Don’t buy the stock dip yet, says Goldman as it warns coronavirus will wipe out earnings growth this year

Wall Street’s big banks have clearly had enough time to chew over the potential fallout for investors from the coronavirus epidemic and some are advising against dipping a toe in turbulent market waters right now.

Count Goldman Sachs among them as strategist from the bank told clients Thursday that they expect the S&P 500 SPX, -4.42% to fall to 2,900 in the near term — a 7% drop from Wednesday’s close — as investors start to believe that a widespread outbreak is inevitable. Investors braced for another day of selling on Wall Street might take some comfort, though, from the fact Goldman sees the index rebounding to 3,400 by year’s end.

The week has been brutal, with the S&P’s five-day loss at nearly 8%, the biggest decline over that many days since February 2018.

Strategist David Kostin and his team looked at the gap between the earnings yield and the 10-year U.S. Treasury yield TMUBMUSD10Y, -3.87% — 427 basis points, versus a long-term average of 230 basis points. If that coronavirus contagion view takes hold, that gap will widen to 500 basis points. Assuming the bond yield drops to 1%, that leaves a forward price/earnings ratio of 16.7 times for the index and the S&P at 2,900, he said.

Read: 10-year Treasury yield pushes below 1.30%, falling further into record territory

The team also has a gloomy assessment of earnings growth, forecasting no growth in 2020 — cutting 2020 earnings per shares estimates to $165 from $174 and 2021 estimates to $175 from $183.

“Our reduced forecasts reflect the severe decline in Chinese economic activity in 1Q, lower end-demand for U.S. exporters, supply chain disruption, a slowdown in U.S. economic activity, and elevated uncertainty,” said Kostin and the team.

But this assumes a short-term impact from the epidemic, and in the worst-case scenario, if the U.S. gets pushed into a recession, S&P 500 index company earnings could fall 13% for 2020, based on history, warned Kostin.

Goldman suggests investors hide out in defensive stocks, which traditionally hold up well in a downturn. They updated their recommendations on several sectors — lifting real estate to overweight from neutral, utilities to neutral from underweight, cutting industrials to neutral from overweight and financials to underweight from neutral.

Elsewhere, Citigroup’s global macro strategist Jeremy Hale and his team said “things may have to get worse before they get better” for the COVID-19 driven risk asset selloff. He cited several reasons why they are “reluctant to buy the dip” in those assets just yet. For starters, incoming economic data for February likely doesn’t capture the full extent of the epidemic to date and consensus earnings growth estimates may have to be lowered further.

“The V-recovery might not come to fruition if COVID-19 becomes truly global. Against this backdrop, recent Fed-speak hasn’t been particularly dovish,” Hale said, noting that the stakes will be high for coming Federal Open Market Committee meetings in March and April. A V-shaped recovery is one in which an economy sees a sharp economic pullback, followed by a quick and steady recovery.

“It will likely take a further tightening in financial conditions to force the Fed’s hand into acting,” he said. “We await signs of a policy response to pull the trigger on risk.”

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