The U.S. stock market has been in a tight trading range for months, as investors await clarity on the uncertain state of the country’s relationship with its biggest trading partners.
Trade is key issue investors are grappling with, and its lack of resolution is preventing major indexes like the Dow Jones Industrial Average DJIA, -0.77% or the S&P 500 SPX, -0.71% from breaking out of that range in either direction. Should the tense relationships deteriorate into a full-on trade war, that is seen as having a markedly negative impact on the economy and corporate profits. Should it be resolved with little additional pain, however, there’s enough positive momentum in terms of economic data and demand that shares could continue pushing higher.
Goldman Sachs currently has a year-end price target of 2,850 for the S&P 500, which represents a gain of just 0.6% from Friday’s closing level. It also sees 2019 S&P earnings of $170.
The investment bank, however, has highly divergent bull and bear scenarios, depending on how the trade situation develops.
In the bear case, marked by an “escalation of trade friction,” earnings would drop from $170 to $159 next year, a decline of 6.5%. Furthermore, the S&P would be expected to end 2018 at 2,380, or 16% below current levels. A drop of that magnitude — considering the S&P is 1.4% below records — would almost be enough to push the benchmark index into bear-market territory, defined as a 20% decline from a peak.
“If trade conflict continues to escalate and a 25% tariff is levied against all imports from China then our 2019 EPS estimate would be reduced by 7% to $159, eliminating all expected EPS growth for 2019,” the investment bank wrote in a note to clients.
Last week, UBS calculated that if the trade issue were to simply escalate, U.S. economic growth would be 1% lower than it would be otherwise, while global growth falls 42 basis points (0.42%). In the more severe possibility of a trade war, on the other hand, 245 basis points is expected to be cut from U.S. growth, while global growth would be expected to be 108 basis points lower.
Read: Another stock market risk: GDP growth is slowing across the globe
The flip side of that scenario is dramatically different. In the bull case, where “trade tensions ease, the Fed hikes only 2-3 more times, and growth remains strong,” next year’s earnings could grow to $170, while the S&P ends this year at 3,150, or 11.2% above current levels.
The firm, led by David Kostin, its chief U.S. equity strategist, wrote, “Trade risks aside, S&P 500 fundamentals are strong.” The report noted that the second-quarter earnings season was extremely strong, with profit growth of 25%, matching the first quarter for the fastest pace of growth in seven years.
“Not only was the magnitude of EPS growth strong, 56% of firms beat consensus estimates, the highest percentage since 1Q 2010. Moreover, the number of stocks missing EPS expectations was the lowest since 2010, coming in at only 9%.”
Other investment banks are more cautious on the U.S. stock market. Morgan Stanley recently cautioned that investors should prepare for the biggest selloff in months, with the bull market in its “last innings.” In particular, Morgan Stanley expects “a breakdown in both legs of momentum,” which it warned “could be a trigger for a significant market correction.”
Thus far this year, the Dow is up 2.4%, the S&P is up 6%, and the Nasdaq Composite Index COMP, -0.67% — boosted by gains in large-capitalization internet and technology stocks — is up 13.4%.
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