Why Goldman Sachs Now Sees S&P 500 at 2,050

Goldman Sachs Group Inc. (NYSE: GS) is trading higher ahead of Tuesday’s earnings report. It turns out that one of the drivers may not just be solid results from Citigroup — it could be the firm’s strategist outlooks. Goldman Sachs has now become much more bullish on equities and on the S&P 500 Index.

After saying that equity valuations were lofty by almost all metrics ahead of the 2014 stock market rally, now the firm is calling for the S&P 500 Index to rise to 2,050.

The firm’s prior target was 1,900 for a year-end valuation, but we would be quick to point out that the S&P 500 Index is now at 1,977 after a nine-point gain. This also sounds high on a nominal basis, but it is really only a call that the S&P 500 will rise another 4% or so. The index had been up more than 6% year-to-date.

Goldman Sachs analyst David Kostin told clients that he is looking for the equity rally to continue, but he also warned that the trajectory of that rally would be shallow. Driving forces were listed as accelerating economic growth and rising earnings.

There is a warning here that we would caution readers about. Kostin is not looking for further price-to-earnings (P/E) ratio expansion. It is this P/E expansion on top of growth figures that has fueled the ongoing stock performance. Rate hikes ahead also remain a risk in the call.

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The most simple explanation of what P/E expansions means is a climate in which investors were willing to pay 15 times earnings and are suddenly willing to pay 17 times earnings.

Trailing P/E ratios now average 19 times earnings for the S&P 500, but of course that figure includes many of the key growth stocks trading much higher and value stocks trading much lower.

Before bashing Goldman Sachs too hard on this call, the reality is that the firm was not the least bullish going into 2014. Our full list of strategist outlooks going into the year showed that several firms were at 18,850 on the S&P 500 and the highest of the bulge bracket firms was J.P. Morgan up at 2,075.