The U.S. stock market has shown strong resilience over the past few months outplaying lofty valuation concerns and global turmoil following geopolitical tensions in Russia, Ukraine and Iraq, sluggish Euro zone recovery and stability in China. This is especially thanks to an accelerated job market, regained housing market momentum and stepped-up economic activities after the first-quarter slowdown.
Further, renewed tensions between Ukraine and Russia due to fresh sanctions by the West, and the crackdown of a Malaysian Airlines jetliner near the Russian/Ukrainian border appear to only be temporary setbacks. The stock market has already endured such threats a number of times this year (read: Russian Sanctions and Malaysian Plane Crash Put These ETFs in Focus).
Given bullish fundamentals and growing optimism, a New York-based research firm, Goldman Sachs (NYSE: GS), lifted its expectation for equity returns. The S&P 500 index is expected to climb to 2,050 by the end of 2014 from the previous projection of 1,900. This represents a modest 3.6% gain from the close of the last trading session. Most of the gains will likely come from strong earnings, which is expected to grow 8% annually.
According to David Kostin at GS, the equity rally will be at the shallow pace. Though domestic economic growth is improving and earnings will continue to rise, the market expectation for the Fed hike within 12 months could limit the P/E multiple expansion. The S&P 500 index currently trades at 15.5 times the forward 12-month earnings, much higher than the 5-year and 10-year historical averages of 13.5 and 14.1 but below the loft days of the tech bubble in the late 90s.
Further, the U.S. equity market also appears attractively valued when compared to bond markets. This is especially true as the fixed income strategists at GS lowered the 10-year Treasury yield forecast by 25 bps to 3% on improving economy that could lead to interest rate hike in the third quarter of next year.
In fact, Kostin expects “lower valuation stocks and those with weak balance sheets, low returns on capital ...
More...