Goldman has a big worry heading into 2020 that could cause market turmoil

GS: Goldman Sachs at the NYSE 100427
Financial professionals sit in the Goldman Sachs booth on the floor of the New York Stock Exchange.
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Goldman Sachs is bullish on equities next year, predicting a 7% gain for the S&P 500, but one topic is raising questions among its clients and has the bank concerned about volatility and downside risk.

The investment firm highlighted a decline in stock buybacks as a risk to the market in its weekly note to clients. Goldman estimates that buybacks will be down 15% to $710 billion this year and will decline another 5% in 2020.

If share repurchases fall more than expected next year, it could lead to slower earnings per share growth and increased volatility. The demand created by buybacks has outpaced demand from other sources, such as mutual funds, since 2011, giving repurchases increased importance to the U.S. markets, according to Goldman.

“A significant decline in buybacks would dramatically shift the supply-demand structure for US equities,” the note said.

The note points to how stocks perform during blackout periods, when buybacks are prohibited, to show what could happen with fewer repurchases. Stocks see larger negative returns and greater realized volatility during these blackout periods.

Earnings per share growth has outpaced earnings growth by an average of 2.6% over the past 15 years for the median S&P 500 company, according to Goldman, a gap that may close if buybacks decrease. Buybacks reduce the share price count, thus boosting earnings per share.

Goldman also addressed other questions from its investors in the note, including defending its above-consensus estimate of U.S. GDP growth in part by pointing to the phase one trade deal between the US and China. The firm also explained why it is more confident in industrials than financials, highlighting strength among aerospace and defense companies.

The question about buybacks from clients got the longest and most concerning response, according to the note.

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