Given the end of the mandatory pause in corporate buybacks prior to earnings reports that removes a key source of equity demand, Goldman Sachs analysts anticipate S&P 500 will rally to touch their year-end 2014 target of 2050.
David J. Kostin and the team at Goldman Sachs in their recent research report titled: “US Weekly Kickstart” point out that the drivers of this upward move relate to positioning, sentiment and historical trading patterns.
Buybacks set to resume
According to the Goldman Sachs analysts, most companies are precluded from engaging in open-market stock repurchases during the five weeks before releasing earnings. Interestingly, for several firms, the beginning of the blackout period coincided with the S&P 500 peak of September 18. Thus, the sell-off occurred during a time when the single largest source of equity demand was absent.
Seth Klarman Tells His Investors: Central Banks Are Treating Investors Like “Foolish Children”
"Surreal doesn't even begin to describe this moment," Seth Klarman noted in his second-quarter letter to the Baupost Group investors. Commenting on the market developments over the past six months, the value investor stated that events, which would typically occur over an extended time frame, had been compressed into just a few months. He noted Read More
As can be deduced from the following graph, over 75% of S&P 500 constituents will have reported third-quarter results by the end of October and will then be able to resume buybacks. The Goldman Sachs analysts anticipate companies to actively pursue repurchase of shares in November and December.
As set forth in the following graph, buybacks typically slow in earnings months and would rise in late fourth-quarter. Since 2007, an 25% of annual buybacks have occurred during the last two months of the year:
S&P 500 will rally 14%
David J. Kostin and team at Goldman Sachs remain confident in the fundamentals of U.S. growth and believe the S&P 500 will rally 14% to 2150 over 12 months. As U.S. real GDP expands above 3%, the analysts reiterate their forecast for S&P 500 EPS to grow by 8% in 2015. The analysts anticipate steady U.S. growth and low interest will keep valuations stable, implying that market levels should rise in line with earnings.
The following chart captures S&P 500 level and Goldman’s EPS forecast:
The Goldman Sachs analysts anticipate repurchase resumption should help support stocks during the balance of the fourth-quarter.
The following table depicts Goldman’s newly re-balanced buyback basket:
The following table sets forth the analysts’ total cash return to shareholders basket:
The Goldman Sachs analysts point out that the companies in the above two baskets should benefit from an EPS boost as share counts shrink, and be rewarded by investors seeking yield in a low growth, low interest rate environment.
The GS team also highlight that their baskets have been effective long-term strategies. For instance, since 1995, their buyback basket has outperformed S&P 500 by an annualized 500 bps. The analysts anticipate the baskets to post similar growth to the S&P 500, with superior yield, at a valuation discount.