A May 8th report from Goldman Sachs Portfolio Strategy Research suggests that U.S. stock markets may trend up for the next few months as the economy rebounds, but are then likely to retrace when the Fed starts raising interest rates towards the end of the year.
In specific, GS analyst David J. Kostin and team project that the S&P 500 index will move up close to 3% from current levels to around 2150 by midsummer, but then back to 2100 by the end of the year “following Fed liftoff”.
Goldman Sachs agrees with Fed Chair Yellen that market valuations are “quite high”
Kostin and colleagues agree with Fed Chair Janet Yellen’s recent assessment that equity market valuations are “quite high.” They note that the S&P 500 trades at its highest P/E multiple in at least the past 40 years (17X), except for during the Tech bubble. The median stock is actually trading at 18x.
The GS analysts also go along with Yellen’s caveat that stock valuations are more reasonable in the context of the current very low bond yields. Bond yields have soared in the last couple of weeks, with US 10-year Treasuries rising more than 30 bp (1.9% to 2.2%), bringing them closer to the firm’s year-end 2015 projection of 2.5%. Of note, German Bunds skyrocketed over 40 bp (0.2% to 0.6%) in that same period. That said, the absolute level of yields is still quite low, and valuation approaches including the Fed Model and proprietary GS models argue that U.S. stocks are close to fair value.
GDP growth: U.S. economy rebounding
Last week’s jobs report “signaled the start of a rebound in US economic data”, according to Kostin et al. The GS team is still looking for around 3% GDP growth through the end of 2015. The headline 223k jobs added in April heralds the start of a rebound in the U.S. economy, which should continue with upcoming retail sales data in mid-May.
The GS analysts suggest that “growth tailwinds from the consumer and homebuilding will outweigh headwinds from the strong dollar and cuts to energy investment.”
They argue that low prices at the pump and ongoing labor market improvement will lead to a recovery in spending. They project 200,000 new jobs per month on average this quarter, with unemployment dropping to 5.4%. Homebuilding is also picking up steam in the spring building season, with single-family home starts up to 1.1 million units in the second quarter
The growth rebound could boost the S&P 500 to 2150 by late in the second quarter. Kostin and colleagues note that the S&P 500 typically returns 4% in quarters when GDP is moving up, which comes very close to their 3-month S&P 500 target of 2150.
Goldman Sachs recommends cyclicals
Finally, the GS report highlights that cyclical sectors typically outperform when the economy is accelerating, with Tech historically being the strongest sector. The team therefore recommends “an overweight in the Tech sector based on attractive growth, below-average valuation, and large cash return to shareholders. Consumer Discretionary also tends to outperform when GDP accelerates, and may be particularly sensitive now given our expectations that the consumer will drive the economic rebound.”