Goldman's Kostin Sees Buyback Break Threatening Stock Rally

Tom Lee Makes Bullish Case for the S&P 500
  • Strategist says stocks need more than central-bank help
  • Says S&P 500 will add just 1.6 percent to 2,100 by year-end

The rapid recovery in the U.S. stock market is more likely to falter before it gets a second wind, according to Goldman Sachs Group Inc.’s David Kostin.

That’s because a 13 percent rally fueled by firming economic data and a dovish Federal Reserve may not be enough to withstand a third straight quarter of declining corporate profits and a stretch where the market loses its main source of demand -- corporate buybacks. For Kostin, chief U.S. equity strategist at the firm, that means the S&P 500 is likely to pull back in the short-term and rise just 1.6 percent over the final nine months of the year.

“When we think about the path, the risk would be near-term lower rather than higher,” Kostin said by phone. “We’d say the next month would be weaker rather than stronger because you have no corporate repurchases, which are a key source -- the only source -- of demand for shares. Then you’ve got your core earnings, which are likely to be muted. So there’s an absence of drivers for why the market goes higher.”

Kostin estimates the benchmark gauge will end the year at 2,100, or 1.6 percent higher than Monday’s close of 2,066.13. His projection puts him in line with the median estimate of 21 strategists surveyed by Bloomberg, which calls for an increase by the S&P 500 to 2,150. Futures on the index fell 0.7 percent at 8:21 a.m. in New York.

Poised to repurchase as much as $165 billion of shares in the first quarter, U.S. companies have been the biggest source of demand for stocks in 2016. The buying contrasts with selling by mutual and exchange-traded funds, who as of March 14 were on pace for one of the biggest quarterly withdrawals on record. Buybacks are customarily suspended during the five weeks before companies report quarterly results, the bank has said.

Investors are unlikely to get much help from the actual earnings results either, Kostin said. With Alcoa Inc. unofficially kicking off the reporting season in one week, analysts project profits to fall 9.5 percent in the first quarter.

“Traditionally you get price-earnings expansion when you have falling bond yields and falling inflation and our view is the basic trend will be higher inflation and bond yields moving higher not lower,” he said. “With earnings growth flat from two years ago, I find it hard to argue why you get expansion in that environment.”

While Kostin’s view for 2,100 by year-end operates on the assumption the Federal Reserve will hike rates three times before the end of the year, the strategist said there is “less conviction around that then there was a week ago,” following Fed Chair Janet Yellen’s comments on March 29. 

Meanwhile, derivatives strategists at Goldman Sachs said Monday that the dovish outlook by Yellen is one reason why volatility in stocks will remain subdued. The Chicago Board Options Exchange Volatility Index, known as the VIX, slumped to a seven-month low of 13.1 on Friday. Accommodative central bank policy, strengthening economic data and a lack of foreseeable catalysts will keep the VIX in the “low teens” before it maybe rises in the second half of 2016, said Krag Gregory in a report.

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