Goldman Sachs Group Inc (NYSE:GS) believes with the S&P 500 near 1865 “the market stands within a band of fair value,” while Goldman’s heavily watched “Hedge Fund VIP List” of stock selections continue to underperform.

Going forward, the legendary investment banks sees more room on the downside than upside, but is ultimately positive. “Looking forward, S&P 500 should rise as the economy strengthens and sales and EPS grow,” they said in their weekly “Kickstarter” portfolio strategy research report. “However, our forecast trajectory is relatively shallow: our 12-month target of 1950 reflects 5% upside, with 13% upside through year-end 2015.”

Goldman Sachs VIP list tumbles while stock picking becomes more difficult

Goldman Sachs

Looking at the late March slide in stocks, Goldman Sachs Group Inc (NYSE:GS) noted the selloff was concentrated in just two areas: stocks with expected high sales growth and firms with high sales multiples relative to earnings, a speculative group.  This included social media, internet and biotechnology firms.  Stocks in this group, which Goldman anointed as “stocks that matter most to hedge fund performance,” otherwise known as the “Hedge Fund VIP List,” took a tumble last month, dropping 2% in March after outperforming in February.  The report noted that low valuation stocks should continue to outperform high growth, high multiple counterparts if GDP growth accelerates towards 3%, as they expect.

Noting the difficulty in stock picking, Goldman Sachs Group Inc (NYSE:GS) says that contrary to popular opinion, “stock return dispersion has been extremely low during the past one and three months. Dispersion has been unusually low in Consumer Discretionary and Info Tech,” the letter said. “Stock picking is always challenging. Low dispersion means it has been more difficult than usual. Only 42% of core mutual funds is beating benchmarks.”

GS kickstart 4 7 2014 buybacks

The best reason Goldman Sachs Group Inc (NYSE:GS) could think of for owning stocks was the absence of credible investor choice.  “The lack of attractive alternatives to owning stocks is the most persuasive argument for why S&P 500 will continue to rally,” a headline in the letter proclaimed. Noting that only 37% of equity inflows went to US stocks, Goldman turned to Fed policy.  “The Fed is on pace to conclude tapering in 4Q but maintain a ZIRP at least through early 2015 (our economists project early 2016). We forecast Treasury yields will end 2014 at 3.25%,” an aggressive forecast, Goldman says, noting “at a recent conference with our largest institutional investors, not one person expected yields to reach that level this year.”

GS kickstart 4 7 2014 6 charts

Recommendation for growth-oriented strategy with high operating leverage

The “intuition” of the investment bank is to see a “slight pick-up in economic activity will lift sales and disproportionately benefit earnings compared with low or average operating leverage firms,” the report said. “This strategy ultimately depends on positive earnings revisions rather than continued P/E expansion from already-high starting levels.”  The letter said examples of such stocks include Bristol-Myers Squibb Co (NYSE:BMY), EOG Resources Inc(NYSE:EOG), and Autodesk, Inc.(NASDAQ:ADSK), while firms returning cash to investors through buybacks include Pfizer Inc.(NYSE:PFE), Cisco Systems, Inc.(NASDAQ:CSCO), Viacom, Inc.(NASDAQ:VIAB), Halliburton Company(NYSE:HAL), and Northrop Grumman Corporation (NYSE:NOC).