Goldman Sachs analysts have increased their 2014 year-end and 12-month price targets for the S&P 500 (INDEXSP:.INX). They raised their year-end price target from $1,900 to $2,050 and their 12-month target to $2,075. Those numbers reflect 4% and 6% returns, respectively.

S&P 500’s performance

In a report dated July 11, 2014, analysts David J. Kostin, Stuart Kaiser, Amanda Schneider and Ben Snider note that the S&P 500 fell by 1% last week. Utilities were the best-performing sector with a 1.5% increase. Industrials were the worst-performing, at -1.8%.

They sat most of this year’s 7% gains are due to growth in earnings. They add that multiple expansion has made up just a small amount of the increase. In contrast, they note that last year, price to earnings ratio expansion made up almost 75% of the full year’s 32% return. Earnings per share growth made up only a small part.

Upcoming earnings for the S&P 500

The analysts’ top-down earnings per share forecast for 2014 is $116, while it’s $125 for 2015, with both of those numbers reflecting 8% growth. They’re slightly lower than consensus estimates, which project a 9% increase this year to $117 and a 12% next year to $131.

Currently the S&P 500 trades at 16.1 times forward 12-month consensus earnings per share and 16.5 times their top-down forecast. They point out that the high price to earnings multiple matches record high profit margins, which have been close to 8.9% for the last three years. They say the only time the index traded at a higher multiple was during the tech bubble between 1997 and 2000.

U.S. stocks look attractive

In addition, they say the index trades at a EV / sales and EV / EBITDA multiples compared to history. They say the “cyclically-adjusted price to earnings ratio suggests that the S&P 500 is now overvalued by between 30% and 45% compared to the average ratio since 1928. Nonetheless, the Goldman Sachs team says U.S. equities look attractively valued when compared to bond yields. The firm lowered its year-end 2014 bond yield projection 25 basis points to 3%.

“If the yield gap converges from the current 370 bp to 300 bp by year-end 2014 (midpoint between the trailing 10- and 20-year averages) the Fed Model would imply a year-end 2014 S&P 500 fair-value of 2080, roughly 5% above the current level,” the analysts wrote.

S&P 500

S&P 500 borrows from the future

The analysts also note a 43% increase in U.S. equities over the last 18 months. However, they say this massive return has “borrowed heavily from the future.” Nonetheless, they expect the rally to keep going but that the trajectory of it will be shallow. They point out that domestic economic growth is speeding up and that earnings will probably keep rising. They don’t expect more expansion in price to earnings multiples because of expectations that the Federal Reserve will raise interest rates within the next 12 months.

S&P 500 Fed Rate hike

They believe “low valuation” stocks will outperform others before the equities market tightens next year. They also expect “low quality” stocks to outperform while improvement in the economy continues.

“Our Micro Equity Factors indicate stocks with weak balance sheets, low returns on capital, low margins, and high volatility have outpaced their “high quality” peers since early 2013,” the Goldman Sachs team wrote.

S&P 500 stocks

S&P 500 weekly balance sheet