Goldman Sachs now sees the benchmark S&P 500 index ending the year at 3,100, above its previous target of 3,000, according to a research note published Monday night.
David Kostin, the bank’s chief U.S. equity analyst raised his target for the S&P 500 stock index SPX, -0.30% despite lowering his estimate for 2019 earnings-per-share growth from its November estimate of 6% to 3% today, resulting in a higher expected price-to-earnings ratio.
“Our target implies a 3% appreciation through year-end 2019, implying a 24% fully year-gain,” Kostin wrote. “Valuation models have expanded by 22% year-to-date, and the S&P 500 trades at roughly fair value relative to interest rates and profitability.”
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Goldman analysts now predicts the S&P 500 forward price-to-earnings multiple will end the year at 17.6 times earnings a marked increase from the 16 times predicted in their 2019 outlook published in November.
The bank’s economist see Federal Reserve policy as a key driver of higher valuations, as they earlier predicted the Fed would raise interest rates 100 basis points in 2019, but now see the fed funds rate ending the year 50 basis points lower.
“The dovish Fed pivot has driven the equity market rally in 2019, and we expect low interest rates will continue to support above-average valuations going forward,” Kostin wrote. But he does not expect Federal Reserve policy to be a major driver of stocks in the immediate month ahead, given his belief that the Fed will institute 35 basis points of rate cuts in 2020, versus market expectations for a 65 basis-point.
“Historically as the market has priced less Fed easing, equity valuations have compressed,” Kostin wrote, but added that “our valuation model implies the price-to-earnings valuation remains stable at 17.6 in 2019 as the Fed ultimately becomes more dovish than the market currently expects, but economic growth reaccelerates to affirm investor confidence in the expansion.”
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Kostin’s faith in the resilience of the current economic expansion led him to announce a 2020 year-end price target of 3400, or a gain of 10%, through a combination of 6% earnings-per-share growth and a multiple expansion to 18.4 times earnings, “as elevated policy uncertainty is more than offset by the tailwind from continued economic expansion.”
Nevertheless, Kostin said that policy uncertainty is the single biggest risk to stocks in the coming quarters, and as events unfold in the 2020 U.S. election process and during U.S.-China trade negotiations, they could pose a greater risk to S&P 500 valuations than he currently expects. If the U.S. or China imposes new trade barriers, if the Department of Justice’s antitrust investigation into large tech firms gains steam or if a Democratic party sweep of the White House and Congress appears more likely, each could materially reduce equity prices.
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