Goldman Sachs says that we are now looking at a ‘regime change’ from steadily rising EPS and PE multiples supercharging market returns over the few years to falling PE for the next couple of years as earnings get a chance to catch up with stock prices. Never ones to be too negative, they point out that slipping PE multiples means that the market will also have better upside potential.

“The drivers of equity returns during the next few years will be reversed: a 10% P/E contraction as the yield curve normalizes but the trajectory of future earnings is much less clear given the range of possible macro scenarios,” write Goldman Sachs analysts David Kostin, Amanda Sneider, and Ben Snider. “We expect during the next four years the P/E multiple will slip by 1-2 points to 15x while investors debate the level of forward earnings given uncertainty around global growth, Fed policy, commodities, and FX.”

Goldman Sachs PE S&P 500 pe 1214

S&P 500: Lower interest rates, oil prices both offer some upside

Goldman Sachs’ baseline is that the S&P 500 reaches 2100 and 2200 in 2015 and 2016 respectively, assuming the US has 3% GDP growth and that the Fed funds rate rises to 1.6% and 10 year yields rise to 3.5% by the end of 2016. The analysts also assume that Brent crude will average $84 in 2015 and $90 in 2016, partly based on previous rebounds from 60%+ drops in the past few decades. The upside in their forecast comes from the possibility that the Fed keeps rates low or that oil prices don’t rebound, either of which they believe would be net beneficial for the economy (or for asset prices at least).

Goldman Sachs PE S&P 500  oil drops 1214

Health care, utilities had best returns in 2014

With the year almost over, health care and utilities had the best returns in 2014, while Brent crude unsurprisingly take the last spot and the energy sector only a few notches above. Cheap oil is supposed to give consumer discretionary a boost, but it certainly hasn’t shown up yet. Consumer staples, on the other hand, had a solid year.

Goldman Sachs PE S&P 500  ytd returns 1214

Surprisingly, Goldman Sachs’ sentiment indicator is sky-high just a few months after it plummeted below 10%. It’s hard to know whether people are counting on cheap oil driving the economy, or if people are betting on a rebound from recent lows.

Goldman Sachs PE S&P 500  projections 1214