Goldman Sachs contends the
can hit 4300 by the end of 2021 as a vaccine proves more important than the election.
The index has risen 9.2% since Oct. 30, in a rally led by value stocks over growth. Investors have recently gotten a jolt of optimism that a Covid-19 vaccine will be ready for use this year and widely distributed throughout 2021. The economic recovery has had momentum, even though there hasn’t been a second fiscal-stimulus bill out of Congress. Companies have beaten third-quarter earnings estimates handily, with earnings falling just 8% year-over-year, according to FactSet estimates, against expectations of a 20% decline at the beginning of the reporting season.
Indeed, “stronger-than-expected [third-quarter] results lead us to raise our S&P EPS forecasts,” chief U.S. equity strategist David Kostin wrote in a note. He raised his 2021 earnings-per-share forecast to $175 from $170 and, more important, his 2022 estimate to $195 per share from $188. Underpinning those assumptions are at least one vaccine becoming widely available in the U.S., less drastic changes in policy because Congress is most likely to be divided, and the continued V-shaped economic recovery.
The reason the 2022 estimate is important is because, by the end of 2021, the market will be pricing in 2022 earnings and using Kostin’s target earnings multiple by that time of 22 times gets close to a 4300 target for the S&P 500.
The average multiple on the index now is at a touch below 22 times, but Kostin thinks the multiple can reach his target and sit there for the foreseeable future, as investors demand a lower-risk premium for being in stocks versus safe Treasuries. That pushes the price of stocks up.
Recently, the risk premium on stocks has shrunk a bit. Before the election, the earnings yield on the S&P 500 was about 3.9% higher than the 10-Year Treasury yield. Now, that risk premium is just above 3.5%, which is an excess return over Treasuries that Kostin thinks investors are willing to accept going forward if the pandemic risks begin to fade.
His research also shows that as economic policy uncertainty rises and falls, so does the risk premium in stocks, reflecting that investors take more risk when policy is predictable.
One factor holding valuations back will be rising interest rates, but Kostin sees that as limited, given that the Federal Reserve is committed to keeping the benchmark lending rate near 0% for the next few years.
Beyond 2021, Kostin, like many others, expects U.S. GDP growth to run at less than 3% and with interest rates unable to fall much from here, gains will have to come from organic economic growth.
Stock gains have more juice left in the tank, but that may not last so long.