As usual, Goldman saves the best for last. From David Kostin: "We are cutting our year-end 2011 price target for the S&P 500 to 1250 from 1400. Our new target reflects a potential return of 5% from the current index level. Our revised price target reflects the heightened uncertainty that characterizes global equity markets today. Our earnings, dividend, and economics forecasts remain unchanged. The unstable macro environment appears likely to persist for the foreseeable future. Downside risk exists to our forecast if the European sovereign debt crisis deteriorates while upside exists if substantial progress is made in addressing the problem." And since Goldman is leaving its S&P EPS forecast untouched, this is merely a contraction in the multiple from 14 to 12.5. Now if one assumes that David Rosenberg, who earlier speculated that the real S&P EPS is closer to 75 than 96, is correct, and applies the revised Goldman multiple, that means that the S&P has about 400 points of downside. Of course all of this means that one can predict the future. Which is impossible. Which leads us to believe that today's firing of David Bianco was merely due to him refusing to play along with the revised script. Which is as follows: the banks are buying everything that their clients have to sell in advance of, you guessed QE3 in the US and more QE in the UK, Europe and Japan for one last record bonus hurrah. While we can only hope we are wrong, if we are right this means the short squeeze on the market is about to slam shut and Goldman will make out like a bandit as usual, with the S&P soaring several hundred points on ever worse macroeconomic and geopolitcal data.
What has changed: A higher discount rate in our valuation model
Ten-year US Treasury yields have plunged by 100 bp to 2% since late July while the equity risk premium (ERP) increased as the European debt crisis threatened the tenuous US growth outlook. The cost of equity discount rate for our DDM rose by 40 bp to 8.7%. Every 10 bp rise in the cost of equity reduces our S&P 500 DDM-implied fair value estimate by about 30 points.
What has not changed: Earnings, dividends, and economic outlook
We continue to estimate S&P 500 operating EPS will hit a new record high of $96 in 2011 and rise by 6% to $102 in 2012. Goldman Sachs Economics forecasts 2.0% GDP growth in 2012 and only a 1 in 3 chance of a recession.
Our uncertainty-based valuation approach suggests downside risk
Our model incorporates four observable measures of market uncertainty and suggests a year-end 2011 P/E range of 9.2X-11.4X or 1025-1275. The 10.3X midpoint implies a year-end index level of 1150, 3% below today.