Goldman Sachs May Be Right — Stocks Getting Overvalued

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It is fairly hard to argue that the stock market is in a bubble if you been through real bubbles before, but it is still fair to question valuations at this time. The gains seen in November and December of 2013 have almost certainly eaten into what should have been the stock market gains of 2014. So what happens when investors realize that Goldman Sachs Group Inc. (NYSE: GS) is calling market valuations being too lofty?

For starters, stocks have sold off on the report. Investors know this quite well, and we would like to remind our readers – Goldman Sachs only advises the wealthy retail investors and many of the institutional investors.

Goldman Sachs’s David Kostin sent a note calling the S&P 500 Index lofty by any measure. This was true of current and forward P/E ratios and many other metrics used by investors to value stocks. Where this gets scary is that the firm hinted that stocks could be 30% to 45% overvalued by some metrics.

While we do not agree at all that stocks are 30% or 45% overvalued, the reality is that when we ran our year-end outlook for the Dow Jones Industrial Average we found that 8 of the 30 DJIA stocks were trading above what analysts considered to be above fair value. Only one of the 30 DJIA stocks was trading above the consensus fair value in the annual outlook a year ago.

We have also covered in an evergreen note, five ways that hedge funds brace for market selloffs.

The warning from Goldman Sachs is one that goes against what true stock market bulls have been touting for more than a year: earnings multiple expansion! That means that for investors to chase stocks up above 17-times earnings companies will actually have to grow their earnings more. In short, raw company performance will be more of a driver than what investors are willing to pay for that performance.

Before you panic, Goldman Sachs has warned of the possibilities of a correction before. Ultimately the firm is still bullish. Goldman Sachs has a S&P 500 Index strategist target of 1,900 for 2014, followed by 2,100 in 2015 and ultimately 2,200 in 2016.

Here are the other strategist reports for S&P 500 Index price predictions for 2014 and beyond:

  • Deutsche Bank is at 1850 for 2014 and 2000 for 2015.
  • Stifel Nicolaus is at 1,850 for 2014 – no sector outlook picks from this firm reported.
  • Wells Fargo is at 1,850 for 2014 – no sector picks for 2014.
  • Barclays has set a target of 1,900 for 2014 based upon $119 in earnings per share – no broad sector picks covered.
  • Citigroup has set a 1,900 target with earnings roughly of $117.50 per share – no major sector picks covered by us.
  • BlackRock has set 1,920 as the target with $120 in EPS – this is a management firm, so picks are different.
  • Goldman Sachs is at 1,900 for 2014 with earnings of $116 per share. The firm made many key changes to its Conviction Buy List for 2014.
  • BofA Merrill Lynch has set a target of 2,000 based upon earnings of $118 per share.
  • Morgan Stanley has set a target of 2,014 in 2014 based upon earnings per share of $116 – no broad sector picks tracked.
  • J.P. Morgan has set a target of 2,075 with earnings of $120 per share.
  • Ned Davis Research was the standout bear here, but only temporarily. The firm called for a 20 percent market correction. The good news is that the team expects a snapback rally from there from a great buying opportunity.