointed to the aftermath of the tech bubble in 2001, when mass losses of wealth in the stock market fed through to consumer spending. Additionally, he recalled how the strong dollar weakened US exports in 2015.
When stocks rocketed this year just before the February correction, their prices pushed Goldman's index to record-easy financial conditions. Among all the variables that go into the FCI, stocks contributed the lion's share.
However, as stocks pulled back from the all-time highs they set in September, financial conditions tightened.
Hatzius estimates that if the S&P 500 finishes the year at 2,850 and earnings per share is at $159 - corresponding with the equity strategy team's year-end targets - stocks would swing from having a neutral impact on growth to dragging GDP by about 0.25 percentage points.
If the index rebounds and hits 3,350 by the end of next year, Hatzius estimates a 0.25-percentage-point boost to growth.
But in a worse scenario, where stocks plunge 15% below their September high, the drag on growth would worsen to -0.75 percentage points.
The bear case is not Goldman's base expectation, but the firm says it's a risk worth watching.
That's partly because it already expects a slight slowdown in US economic growth next year to 2.6% year-on-year. Markets will likely be rattled by such a slowdown, and S&P 500 volatility should pick up, Goldman's Allison Nathan said in a separate note to clients.
"So while we still expect positive equity returns ahead, investors may do well to seek out options-based hedging strategies," she said.