Goldman Sachs issues stock forecasts for next year

After reaching a record high on July 16, the stock market, as measured by the S&P 500 index, stagnated.

So the big question on investors’ minds is where stocks are headed from here. It’s easy to make a case on either the bullish or bearish side.

The Bulls cite the wins to support their case. Earnings per share for the S&P 500 rose 11.3 percent in the second quarter from a year earlier, according to FactSet. While analysts expect earnings growth to fall to 4.9% in the third quarter, that’s still a respectable number.

Goldman Sachs is one of the top two investment banks in the US, along with Morgan Stanley.

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But bears say that, with economic growth slowing, that’s an overstatement. GDP grew by an annualized 1.4% in the second quarter, slowing from 3% in the first.

To be sure, the bulls are quick to point out that the Federal Reserve Bank of Atlanta’s forecast model shows economic growth returning to 3% this quarter.

In any case, bears argue that the stock is overvalued after the S&P 500’s 26% gain over the past 12 months.

As of Sept. 13, the S&P 500 was trading at 20.9 times analysts’ 12-month earnings estimates for its constituent companies. This is well above the five-year average of 19.4 and the 10-year average of 18.0.

Impact of Fed rate cuts on stocks

Meanwhile, investor views are mixed on what a Sept. 18 interest rate cut by the Federal Reserve would mean for stocks. Some experts expect the Fed to cut rates by 25 basis points (a quarter of a percentage point) and others by 50 basis points (half a percentage point).

You could argue that a smaller cut is good for stocks because it shows the Fed doesn’t think the economy is in big trouble.

Related: Former Fed official reveals bold Fed rate forecast for this week

Or you could argue that it’s bad for stocks because a smaller discount will stimulate the economy less, thus boosting earnings less.

As for a bigger rate cut, you could argue that it’s good for stocks because it will lift the economy more. Or you could argue that it’s bad for stocks because it indicates that the Fed thinks the economy is in danger of recession.

Goldman Sachs sees a quarter point Fed rate cut

Goldman Sachs strategists are slightly bullish on the stock. Investors have recently abandoned mega-cap tech stocks in favor of neglected sectors such as consumer staples and real estate, they note.

This “reflects a downgrade in the market’s outlook for economic growth,” they wrote in a commentary. “But the prospect of Fed easing has left the S&P 500 near an all-time high. The S&P 500 settled at 5,628 on Tuesday, down less than 1% from its July 16 record close of 5,667.

Related: Top Research Firm Unveils Stock Market Forecast for Q4

Goldman economists expect the Fed to cut rates by 25 basis points on Wednesday and forecast 200 basis points of easing by the first quarter of 2026.

“But the trajectory of (economic) growth is a more important driver for stocks than the speed of rate cuts,” strategists said.

Goldman Sachs S&P 500 Forecast ‘Higher’

They addressed several different scenarios for actions. “If the market prices the Fed lower because the economy is proving resilient, stocks will rise despite higher bond yields,” Goldman Sachs said.

Higher yields often hurt stocks because they tend to depress economic growth and make bonds more competitive with stocks as an investment.

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“Conversely, if the market prices further Fed cuts because economic data worsens, stocks will struggle even as bond yields fall,” strategists said. Falling yields tend to support stocks as they boost earnings.

The bottom line is: “With (price-earnings) multiples standing, earnings growth will drive the S&P 500 modestly higher,” they said.

Goldman strategists expect the S&P 500 to end the year at 5,600. They have a six-month goal of 5,700 and a 12-month goal of 6,000. The latter represents a 7% gain from Tuesday’s level.

Related: The Veteran Fund Manager Who Correctly Estimated the Outlook for Stocks’ Downgrade