Bank of America and Citigroup have lowered their U.S. corporate profit forecasts while pointing out the risk of a recession as trade tensions escalate.
Savita Subramanian, who heads the U.S. equity strategy team at BofA, cut her 2019 estimate for S&P 500 companies by $2 a share to $166, saying import tariffs are set to increase costs, hurting profits for American firms. Tobias Levkovich, chief U.S. equity strategist at Citi, trimmed his projection by the same amount, to $170 a share.
They’re among the first Wall Street strategists to lower their estimates since President Trump last month escalated a trade war with China and threatened tariffs on all Mexican goods unless the country steps up its fight against illegal immigration. While neither revised their year-end price targets for the S&P 500, both BofA and Citi discussed the prospect of the worst-case scenario, where trade tensions trigger a recession.
“Globalization has benefited S&P 500 margins for decades, and protectionism coupled with rising wages/input costs, pose risks to peak margins,” Subramanian wrote in a note to clients. “The indirect negative impacts from trade tensions (consumption, capex, confidence hits, Huawei ban, oil, …) are likely more extreme than direct impacts. Worst case -- an economic recession -- typically sees average peak-to-trough EPS declines of ~20%.”
The Trump administration’s trade clashes around the world are occurring at a time when U.S. profit growth is already grinding to a halt. Earnings in the S&P 500 came very close to falling in the first quarter. And it doesn’t get any easier from here. Analysts expect growth to be virtually zero for this quarter and next, and the last thing bulls needed was an exogenous trauma making it worse.
While a recession is not Citi’s base case, the bank’s study on market cycles over the past seven decades showed an economic downturn has usually coincided with profit declines and equity sell-offs. Specifically, earnings fell 16% on average in that environment while the S&P 500 tumbled a median 24%.
Earnings estimates could go lower still because of the trade war, but Levkovich is sticking to his projection that the S&P 500 may hit a fresh record of 3,000 by the middle of next year. The pullback may prove nothing more than a correction, he said.
“Investors have been asking us about downside risk versus upside potential, which is different from late April when complacency was evident,” Levkovich wrote in a note. “In the course of a typical 10% correction, one could envision a dip to 2,650 from the recent high of 2,945. And with upside appreciation potential of 3,000 by mid-2020, the market is getting intriguing.”
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