The Goldman Sachs mid-year price target of 1300 on the S&P didn’t quite pan out, but they’re not giving up that easily. They still believe their framework for the market will lead to 1300 by year-end:
1. Economy: The US economy remains in a fragile state
- GS Economics forecasts sluggish recovery, high unemployment in 2010, and no Fed rate hike until 2012.
- Benefit of inventory re-stocking and fiscal stimulus ends in the middle of 2010.
- Excess capacity will affect inflation, interest rates, margins, and capex.
- Federal and State fiscal imbalances are key risks; solutions will involve higher taxes and fewer benefits.
2. Earnings: Our S&P 500 operating EPS estimates are $78 for 2010 and $93 for 2011
- Focus on $83 of pre-provision EPS in 2010 (+15%) and $93 in 2011 (+12%).
- We forecast S&P 500 operating EPS will reach 102% of prior peak in 2011.
- Net profit margins troughed in 2009 at much higher level than in prior cycles, accelerating earnings recovery.
- EPS forecast in 2011 does not imply a new S&P 500 price level peak.
3. Valuation: Our year-end 2010 DDM fair value estimate of 1250 implies 13.5x NTM EPS
- Our 3-month, 6-month, and 12-month S&P 500 targets equal 1160 (+5%), 1250 (+13%) and 1300 (+18%).
- P/E typically remains flat during the second year of recovery; equity returns are a function of EPS growth.
- S&P 500 is 60% above March 2009 low and trades below our year-end 2010 DDM fair value of 1250.
- Recent sell-off is fifth decline of 5%+ since rally stalled, consistent with pattern of past bear market recessions.
4. Money flows: An improving back-drop for stock investors in 2010
- We estimate $600 billion of potential flows into the US equity market.
- Individuals: $350 billion potential re-allocation to risky assets from money market funds and savings deposits.
- Institutions: $150 billion from hedge funds and foreign investors.
- Corporations: $100 billion net flows from buybacks, M&A, and pension contributions, less equity issuance.
In terms of allocations they favor the following: