Why a Stock Market Crash Like 1987 Is Unlikely: Insights from Goldman Sachs

Last week, the S&P 500 Index (SPX) dropped 3.9% from its all-time high and continued to fall sharply on Monday, triggering concerns about a potential market correction of 10% or more, or even a bear market. In contrast, the largest decline in 2017 was just 2.8%, according to Goldman Sachs Group Inc. This recent downturn has led many of Goldman’s clients to wonder if a repeat of the 1987 stock market crash, known as Black Monday—when the Dow Jones Industrial Average (DJIA) plunged roughly 22% due to a flood of sell orders—is imminent. However, Goldman Sachs argues that these worries are exaggerated and highlights strong fundamental reasons to remain optimistic, as detailed in their latest U.S. Weekly Kickstart report.

Robust Economic Fundamentals

Goldman Sachs emphasizes that 2018 kicked off with accelerating GDP growth, rising commodity prices, and a weaker-than-expected U.S. dollar. These factors collectively contribute to upward revisions in corporate earnings forecasts. Moreover, the report points out that the gains in stock prices so far this year have been driven primarily by increasing earnings per share (EPS), partly fueled by corporate tax reform, rather than by expanding valuation multiples. Corporate stock buybacks and strong demand for equities from individual investors also support their bullish outlook, projecting the S&P 500 could reach 3,000—an 8.6% increase from Friday’s close. Their more conservative base case foresees the index at 2,850, representing a 3.2% rise.

2018 Versus 1987: A Clear Distinction

Since 1950, there have been 12 years when the S&P 500 rose by 5% or more in January, with 2018’s 5.7% gain included, according to Goldman Sachs. In those years, the median January increase was 7%, and the median gain for the remaining 11 months was 17%. The sole exception was 1987, which experienced a 10% decline from February through December. Goldman Sachs views 2018 as fundamentally different from 1987.

In 1987, the market was overheated due to expanding valuation multiples rather than rising earnings. The S&P 500 surged 13% in January and added another 20% by August before plunging 20% on Black Monday, October 19, 1987. Despite this, the index still closed the year with a modest 2% gain, Goldman notes.

The outlook for 2018 is distinct. Goldman expects the forward price-to-earnings (P/E) ratio on the S&P 500 to stay steady at 18 times EPS. Their optimistic target of 3,000 for the index is based solely on strong EPS growth expectations. They anticipate four Federal Reserve rate hikes in both 2018 and 2019, with the 10-Year U.S. Treasury yield reaching 3.0% by the end of 2018. Rising interest rates are expected to curb further expansion of equity valuation multiples.

Sector Highlights in January 2018

Analyzing sector performance in January 2018, when the S&P 500 rose 5.7%, Goldman found that the top performers were consumer discretionary (+8.2%), financials (+7.6%), and information technology (+7.6%). The laggards included utilities (-4.6%), real estate (-3.7%), and consumer staples (+1.1%). The rise in interest rates primarily pressured utilities and real estate sectors, which typically offer high dividend yields and act as bond substitutes for income-focused investors.

Factors Warranting Vigilance

Despite the positive outlook, Goldman Sachs advises caution. Consensus EPS estimates for 2018 may prove overly optimistic, potentially leading to sharp stock declines if companies miss analysts’ expectations. Additionally, the net EPS benefits from tax reform might be overstated, as tight labor markets could drive wage inflation and competitive pressures may force price reductions.

Furthermore, equity futures markets are showing their highest net long positions since 2007, the year the last bear market began, which could be a contrarian signal. Stock prices are also being supported by historically high margin debt levels. Goldman notes that the ratio of NYSE net margin debt to market capitalization is at its highest point since at least 1980.

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