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Goldman Sachs' Recession Call: Stocks Will Feel Reductions

Wednesday, 9 Jan 2008 | 11:54 AM ET

Goldman Sachs today joins a growing roster of Wall Street firms, who say the U.S. economy will fall into recession this year. Watch for more reductions in stock price and earnings forecasts to follow.

For example, Goldman equities analysts already made a round of cuts to estimates on communications, media and entertainment companies to go along with the recession view of the firm. Goldman's auto analysts this morning also said they were cutting all estimates, price targets on the auto sector to reflect a recession this year.

The Goldman call is important because, as we know, Goldman is widely followed and has been doing quite well for itself while other firms suffered in the subprime tsunami.

Goldman's chief U.S. economist Jan Hatzius issued the recession call this morning. In the note, he says the economy should contract modestly through late 2008, with a gradual recovery during 2009. The recession is likely to last two to three quarters and should be relatively mild by historical standards, he says.

"Over the past few months, we have become increasingly concerned the U.S. housing and credit market downturn would trigger not just a growth slowdown and substantial Fed easing -- our long standing view -- but also an outright recession," the note said. "The latest data suggest that recession has now arrived, or will very shortly."

Goldman forecasts real GDP will contract one percent in the second and third quarters and that unemployment will reach 6-1/4 percent by the end of the year. Hatzius sees a setback in corporate profits of about 7-1/2 percent on an after-tax basis. Goldman also expanded its forecast for the cumulative decline in nominal housing prices, to a 20 to 25 percent peak-to-trough from a previous forecast for a 15 percent drop.

The firm says though it is optimistic about the economy's longer-term prospects despite the recession view. Hatzius says in the note that many economists have turned more cautious about the longer-term growth outlook, but he expects that most of the recent weakness in productivity is cyclical and that real GDP can grow at close to a 3 percent trend rate without igniting inflation.

Whether there's a recession coming or not, these types of big Street calls can have an impact.

Here's an example of the potential ripple effect for stocks. Goldman this morning removed Tenneco from its conviction buy list and cut its price target on the stock while keeping a buy rating. Why? It says the change goes along with those broad estimate and price reductions it made across the auto sector because of the firm's recession call.

Goldman equities strategist David Kostin issued a note too this morning, saying investors should be extra defensive when recessions start. He basically reaffirmed some of his previous views but said investors should boost holdings in health care and consumer staples. He said those sectors tend to outperform during the first phase of recessions, along with energy, utilities and telecom. (interesting that the DJ utilities index made a new all time high yesterday) Cyclical consistently lag, he said.

Merrill Lynch economists made a recession call earlier this week, and Morgan Stanley reiterated its recession view Monday. Yet, Bear Stearns economist David Malpass said on "Squawk Box" this morning that he believes the economy will avoid recession.

And just yesterday we heard from National Bureau of Economic Research president Martin Feldstein who says there's no recession yet though there could be a downturn coming. (Feldstein and NBER are the official arbiters of whether there is a recession)

Today, Morgan analysts lowered price targets on Applied Materials and others in that sector to take into account a moderate U.S. recession and reduced expectations for global semiconductor capital expenditures.

Morgan Stanley's economists issued a note Monday, titled "Is Recession now in the Price?"

The economists say much of the recession news has been priced into Treasurys. But "Not so for U.S. equities: our strategy team expects a 10 percent decline from start-of-year prices. Nor is our expectation for slower growth abroad in the price, and we expect that eventually the dollar will strengthen and transatlantic spreads will reverse."

Risks to its view that the recession will be modest are the potential for higher energy and food prices that could result in stagflation. Also, consumers and business could pull back in an uncertain environment and deepen the downturn, Morgan economists said.

Questions? Comments? marketinsider@cnbc.com

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    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

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