Goldman Sachs David Kostin:
Slower economic growth in the US and China and a lower oil price than we previously assumed translate into a reduced profit forecast and a lower trajectory for US stocks. Our revised top-down 2015 S&P 500 EPS forecast of $109 (from $114) represents a 3% year/year decline. Our new 2016 EPS estimate of $120 (from $126) reflects annual growth of 10%. We expect S&P 500 will rise by 6% to our lowered year-end target of 2000. We expect S&P 500 will climb by 5% to 2100 in 2016. Focus on stocks with high US sales, firms returning cash to shareholders, and high quality stocks.
Some details:
We have lowered both our S&P 500 earnings estimates and price targets. The impetus for these reductions is that our models now incorporate a slower pace of economic activity in the US and China and a lower oil price than we had been previously assuming. We cut our 2015 EPS estimate by 4% to $109 and our year-end price forecast by 5% to 2000. Previously, we had assumed EPS of $114 and expected the index would climb to 2100 by the end of this year.
A lower path of profits is an obvious reason to lower a price target but the risks for the index level and P/E multiple have also increased. In 2016, we expect US GDP will rise by just 2.4% and the world ex-US will expand at 3.7%, down from our prior assumptions of 2.8% and 4.3%, respectively. China is growing much slower than we previously assumed. Our CAI suggests economic growth is about 100 bp slower than the official GDP data indicates.
We expect the Fed will begin its long-awaited tightening process this December. Historically, rising short-term interest rates have been associated with declining P/E multiples. We expect the Treasury curve to bear flatten as short-rates rise at a faster pace than ten-year note yields during the next few years. Rising bond yields are consistent with lower multiples. Using our estimates, the P/E will slide from 16.4x today to 16.1x by 2017.
Finally, the political landscape in Washington, DC remains unstable following the resignation of Speaker Boehner. The federal debt ceiling will be reached in November. Precedent suggests raising the debt limit will be contentious and may rattle investors.
Our baseline forecast is that the US economy will grow at a modest pace, earnings will rise, and the S&P 500 index will climb slowly while the P/E multiple declines as interest rates rise (see Exhibit 2). “Flat is the new up” will be the 2016 investor refrain.
