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Goldman Sachs analysts cautiously optimistic on US equities

The analysts expect the S&P 500 to rise over the next two years but warn a US recession is likely
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Goldman says piling into financial stocks is a good idea

Goldman Sachs analysts are bullish on US equities, but they are shaking up their sector recommendations on the view that a US recession is likely, according to a new research report.

Today, the US economy and equities look healthy, but in the coming years, the picture could worsen, the Goldman analysts wrote.

Goldman's take is that while the US economy and corporate profits are blossoming, and stock prices should still climb next year, any progress will be clipped by the tightening of monetary policy, a flattening yield curve, mid-term Congressional elections and international trade tensions.

“The appreciation potential will be constrained,” wrote Goldman analysts.

In today’s conditions of “above-trend economic growth” and rising interest rates, cyclical stocks should continue to outperform defensive stocks. As a result, Goldman is reiterating its Overweight position in financials, a key cyclical sector.

“The sector should benefit when the Fed’s Comprehensive Capital Analysis and Review test results are released this month,” the new report states. “Our analyst expects banks will boost capital returned to shareholders via buybacks and dividends by 21%.”

Goldman is also lifting its position on Information Technology stocks to Overweight from Neutral. The analysts’ take is that technology stocks will see the “fastest sales and earnings growth” through 2019 and the sector will reap the benefits in the “current late-cycle environment.”

While Goldman is bullish on certain sectors, it remains bearish on industrials and its analysts are paring back their position in the sector to Neutral from Overweight given the decelerating economic growth and rising “input” costs.

S&P 500 

Goldman analysts expect a modest 3% rise in the S&P 500 this year to its year-end target of 2850 followed by a 5% gain in 2019 to 3,000. It’s also raising its S&P 500 earnings-per-share estimates to US$159 this year (from US$150); US$170 in 2019 (from US$158); and US$178 in 2020 (from US$163).

The economic and profit growth environment is unlikely to improve from the current situation, according to Goldman. Margins are at record high levels, aided by US tax reforms. A tight labor market is pushing up wages and tariffs may add to pressure on the cost of imports. “Margin compression is a risk,” according to the report. “Our economists’ model forecast does not include a recession during the next three years, but risks of a downturn will increase over time.”

The last six months have been challenging for most equity portfolio managers, Goldman points out. With an average year-to-date return of 3.5%, only 36% of large-cap core mutual fund managers are beating the S&P 500’s 4.3% total return.

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